Running head: REVIEW OF ACCOUNTING ETHICS

Strayer University

Critique of Accounting Ethics
Assignment # 1






A research Paper submitted to the Faculty of the School of Business in Fulfillment of the Partial
Requirements for ACC 557 Course




To
Dr. Mohamed Gurey

By
Kan Nguessan




Summer 2014
Deadline: July 24, 2014
Submitted date: July 24, 2014


REVIEW OF ACCOUNTING ETHICS 1

Ethical accounting breaches are becoming the most common problem related to
most U.S. firm bankruptcies. Lehman brother was known to belong to the category of
too big to fail investment bank; however the filing for bankruptcy in September 2008
was a big shock for most investors and shareholders. Some analysts have predicted such
outcome prior to month of scrutiny investigation of the firm which collaborate with E&Y
which is among the fourth biggest auditing company with the headquarter located in
London. After registering for bankruptcy, many specialist of accounting regulation and
lawmakers addressed the different causes behind such shortcomings prior to preventing
future problems via reinforcing the industry ethical regulations.
This paper will also address six major points which are the current business and
regulatory system, the description of the accounting ethical breach and its impacts on
Lehman Brother, the determination of the ethical issue, the account impacted or the
violated guideline, and suggestions of a recommendation Lehman brother could have
taken to avoid such bankruptcy.
Lehman Bother ethical breaches and the current regulatory arrangement
Prior the Enron scandal, regulators did not emphasize on the disclosure of non-
GAAP earnings. The current regulatory scheme proposed by lawmakers implies the
application of the Sarbanes-Oxley act of 2002 tighten the rules of financial accounts for
any operating companies in the U.S. for example, the section 404 of the new regulation
suggests that societies should act to introduce information regarding the level of accuracy
in their financial statement. Companies are constrained to be their first auditory organism.
Other accounting scandals such as Enron and WorldCom brought more attention
to the public and government in general. According to Auerbach, (2014) The Sarbanes-
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Oxley Act of 2002 was born of the illicit actions of Enron and WorldCom executives and
the glaring accounting loopholes they exploited(p.4). In fact, these companies used
defective and sensitive part of the accounting system to create divergences and
misappropriation of their company assets.
The foundation of regulatory entities like the (PCAOB) which study the
transparency of the audit of public companies, the U.S. more companies are taking major
amounts to avoid the disturbance of their line of work. The entry of more regulations,
emphasizes on chief executive spending and bonuses. Also, non-GAAP earnings such as
grants should also be reviewed and disclosed by the company for more transparency.
According to Devi, (2012) The PCAOB has been empowered to set and enforce
auditing, attestation, quality control and ethics standards for public companies. The
Board also has abilities to inspect and discipline public accounting firms that audit public
companies. Therefore, it is less conducive for the current accounts and CFO to bypass
those entities for fraudulent financial reports. The government is reinforcing laws to
prevent more Enron and Lehman Brothers bankruptcy.
Breaches and impacts on Lehman Brothers
Lehman Brothers was one of the biggest investment banks in the U.S. the
company was publicly owned since it sold securities on Wall Street. Therefore,
shareholders could buy the company security in exchange of a future dividend that the
society must compensate to them. Lehman Brother violated the ethical use of repo 105
since the company used such method to eradicate their trouble assets and liabilities
resulted from the subprime mortgage crisis in 2008.
REVIEW OF ACCOUNTING ETHICS 3

The company was lending money to households in order to buy their dream
mortgage without any confirmation of their monthly payroll in order to identify their
eligibility. According to Jeffers, (2011) Aurora was acquired by Lehman Brothers since
the agency was specialized in lending without requesting their income. These
deregulation led to the encroachment of the rule of accountability by Lehman Brothers.
The firm used their purchased loans under Repo 105 to create entries in their financial
statement prior to quarterly publication. Therefore, the accounting book appears to have
less intoxicated assets and financial obligations to ensure investors and insure their stock
market price thereby by avoiding volatilities on Wall Street.
The misapplication of their assets via massive loans create a deadly situation
which led to the crash of Lehman Brothers. Ernst & Young were also accused of hiding
Lehman Brothers misleading accounting practice known as window dressing. In fact, this
term is specified as the avoidance of payments of debts since to avoid a negative cash
balance, the investment bank used such method to hold up their payments prior to the
revelation of their financial statement. Ernst & Young are also accused of contributing to
the collapse of Lehman Brothers since those practices were not revealed. This violation
of the accounting ethics formally result in the collapse of one of the biggest investment
bank in America. Those accounting frauds were hidden by Ernst & Young to secure their
audit contract with Lehman Brothers. The S&P also understated the financial state of
affairs of major firms, thereby increasing their generate rate to to mislead investors.

Discovery of ethical issue and failure of management
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The organizational ethical issue was discovered by the excessive use of repo 105
from 2007 t o 2008. In this instance, JP Morgan and City Bank discovered that those
assets were toxic. Worthless assets from Lehaman Brothers were used as a collateral to
acquire their loan from some other financial establishment which was intended to be a
short- term liability which is considered a one week obligation repayment.
Lehman Brothers declared up to $59 billion in their financial statement which
mislead investors. In such event, the companys management must access the situation
and describe it to avoid violating ethical practices.; however, management were silent on
behalf of this event. The acceptance of such behavior suggested that directors were aware
of the prevailing state of affairs, but neglect to call for serious actions towards the CFO.
Management also benefited from those accounting practices, this is the primary
reason why proposition G was introduced to talk non-GAAP transactions. According to
Han, (2012) non-GAAP earnings disclosures are less pronounced for sample firms with
losses or negative GAAP earnings changes (i.e., possible opportunistic motives) (p. 98).
In such case management failed to create an ethical environment, thereby hiding the
dubious transaction between Lehman and other investment banks, which received those
toxic securities to be repurchased by Lehman Brother in a week prior to consolidate their
financial statement numbers. In addition, Lehman Brothers management engaged in
transactions that did not make long-term economic sense, costing the firm amounts
(Jones, 2013, p. 60); the usage of repo 105 and 108 are considered to be beneficial in the
short-term.

Account impacted and violated guidelines
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Lehman Brothers attributed these frauds to their assets, one claim of these
numbers was the mortgage and asset-backed securities. In their transactions, the firms
deliberately sold their toxic assets in exchange for cash, the drawbacks of such purchase
remains the fact that Lehman brothers had to pay double interest rate to other investment
banks which provide their rep 105 transaction. Since Lehman Brothers was an investment
bank and lenders, it is logic to examine their assets account which was overstated prior to
their quarterly financial accounts.
The Company violated the principle of the off balance sheet transaction via the
use of repo 105 and 108 which can be hidden since the final reports do not disclose such
transactions. In fact, many companies use report 105 to acquire temporary cash for
special purpose like landing. In this example the company violates the guidelines to cover
this transaction as loans. Therefore, the financial statement overstates their total asset,
thereby overstating their sales. These securities aimed to produce an air of trust among
investors and stakeholders.
How Could the Ethical Breaches be Avoided ? What are the Future
Recommendations
It is important to denote that this example of a Ponzi scheme is really complex to
investigate; however, if the government were putting in regulations to change the
complex banking industry, this state of affairs could have been averted. Alas, the
deregulation was tackled by the administration after numbers case such as AIG, Enron,
Worldcom frauds were detected. As a CFO, the most important step to be taken is to
make certain that the company audit are well performed by one more company. This
pattern will take the cost of auditing high which will head to more spendings; however,
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different societies could cause different answers and plant out the severance.
Ernst&Young failed to comply with the general rule. Another room to tackle the future is
by applying the non-GAAP transaction.
In conclusion, These collections of non recorded transactions such as the use of
repo and other personal use should be disclosed as additional documentation to the
public. Theses transactions will be taken from the financial statement, but the CFO will
want such information to reexamine the final direction in order to find out whether or not
it is necessary to bid for a second audit to find brushes.















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References
Auerbach, M. P. (2014). Sarbanes-Oxley Act of 2002. Sarbanes-Oxley Act Of 2002 . Research
Starters Business, 1-6.
Devi, S. K. (2012). Regulation of firms: evidence from Fiji. . Global Journal Of Business
Research, 6 (1), 91-101. .
HAN, Y. (2012). Has Regulation G Improved the Information Quality of Non-GAAP Earnings
Disclosures?. Seoul Journal Of Business, , 18(2), 95-145. .
Jeffers, A. E. (2011). How Lehman Brothers Used Repo 105 to Manipulate Their Financial
Statements. Journal Of Leadership, Accountability & Ethics, 8(5), 44-55. .
Jones, B. &. (2013). Law and accounting : did Lehman Brothers use of rep 2015 transaction
violate accounting and legal rules ? . Journal Of Legal, Ethical & Regulatory Issues ,
16(2), 55-91. .