What is a corporation?

Most businesses start out as a small company, owned by one person or by a partnership. The most common type of business when there are multiple owners is a corporation. The law sees a corporation as real, live person. Like an adult, a corporation is treated as a distinct and independent individual who has rights and responsibilities. A corporation's "birth certificate" is the legal form that is filed with the Secretary of State of the state in which the corporation is created, or incorporated. It must have a legal name, just like a person.



A corporation is separate from its owners. It's responsible for its own debts. The bank can't come after the stockholders if a corporation goes bankrupt.



A corporation issues ownership share to persons who invest money in the business. These ownership shares are documented by stock certificates, which state the name of the owner and how many shares are owned. the corporation has to keep a register, or list, of how many shares everyone owns. Owners of a corporation are called stockholders because they own shares of stock issued by the corporation. One share of stock is one unit of ownership; how much one share is worth depends on the total number of shares that the business issues. the more shares a business issues, the smaller the percentage of total owners' equity each share represents.



Stock shares come in different classes of stock. Preferred stockholders are promised a certain amount of cash dividends each year. Common stockholders have the most risk. If a corporation ends up in financial trouble, it's required to pay off its liabilities first. If any money is left over, then that money goes first to the preferred stockholders. If anything is left over after that, then that money is distributed to the common stockholders.

What is financial window dressing?

Financial managers can do certain things to increase or decrease net income that's recorded in the year. This is called profit smoothing, income smoothing or just plain old window dressing. This isn't the same as fraud, or cooking the books.



Most profit smoothing involves pushing some amount of revenue and/or expenses into other years than they would normally be recorded. A common technique for profit smoothing is to delay normal maintenance and repairs. This is referred to as deferred maintenance. Many routine and recurring maintenance costs required for autos, trucks, machines, equipment and buildings can be delayed, or deferred until later.



A business that spends a significant amount of money for employee training and development may delay these programs until the next year so the expense in the current year is lower.



A company can cut back on its current year's outlays for market research and product development.



A business can ease up on its rules regarding when slow-paying customers are written off to expense as bad debts or uncollectible accounts receivable. The business can put off recording some of its bad debts expense until the next reporting year.



A fixed asset that is not being actively used may have very little current or future value to a business. Instead of writing off the un-depreciated cost of the impaired asset as a loss in the current year, the business might delay the write-off until the next year.



You can see how manipulating the timing of certain expenses can make an impact on net income. This isn't illegal although companies can go too far in massaging the numbers so that its financial statements are misleading. For the most part though, profit smoothing isn't much more than robbing Peter to pay Paul. Accountants refer to these as compensatory effects. The effects next year offset and cancel out the effects in the current year. Less expense this year is balanced by more expense the next year.

What happened in corporate accounting scandals?

Some recent corporate accounting scandals have consumed the news media and ruined hundreds of thousands of lives of the employees who had their retirement invested in the companies that defrauded them and other investors. The nuts and bolts of some of these accounting scandals are as follows:

WorldCom admitted to adjusting accounting records to cover its operation costs and present a successful front to shareholders. Nine billion dollars in discrepancies were discovered before the telecom corporation went bankrupt in July of 2002. One of the hidden expenses was $408 million given to Bernard Ebbers (WorldCom's CEO) in undisclosed personal loans.

At Tyco, shareholders were not informed of the $170 million in loans that were taken by Tyco's CEO, CFO, and chief legal officer. The loans, many of which were taken interest free and later written off as benefits, were not approved by Tyco's compensation committee. Kozlowski (former CEO), Swartz (former CFO), and Belnick (former chief legal officer) face continuing investigations by the SEC and the Tyco Corporation, which is now operating under Edward Breen and a new board of directors.

At Enron, investigations against uncovered multiple acts of fraudulent behavior. Enron used illegal loans and partnerships with other companies to cover its multi-billion dollar debt. It presented erroneous accounting records to investors, and Arthur Anderson, its accounting firm, began shredding incriminating documentation weeks before the SEC could begin investigations. Money laundering, wire fraud, mail fraud, and securities fraud are just some of the indictments directors of Enron have faced and will continue to face as the investigation continues.

What happened at Enron?

Enron began in 1985 selling natural gas to gas companies and businesses. In 1996, energy markets were changed so that the price of energy could now be decided by competition among energy companies instead of being fixed by government regulations. With this change, Enron began to function more as a middleman than a traditional energy supplier, trading in energy contracts instead of buying and selling natural gas. Enron's rapid growth created excitement among investors and drove the stock price up. As Enron grew, it expanded into other industries such as Internet services, and its financial contracts became more complicated.

In order to keep growing at this rate, Enron began to borrow money to invest in new projects. However, because this debt would make their earnings look less impressive, Enron began to create partnerships that would allow it to keep debt off of its books. One partnership created by Enron, Chewco Investments (named after the Star Wars character Chewbacca) allowed Enron to keep $600 million in debt off of the books it showed to the government and to people who own Enron stock. When this debt did not show up in Enron's reports, it made Enron seem much more successful than it actually was. In December 2000, Enron claimed to have tripled its profits in two years.

In August 2001, Enron vice president Sherron Watkins sent an anonymous letter to the CEO of Enron, Kenneth Lay, describing accounting methods that she felt could lead Enron to "implode in a wave of accounting scandals." Also in August, CEO Kenneth Lay sent e-mails to his employees saying that he expected Enron stock prices to go up. Meanwhile, he sold off his own stock in Enron.

On October 22nd, the Securities and Exchange Commission (SEC) announced that Enron was under investigation. On November 8th, Enron said that it has overstated earnings for the past four years by $586 million and that it owed over $6 billion in debt by next year.

With these announcements, Enron's stock price took a dive. This drop triggered certain agreements with investors that made it necessary for Enron to repay their money immediately. When Enron could not come up with the cash to repay its creditors, it declared for Chapter 11 bankruptcy.

What is the Sarbanes-Oxley Act?

--Certification of financial reports by chief executive officers and chief financial officers

--Auditor independence, including outright bans on certain types of work for audit clients and pre-certification by the company's Audit Committee of all other non-audit work

--A requirement that companies listed on stock exchanges have fully independent audit committees that oversee the relationship between the company and its auditor

--Significantly longer maximum jail sentences and larger fines for corporate executives who knowingly and willfully misstate financial statements, although maximum sentences are largely irrelevant because judges generally follow the Federal Sentencing Guidelines in setting actual sentences

--Employee protections allowing those corporate fraud whistleblowers who file complaints with OSHA within 90 days, to win reinstatement, back pay and benefits, compensatory damages, abatement orders, and reasonable attorney fees and costs.

What is forensic accounting?

Investigation is the act of determining whether criminal matters such as employee theft, securities fraud (including falsification of financial statements), identity theft, and insurance fraud have occurred. As part of the forensic accountant's work, he or she may recommend actions that can be taken to minimize future risk of loss. Investigation may also occur in civil matters. For example, the forensic accountant may search for hidden assets in divorce cases.

Forensic accounting involves looking beyond the numbers and grasping the substance of situations. It's more than accounting...more than detective work...it's a combination that will be in demand for as long as human nature exists. Who wouldn't want a career that offers such stability, excitement, and financial rewards?

In short, forensic accounting requires the most important quality a person can possess: the ability to think. Far from being an ability that is specific to success in any particular field, developing the ability to think enhances a person's chances of success in life, thus increasing a person's worth in today's society. Why not consider becoming a forensic accountant on the Forensic Accounting Masters Degree link on the left-hand navigation bar.

What are auditors?

Specific job duties vary widely among the four major fields of accounting: public, management, and government accounting and internal auditing.

Internal auditors verify the accuracy of their organization's internal records and check for mismanagement, waste, or fraud. Internal auditing is an increasingly important area of accounting and auditing. Internal auditors examine and evaluate their firms' financial and information systems, management procedures, and internal controls to ensure that records are accurate and controls are adequate to protect against fraud and waste. They also review company operations, evaluating their efficiency, effectiveness, and compliance with corporate policies and procedures, laws, and government regulations. There are many types of highly specialized auditors, such as electronic data-processing, environmental, engineering, legal, insurance premium, bank, and health care auditors. As computer systems make information timelier, internal auditors help managers to base their decisions on actual data, rather than personal observation. Internal auditors also may recommend controls for their organization's computer system, to ensure the reliability of the system and the integrity of the data.



Government accountants and auditors work in the public sector, maintaining and examining the records of government agencies and auditing private businesses and individuals whose activities are subject to government regulations or taxation. Accountants employed by Federal, State, and local governments guarantee that revenues are received and expenditures are made in accordance with laws and regulations. Those employed by the Federal Government may work as Internal Revenue Service agents or in financial management, financial institution examination, or budget analysis and administration.

What is the FASB?

The FASB is one organization that provides standardized guidelines for financial reporting. The mission of the Financial Accounting Standards Board (FASB) is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors and users of financial information.

Accounting standards are essential to the efficient functioning of the economy because decisions about the allocation of resources rely heavily on credible, concise, transparent and understandable financial information. Financial information about the operations and financial position of individual entities also is used by the public in making various other kinds of decisions.



To accomplish its mission, the FASB acts to:



--Improve the usefulness of financial reporting by focusing on the primary characteristics of relevance and reliability and on the qualities of comparability and consistency;

--Keep standards current to reflect changes in methods of doing business and changes in the economic environment;

--Consider promptly any significant areas of deficiency in financial reporting that might be improved through the standard-setting process;

--Promote the international convergence of accounting standards concurrent with improving the quality of financial reporting; and

--Improve the common understanding of the nature and purposes of information contained in financial reports.



The FASB develops broad accounting concepts as well as standards for financial reporting. It also provides guidance on implementation of standards. Concepts are useful in guiding the Board in establishing standards and in providing a frame of reference, or conceptual framework, for resolving accounting issues. The framework will help to establish reasonable bounds for judgment in preparing financial information and to increase understanding of, and confidence in, financial information on the part of users of financial reports. It also will help the public to understand the nature and limitations of information supplied by financial reporting.