Editorial

The recent high-profile failure of certain companies, such as Enron and Global Crossing in the US and HIH Insurance in Australia, provides a stark and timely reminder of how the economy and society are impacted by major instances of corporate collapse. Across time and space, accountants and auditors

have been implicated in many instances of corporate failure for their roles in preparing and authenticating financial information for communication to stakeholders of companies where the audited financial repons are later shown to have materially misrepresented the financial performance and position of failed corporations.1 The objective of this special issue of Accounting History, for which the present author has had the great pleasure of being special editor, is to provide historical accounts of audit failure and financial statement fraud in the context of corporate collapse. The four contributions appearing in this special issue examine this phenomenon from a variety of perspectives. Before discussing the academic contribution of each of these papers some personal reflections are provided.

The first observation is that audit failure within corporate collapse is far from a recent phenomenon. For example, John B. Miles, President, Sydney Institute of Public Accountants, wrote in 1895 that auditors in too many cases are unable and/or unwilling to provide "diligent examination of the accounts" and voluntarily become the "acquiescent minions" of company directors (An Address Delivered by the President of the Sydney Institute of Accountants entitled "Concerning Auditing", and reproduced in Carnegie & Parker, 1999, pp.207-26).

A second observation is that symptoms of audit failure are remarkably similar and persistent over time. For example, compare the 1895 comments of Miles with the contemporary findings of Justice Owen in the HIH Royal Commission Report (2003) as reproduced below:

The auditors failed to ensure that the accounts of HIH which they certified were presented in such a way that they gave a true and fair view of the company's financial position, and in virtually every instance of controversy, ultimately yielded to management's view of the accounting treatment to be adopted, which invariably had the effect of overstating profitability and understating liabilities (para. 10-15).

Moreover, the problem also seems to be relatively common across jurisdictions. For example, the Powers Report (2002) into the collapse of US energy company, Enron, stated: "... there was an absence of ... objective and critical professional advice by ... auditors at Andersen" (p. 17).

A final reflection relates to repeated calls made by accounting practitioners, regulators and researchers alike for a major corrective response to major accounting and auditing scandals. For example, Levitt in Schlank (2002, p.l) asserted:

... the leaders of the Big Five accounting firms and the AICPA were so mindless of a developing crisis in how they were viewed by the public. I began to see more cases of financial fraud, really bad behavior, and situations with the accounting firms that were real conflicts of interest.

Similarly, Briloff over a period of four decades2 has championed the cause of auditor independence and lambasted the accounting profession for placing commercial interests above those of its public interest duties. He contended that auditors have been endowed with a "covenant" or "special franchise" to provide services that involve the signing, delivering or issuing of an opinion on financial or related statements (Briloff, 1990, p.S). Briloff noted that this covenant is enshrined in law and its origins extend back for over a century and lamented that this sacred covenant has systematically been desecrated by the accounting profession over a period of decades. The outcome depicted by Briloff is the antithesis of what Colonel Arthur Carter, Head of the New York State Society of CPAs envisioned for the profession in 1933. When questioned about who audits the auditors Carter simply answered "... our conscience" (US Senate Committee Hearings into Banking and Currency of 1 April 1933, cited in Brewster, 2003, p.80).

Now that some thoughts have been provided on the persistent problem of audit failure across time, this critique will address the contribution of the four studies that comprise this special issue. The first paper by Chandler and Rees involves a detailed review of UK cases involving allegations of auditor negligence between 1887 and 1936. Their study covers a period epitomised by not only the development of the auditing function but a growing awareness of the potential legal liability of auditors. This period also witnessed the first major efforts by auditors to seek professional indemnity insurance. The authors intertwine the apparent growing liability of auditors as depicted in celebrated cases such as Re London and General Bank (No.2) and Re Kingston Cotton Mill Co. (No.2) with the increasing pressure by the profession both to restrict its liability and to reduce risks through insurance. While previous studies have examined the evolving role of the auditor with reference to some of these earlier influential court cases (see, for example, Chandler, Edwards & Andersen, 1993; Chandler, 1997), they have not generally sought to juxtapose them with the growing thrust for professional indemnity insurance.

Heier, Dugan and Sayers document changes in internal control definitions, applications and procedures over the period from 1905 (when the importance of a formal assessment of client internal controls within the audit process was formalised in an influential auditing manual entitled: Auditing: A Practical Manual for Auditors, by Dicksee, 1905) to the present time marked by the introduction of the Sarbanes-Oxley Act and the formation of the Public Company Accounting Oversight Board. The authors' analysis is especially important in considering the contribution of poorly performed audits to misleading financial reporting. This is because inadequate internal controls are often a significant contributor to major financial statement fraud. For example, the conflicts of interest of key Enron executives combined with a readiness of the company's Board of Directors and executive management to over-ride and/or ignore key internal controls assisted in the capacity of some executives to conduct a series of deceptive transactions with the now infamous special purpose entities (O'Connell, 2004).

Heier et al. demonstrate that the culmination of the evolution of company and auditor requirements pertaining to the adequacy of internal controls is, by means of Sarbanes-Oxley, to oblige management and auditors to formally report on the adequacy of internal controls. They highlight that this outcome refers to mandates under the securities Act 1933 and earlier calls from writers, such as Stempf (1934), to emphasise the assessment of internal controls. Hence, the study places the present controversial Sarbanes-Oxley rules for internal controls within an historical context.

Abeysekera's study applies literature from Streeck and Schmitter's (1985) model of political economy theory. This model, which to date has not been widely applied in the accounting literature, divides the social order into four types of institutional constituents. These are the community, the market, the state (or the bureaucracy) and the "corporative association". The author contends that the professional accounting bodies can be classified as corporative associations that negotiate with government agencies on behalf of their constituents.

Through a focus on the recent high-profile collapse of HIH Insurance in Australia, the author demonstrates the efforts of the accounting profession to influence the new order flowing from post-legislative and accounting reforms, and provides evidence of the historical interplay between the accounting profession and government agencies. Abeysekera portrays this interchange as being volatile over time with periods epitomised by strong autonomy and constituent legitimacy, such as post the second World War to the 1960s, and other periods where the profession was besieged as a consequence of corporate collapses, such as around the mid 1960s and the early 2000s. The author provides useful insights into how the accounting profession can best enhance the possibility of its solutions being accepted.

Fogarty and Dirsmith present an indepth case study of the bailout of the financially troubled Chrysler Corporation during the early 1980s. In this case, a giant corporation on the verge of bankruptcy was saved by explicit government intervention into the credit market through the provision of government loan guarantees. While the case does not focus on corporate collapse in technical terms, there seems to be little doubt that Chrysler would have been forced into Chapter 11 bankruptcy protection had it not been for this decisive government intervention.

The authors employ the lens of Burchell, Clubb, Hopwood, and Nahapiet (1980) to study the Chrysler case and how accounting information was utilised by the company and its supporters to rationalise the decision to provide explicit government support. The contribution of this study is to prove that while accounting information may provide a useful input to actual choice, it alternatively can be exploited to provide a "post-hoc patina of rationality to a decision made on other grounds" (p.91).

In conclusion, the four contributions in this special issue assist us to place contemporary developments in the regulation of accounting and auditing within an historical context. These papers demonstrate the ongoing interface between the accounting profession (with its preference to maintain autonomy and legitimacy) and government and regulatory forces (with their emphasis on monitoring and controlling corporate behaviour and the maintenance of smooth operations of capital markets). The authors establish that at distinct time periods since the advent of the joint stock company, government and regulators have sought to significantly reduce the accounting profession's independence and increase oversight of its operations. Typically, these efforts are ignited by pivotal events such as major corporate collapses. The courts too have played their part in exploring the contribution of accountants, and especially auditors, to corporate collapses resulting in efforts by the profession to limit or transfer liability to claimants.

FOOTNOTE

Notes

1. It is difficult to quantify the extent of audit failure since, in the vast majority of alleged cases, legal actions never reach the courts. This is due to the preference of accounting firms to settle these cases out of court, without admission of wrongdoing, for considerable sums (Clarke, Dean & Oliver, 2003).

2. See, for example, Briloff (1972; 1984; 1987; 1990).

REFERENCE

References

Briloff, A.J., (1972), Unaccountable Accounting, New York, NY: Harper and Row.

Briloff, A.J., (1984), "Double Entry: Double Think: Double Speak", in Tinker, T. (ed.), Social Accounting for Corporations: Private Enterprise versus The Public Interest, New York, NY: Markus Wiener Publishing, pp.37-98.

Briloff, A.J., (1987), "Do Management Services Endanger Independence and Objectivity?", The CPA Journal, August.

Briloff, A.J., (1990), "Accounting and Society: A Covenant Desecrated", Critical Perspectives on Accounting, Vol. 1, No. 1, pp.5-30.

Brewster, M., (2003), Unaccountable: How the Accounting Profession Forfeited A Public Trust, Hoboken, NJ: John Wiley & Sons.

Burchell, S., Clubb, C., Hopwood, A. and Nahapiet, J., (1980), 'The Roles of Accounting in Organizations and Society," Accounting, Organizations and Society, Vol.5, No.1, pp.5-28.

Carnegie, G.D. and Parker, R.H. (eds.), (1999), Professional Accounting and Audit in Australia, 1880-1900, New York, NY: Garland Publishing, Inc.

Chandler, R.A., (1997), 'Taking Responsibility: The Early Demand for Institutional Action to Define an Auditor's Duties", International Journal of Auditing, Vol. 1, No.3, pp. 165-74.

Chandler, R.A., Edwards, J.R. and Anderson, M., (1993), "Changing Perceptions of the Role of the Company Auditor, 1840-1940", Accounting and Business Research, Vol.23, No.92, pp.443-59.

Clarke R, Dean, G. and Oliver, K., (2003), Corporate Collapse: Accounting, Regulatory and Ethical Failure, revised edition, Cambridge: Cambridge University Press.

Dicksee, L.R., (1905), Auditing: A Practical Manual for Auditors (Authorized American edition). New York, NY: Robert Montgomery. Reprinted in 1976, New York, NY: Arno Press.

HIH Royal Commission Report, (2003), The Failure of HlH Insurance Volume I: A Corporate Collapse and its Lessons, Canberra, ACT: Commonwealth Publishing, Commonwealth of Australia. Available at: http://www.hihroyalcom.gov.au/finalreport/

Miles, J.B.C., (1895), "Concerning Auditing", An Address Delivered by the President, Sydney: The Sydney Institute of Accountants, 28 November, 21 pp., reproduced in. Carnegie, G.D. and Parker, R.H. (eds.), ( 1999), Professional Accounting and Audit in Australia, 1880-1900, New York, NY: Garland Publishing, Inc.

O'Connell, B.T., (2004), "Enron Inc: He that Filches From Me My Good Name ... Makes Me Poor Indeed", Critical Perspectives on Accounting, Vol.15, No.6-7, pp.733-49.

Powers, W.C., Troubh, R.S. and Winokur, H.S. (Powers Report), (2002), Report of the Investigation by the Special Investigative Committee of the Board of Directors of Enron Corp. (February 1), Houston, Texas. Available at: http://news.findlaw.com/wp/docs/cnron/specinv020102rpt1.pdf.

Schlank, R., (2002), "Former sec Chairman Rails Against Accounting Profession", AccountingWEB US (3 December), Retrieved from: http://www.accountingweb.com.

Stempf, V.H., (1934), Preparation of Balance Sheet Audits, New York, NY: Touche Nivens and Co.

Streeck, W. and Schmitter, P.C., (1985), "Community, Market, State - and Associations? The Prospective Contribution of Interest Governance to Social Order", in Streeck, W. and Schmitter, P.C. (eds.), Private Interest Government, London: Sage.

US Senate Committee Hearings into Banking and Currency, (1933), Testimony by Arthur A. Carter on the Introduction of the Federal securities Act of 1933, (1 April) cited in Brewster, M., (2003), Unaccountable: How the Accounting Profession Forfeited A Public Trust, Hoboken, NJ: John Wiley & Sons.