Public Accountants’ Perceptions by McEnroe (2010) is a highly instructive article that aims to determine the perceptions of auditors with regard to earnings management practices. In particular, the author determines these perceptions through the application of Generally Accepted Accounting Principles (GAAP) in the post-Sox period. Results of previous studies conducted to understand the perceptions of auditors indicate that auditors did not perceive many possibilities of legal action because the GAAP acted as a ‘safe harbor’ against such legal actions. Therefore, the auditors issued clean audit opinions on financial statements prepared by public accountants. In this study, the author aimed to determine the level of conservatism of auditors taking into account the accounting scandals involving WorldCom and Enron that resulted in the passing of the Sarbanes-Oxley Act (SOX). The author uses a qualitative research method to determine the perceptions of auditors. In particular, McEnroe used five cases in which he required managers and audit partners to respond to various accounting procedures related to earnings management. One of the conclusions of this research is that auditors are now more likely to be conservative when issuing audit opinions than they were a decade ago. Secondly, the auditors did not perceive the possibility of a lawsuit as influencing their decisions to issue a clean audit opinion on matters involving earnings management. Besides, responses by participants in the debt retirement study confirm that the auditors are reluctant to use audit views to scrutinize poor business decisions. Lastly, the results indicate that the auditors would still issue clean opinions when their clients record transactions with their form as opposed to their substance.
According to McEnroe (2010), GAAP is no longer a safe harbor. In my view, this position is true because financial statements are always a representation of management. Besides, GAAP presents managers with many loopholes to perpetrate fraudulent activities. In this case, management might fail to observe the requirements of GAAP as originally intended, thereby resulting in the unfair presentation of financial statements to investors. Moreover, the financial statements prepared by management might not be objective and transparent to reveal valuable information that helps investors to understand all material aspects related to their investments. This position is fair to managers who simply aim to fulfill the requirements of GAAP because it requires them to exercise vigilance in their selection and application of accounting policies. Failure to observe Section 302 (a) of SOX is likely to result in a qualified audit opinion. Thus, this position would push managers to ensure transparency, fairness and completeness as they apply accounting policies (Moeller, 2008). Officer certification requirement of SOX is essential because it plays a critical role in ensuring that managers act responsibly when issuing financial statements. This requires managers to indicate that the financial information they release on their statements meets the standards of completeness and overall material accuracy, over and beyond the requirements of GAAP. Most significantly, this move is likely to heighten public confidence in audited financial statements.
In my view, the introduction of SOX in 2002 was a positive move that helped to increase conservatism in financial statements. Section 302 (a) certification requirements have resulted in increased vigilance in the selection and application of accounting principles. McEnroe (2010) notes that there has been a noteworthy reduction in discretionary accruals after SOX became effective. Moreover, SOX pushes companies to report losses in a manner that is more prompt than they report gains in the financial records. In addition, Moeller (2008) indicates that most companies adopted accounting approaches that were more conservative following the passing of SOX. The author also indicates that most organizations improved on their practices relating to earnings management after SOX became effective. This shows that the introduction of SOX was necessary because it pushed companies to adopt ethical financial practices that helped to improve the level of fairness in financial reporting (Stein, 2012). Although Section 302 (a) of SOX has resulted in increased conservatism, this study reveals that auditors still show some level of reluctance because they allow their clients to record earning management practices using GAAP. In addition, the auditors are ready to issue a clean audit opinion even in cases where their clients record financial statements in accordance with their form as opposed to their substance. Therefore, reluctance on the part of auditors makes it difficult to achieve transparency, fairness and full/complete disclosure, which are the fundamental pillars of ethical financial reporting.
McEnroe (2010) also states that auditors will not monitor unfavorable business practices based on audit opinion, even in circumstances that involve earnings management. In this case, auditors perceive low possibility of an SEC investigation because auditors have no responsibility for reprimanding poor business decisions. In this case, the most that the auditors can do is to make full disclosure relating to such decisions and practices in their reports. This position is correct because auditors have no role to play in the day-to-day management of their clients’ businesses. I consider this position to be correct because the most auditors can do in such situations is to make full disclosure to the investors (Stein, 2012). Such disclosure should be full and fair to enable investors to make well-informed decisions regarding their managers.
McEnroe, J. E. (2010). Public accountants’ perceptions of the acceptability of earnings management practices through the employment of GAAP in the post-Sox period. Journal of Applied Business Research, 26 (1), 59-72.
Moeller, R. R. (2008). Sarbanes-Oxley internal controls: Effective auditing with AS5, CobiT, and ITIL. Hoboken, NJ: John Wiley & Sons.
Stein, D. (2012). The Sarbanes-Oxley Act – accounting and conservatism: An analysis mainly based on section 404 of the Sarbanes-Oxley Act. Munich: GRIN Verlag.