Critically Assess Failures Of Financial Institutions Accounting Essay

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Global Economies are going through a deepening financial crisis due to banking failures. Bank failures in the last twelve months has risen to 106, but still fall short of the 181 that collapsed in 1992 at the end of the savings and loans crisis, bank failures have cost the F.D.I.C (Federal Deposit Insurance Corporation) a whopping $25billion this year and are expected to cost $100billion through the next five years (Marcy Gordon AP Business October 2009). This essay hopes to assess the themes of representation, control and accountability with particular emphasis on the recent financial turmoil and raise the question: where the banks accountable? Where were the accountants? What type of representation was provided in the financial statements? And what form of control existed?

Sanders Hatfield and Moore (1938, p.4) stated that the function of accounting was to prepare statements to satisfy "the need for information of all the parties in interest, especially management of the business, investors, creditors and government in such matter as taxation and regulation". In a lay mans terms understandable information for everyone to use. Accounting creates a self image that is neutral to the set of techniques which passively and objectively record and represent actions of organizations and individuals.

Ijiri (1975) suggests that to account for a consequence e.g. cash balance, cash receipts and disbursements means to show the evidence that produced the result. The firm or manager must present documents that show how a financial transaction was transacted. The American Institute of accountants committee on terminology defined accounting as the act of recording classifying and summarizing in a significant manner; in terms of money, transactions and events. The classification leads to a financial character i.e. financial statement which in turn leads to results (Cited in Grady 1965 p.2). These results thus complete the process of accountability. The sociological definition of accountability states that accountability denotes the exchange of reasons for conduct, i.e. to give an account or provide reasons for one's behaviour, to explain and justify what one did or did not do. Such accounts are provided in order to render behaviour intelligible and to ''prevent conflicts from arising by verbally bridging the gap between action and expectation" (Scott & Lyman, 1968, p. 46). Accounting needs to be complemented with a situation-specific sensitivity for the ''particular other whose interests and values cannot be appropriately accounted for by a system of general rules or principles" (e.g. Lehman, 1999; Roberts, 2003; Shearer, 2002). Ijiri (1975, p.33) was of the view that current accounting practice can be better interpreted if we view accountability as an underlying goal. He explained further that unless accounting is viewed in this manner, much of current practice would appear to be inconsistent and irrational. The need for consistency in accounting is emphasised because an alteration or change in the accounting information can be catastrophic.

Accountability is limited by the opaque nature of a person's experiences and practical engagements, this experience and engagements must definitely be accounted for, so future events can rely on them for guidance and reference. Several authors have suggested that accountability may be achieved through social and environmental reporting practices (e.g. Gray, 2002; Shearer, 2002; Unerman & Bennett, 2004). But other writers are of the view that it ''needs to get beyond the constraints" (McKernan & MacLullich, 2004, p. 345). Accountability should not just be a process of checking credit and debit in a transaction, but it should be able to offer advice and direction. Butler (2001, 2004, 2005) argues that the accountable self is vulnerable to accountability insofar as it is an opaque self that cannot account for everything it has lived through; an exposed self that experiences accountability as an intrusion into its own practice; and a mediated self whose accounts have to rely on a medium that is not of its own making. The vulnerability of the accountable self implies that there are limits to accountability as an ethical practice (Sinclair 1995, p. 221).

Accounting should move from the conventional view of accounting for-the-self to an accounting for-the other. As a consequence, any conception of accountability needs to acknowledge this priority of the other, because the ''motive for being accountable is never simple" (Schweiker 1993 p. 245). To be accountable means to be accountable to someone else, and to reduce the notion of accountability to the justification of one's own actions for one's own sake is to misconstrue accountability as this makes the individual feel purely guided by their self-interests and unaccountable to just a comprehensive social good.

Accountability can further be broken down into two ideal forms; hierarchical and socializing forms of accountability; hierarchical form of accountability, in which individuals take for granted that their value and worth depends upon their position within the organizational hierarchy. In striving for acceptance and recognition, individuals are forced into conformity with the standards of utility upon which 'success' depends, while the socialising form of accountability means relation to others is characterized by a quest for mutual understanding which goes beyond giving and demanding of accounts through formal categories, as provided by accounting. Socializing forms of accountability thus foster a recognition of the self and of others that is free from distortion by any imposed formal definitions of the situation. "By seeking accountability we recognize the obligation to the others" (Shearer, 2002 p 570).

The impact of lack of accountability is severe, as this creates room for corruption and lack of economic development, For example the current global financial crisis due to lack of accountability has cost, "the US government nearly $8.5 trillion, around 60% of its gross domestic product, to arrest the collapse of its financial system" (San Francisco Chronicle, 26 November, 2008). The European Central Bank has "provided around €467 billion to support banks, Germany has set aside over US$400 billion to bailout ailing banks" (Wall Street Journal, 11 October, 2008). These funds could have been channelled into other sectors of the economy thereby generating employment and improving the welfare of the citizenry. Accountability requires that every action taken should be documented in order to reconcile past events with the present. Accountability can be viewed from different perspective; some require it for making financial decisions which usually appear as such as profit and loss statements, and earnings announcements, others for the public accountability perspective which requires a public individual to be accountable, since the important characteristic of this account is not their financial nature but the fact that they affect the economy and economic planning.


Accounting information can be represented in multiple ways, but the important thing is for the information represented should be non-arbitrary. Accounting representation must be verifiable, reliable and readable to everyone, whether financially knowledgeable or not. The information represented must be faithfully presented, without any form of bias or partiality. FASB 1980 (Financial Accounting Standard Board) described representational faithfulness as "correspondence or agreement between a measure or description and the phenomenon it purports to represent". A bold step was taken in the USA with the enactment of the (Sarbanes and Oxley act 2002) with the aim to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes. This act provides guidance for what to be stated in financial statements and provides punishments for any false representation and hidden information. With particular reference to Sec 302 (2) and (3) which talks about corporate responsibility for financial Report. Which states "A report must not omit any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made". Reporting the financial situation of a firm must be faithful, and the information given must not be deceiving or misleading thereby disclosing every material and non-material fact. The third part states that "the financial statements and other financial information included in the report, fairly present in all material respects the financial condition and results of operations of the issuer as of, and for, the periods presented in the report"; Every operation undertaken during the period under review must be explicitly presented in the report, without any form or bias or favouritism.

The Sarbanes-Oxley act holds management responsible for ensuring that "it meets stated standards in accounting procedures and controls, and guarantee that the results of operations and financial condition of the company are being accurately reported, no matter how good or poor those results are"(Needleman 2009). Different criticism have been levelled to this act, many are of the view that the SOX is "just another sign of government meddling with business" (Needleman 2009). E.g. the adverse effect it had on the New York stock exchange (NYSE), claiming that the reduced number of Initial Public Offerings (IPOs) on these exchange has been a result of SOX act. Whereas productivity and opportunity for improvement have increased substantially since the passage of SOX.

The impact of bad representation has been shown, after a large number of enterprises have declared bankruptcy within a short period after receiving unqualified audit reports. Distressed financial enterprises, "whether in the UK, USA, Germany, Iceland, The Netherlands, France or Switzerland, received unqualified audit opinions on their financial statements published immediately prior to the public declaration of financial difficulties, e.g. Lehman Brothers received an unqualified audit opinion on its annual accounts on January 28th 2008, followed by a profit on its quarterly accounts on July 10th 2008. A month after it experienced severe financial problems and filed for bankruptcy on the 14 September 2008. Bear Stearns, America's fifth largest investment bank, received an unqualified audit opinion on 28 January 2008. Three months after its financial problems hit the headlines and on 14 March, with state support, it was sold to JP Morgan Chase" (US Securities and exchange commission 2008). Is this lack of bad representation? Or false representation? The current financial crisis has crippled a lot of Western economies, most notably the US economy, which created an abundance of credit and encouraged excessive risk taking through complex financial instruments (derivatives, credit default swaps) and corporate structures and ineffective regulatory mechanisms (Ferguson, 2008; Morris,2008; Soros, 2008). Accounting information should represent economic resources, obligation, the transactions and events which can change those resources and obligations so that the "faithfulness of reported measurements lies in the closeness of their correspondence with the economic transactions, events or circumstances that they represent" (Brendan Mcsweeney 1997). Accounting representation should be interpreted in the context of what it is meant for, "without any form of doubt in the interpreters mind, Regulators and investors have traditionally relied upon corporate financial statements to make sense of bank liabilities, risks and economic exposure, but this has been highly problematic" (Stiglitz, 2003). Early in the year 2008, banks had around US$5000 billion of assets and liabilities off balance sheet (Financial Times, 3 June, 2008). Looking at this situation will raise doubt about what was represented in their financial statements, some have shown assets, especially subprime mortgages, at highly inflated values and derivatives have long been a ''tool for inflating company profits by hiding losses and hence the risks of company operations" (Hildyard, 2008, p. 30). Accounting information can be represented in different format and styles, based on different organisational forms being practiced, but it should contain verifiable information. Spiceland & Tomassini (2001) added that this information should include users that make critical resource allocation decisions that affect the nation`s economy, whether positive or negative.

Accounting representations can be separated from, for example, fictional literature not on the simple grounds that one is true and the other is not, but rather that an accounting representation explicitly seeks to re-present that beyond itself (Brendan Mcsweeney 1997). Representation cannot be said to be perfect, i.e. they is no pure representation. The U.S Financial Accounting Standard Board to sets out: "concepts that guide the selection of transactions, events, and circumstances to be accounted for, their recognition and measurement, the means of summarizing and communicating them, concepts of that type are fundamental in the sense that other concepts flow from them and repeated reference to them will be necessary in establishing, interpreting and applying accounting and reporting standards (FASB, 1980)". Emphasis was placed on Relevance and Reliability, accounting representations are not exact rather they are approximations involving numerous estimates, summarizations, judgments and allocations.

Representation may exclude some information in the financial reports based on choice, cost and some other factors, but the FASB tries to correct this with its view that incomplete information is biased: But what is not present cannot be 'faithfully represented'. The achievement of representational faithfulness would require the re-presenter to function merely as a conduit, a neutral someone, albeit usually an expert one, who would record without biases or predictions (Brendan Mcsweeney 1997). As Hines (1988, p.258) says reality does not exist independently of accounts of it, but rather there is no self-manifestation, no pure re-presentation.

Accounting representation can only represent what the organization or individuals wants it to represent, and can be guided by some principles or rules which make them acceptable to the public (investors, tax officers and creditors). Different researchers have tried make accounting representation (particularly financial statements) to be easily understood using the regulative ideal which reduces the variability of what is potentially an open-ended process. But other writers advise that we should see "truth as what is better for us to believe".


Control in accounting has different shades and meaning. The most common idea it suggests is that of dominance; the domination of one individual or group by another through the exercise of power. However, there is a second strand of meaning that emphasizes the idea of regulation and the monitoring of activities (D.T. OTLEY and A.J Berry 1980). These monitoring comes from above, usually supervisor to subordinates. Accounting itself can be viewed as a control process, it controls what the organization or individual spends, how it was spent, why it was spent and evidence that it was spent must be shown to complete the process of accountability. But, then, what does control mean? To whom or to what should it be attributed? Is it a sequential or simultaneous process, exercised over or with (Boland, 1979)? The ever-increasing recognition of the existence of autonomous processes continually raises these questions, but managerial control theory provides no answer. If they are no form of control in place, the set goals and objectives of the firm cannot and will not be achieved.

Control establishes an unusual consciousness in the firm about their own behaviour; different firms find themselves having several types of control in place to help balance their books and accounts. Some organization practise the bureaucratic form of control whereby rules, policies, hierarchy of authority and other bureaucratic mechanisms to standardize behaviour and assess performance (daft 2006). This form of control is used to control the employee's behaviour to adopt the organisation accounting format and procedure. This form of control is usually adopted in large organisations. Some organisations also adopt market control where price competition is used to evaluate the output and productivity of an organisation. This form of control uses sales and cost report of previous years to compare with the current year performance or other corporations in the same sector. This form of control can only be effective in a competitive environment. Clan control is use of social characteristics such as corporate culture, shared values and beliefs to control behaviour. This form of control is practiced mainly in small organizations where they are ambiguity and uncertainty. One would ask if all these form of control can be adopted in an organisation, which is impossible because clan control cannot be adopted in large organizations, whereas bureaucratic and market control can be combined. Tannenbaum (1968) claimed that "organization without some form of control is impossible". Every organization needs system for guiding and controlling, they adopt different strategy and methods to make sure effective control is available. Control aims to ensure that specific outcomes will be achieved and involves monitoring, measuring and taking corrective actions. Control systems may focus more on problem finding than problem solving, However, the specific controls such as standard costing, flexible budgeting, internal auditing (Miles & Snow, 1978; Porter,1980) helps in making control process acceptable to all.

The question of internal control was actually addressed by the Sarbanes and Oxley act, by placing full control on management for establishing and maintaining internal control. Under Section 302, management has to accept responsibility for the appropriateness and fairness of the financial statements. This doesn't absolve the auditor of responsibility, nor obviate the need for an audit letter, but means that management can no longer just rubber stamp an "everything's okay" report (Needleman 2009). There have to be tight and effective internal controls in place so that major discrepancies are uncovered, and that poor workflow and procedures are not only identified, but also repaired. In the recent financial crisis the economy was estimated to have lost around US$2.8 trillion (Bank of England, 2008). The social cost of the unfolding crisis is difficult to estimate, but vast amounts of public money are being used to prop-up distressed financial enterprises. One would ask if effective control was in place would we need to spend such huge amount of money. And what risk mechanism structure was in place? Risk assessment and management is directly related to internal control, as no set of internal controls can be assumed to be 100percent effective 100 percent of the time. The process of risk assessment helps to measure how effective internal controls are at any time, and details procedures and management responsibilities for reporting and correcting any inadequacies that are detected (Sikka, P 2009)


Most observers are of the view that ''big part of the problem is that accounting rules have allowed banks to inflate the value of their assets", thereby making them attractive to the public. Auditors are meant to detect all this because of the belief that ''a green light from an auditor means that a company's accounting practices have passed muster" (New York Times, 13 April, 2008). Many researchers have emphasised the need for accountability, proper representation and effective control, as this is the only way we can be saved from institutional collapse and fraud. Accountability should be seen as a peace maker. This paper stated the different forms of control to ensure adequate reporting and proper accountability. Various regulations in support of representational faithfulness and control has still not saved our society from financial irregularity, so the question is can accounting information be ever faithful or pure? Organizational control procedures must include procedures which act to maintain viability through goal achievement, but must be within the law (Otley D and Berry A 1980).


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