How to Read a Financial Report: Wringing Vital Signs Out of the Numbers

Chapter 21. AUDITS OF FINANCIAL REPORTS IN THE POST-ENRON ERA

Opening Comments

Before getting into the discussion of audits of financial reports by independent certified public accountants (CPAs), I should open this chapter with a brief history of recent events. The Enron scandal was the tipping point that caused Congress and the public accounting profession to take action. During the last two decades of the twentieth century, an incredible number of accounting fraud cases were splashed across the headlines—WorldCom, Enron, Tyco, Ahold, Xerox, Rite Aid, Global Crossing, HealthSouth, Waste Management, and Adelphia Communications, to name just a few. Well-known and reputable CPA firms audited the financial statements of these companies.

When the financial reporting frauds committed by these companies became known, the market prices of their stock shares plunged and their shareholders suffered huge losses. Unfortunately, many employees of these companies had the bulk of their retirement savings invested in their own companies' stock shares. Many of these businesses went into bankruptcy. Frankly, I was astonished at the large number of accounting frauds. There had been accounting frauds over the years—in the 1930s and a rash in the 1960s. The accounting frauds in the 1980s and 1990s were much more troublesome.

Most of the companies that cooked their books were audited by the Big Five CPA firms, presumably the best auditors in the world. One CPA firm—Arthur Andersen—was convicted of obstruction ...