Accounting Education Changes Resulting from Sarbanes-Oxley

Deloitte/FSA Faculty Consortium

"Risk Management in the Sarbanes-Oxley Era"

Drake Hotel- Chicago, IL May 19-20, 2005 By Thomas J. Linsmeier
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Wish List of Recent Accounting Graduates

The term corporate governance was not even defined Need a framework/context to understand the issues

Roles of management, board and public accounting firms Roles of FASB, SEC, AICPA, Stock Exchanges, etc.

Lack of understanding and coverage of the SEC

How pervasively important the SEC is SEC filing and other requirements
Ethics the Perception that accounting is rules-based and mechanical Sarbanes-Oxley

Other topics

Informal survey by Ken Love, D&T partner, 2003 FSA Conference.

Teaching Corporate Governance at Michigan State University

Should corporate governance be taught in a standalone course to accounting students?

We decided yes

ACC 852 Corporate Governance & Accounting Control

Should corporate governance be integrated into the accounting curriculum?

We decided yes, especially post-SOX

321 411 814 824 841

Accounting Information Systems Auditing Advanced Auditing Digital Business Models & Processes Strategic Management Accounting
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Developing a Framework to Teach Corporate Governance

Corporate governance represents the relationships created among the various stakeholders of a business corporation to effectively direct its activities in meeting the objectives of the stakeholders

Public Corporations and Governance

The Securities Act of 1933 The Securities Exchange Act of 1934
Business Corporation
Lenders Senior Management Government

Suppliers
Board of Directors

Competitors

Employees

Customers

Corporate Control

Shareholders

Equity Analysts

Sarbanes-Oxley Act
External Governance

Exchange Listing Requirements

Internal Governance Mandated Governance
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Teaching Corporate Governance at Michigan State University

How do we integrate corporate governance into the accounting curriculum? How do we teach corporate governance in a standalone course to accounting students?

Cornerstones of Corporate Governance

Trusteeship Protect and enhance shareholder value Also responsible to other stakeholders Empowerment Vest decision-making powers at the most appropriate levels Incentives and Control Freedom of management should be exercised within a framework of appropriate checks and balances Ethical Corporate Citizenship Importance of tone at the top Transparency of Public Disclosures Possibly involves tradeoff between lower cost of capital and disclosure of strategic information
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Corporate Governance and the COSO Framework in the Accounting Curriculum at MSU
Accounting & Information Systems Courses 321 411 814 824 841 852 Professional/Ethical Values Enterprise Risk Management
Business and Fraud Risk Assessment Delegation and Control Environment Monitoring and Evaluation Information System for Planning and Control Control Procedures to Mitigate Risks

Structuring of Board of Directors Independent External Auditor Disclosure Transperancy

1. 2. The elements of enterprise risk management are based on the COSO framework. Other courses cover corporate governance from specialized perspectives, e.g., ACC 843 (value and supply chains) and ACC 844 (international).

Teaching Corporate Governance at Michigan State University

How do we integrate corporate governance into the accounting curriculum? How do we teach corporate governance in a standalone course to accounting students?

ACC 852 CORPORATE GOVERNANCE AND ACCOUNTING CONTROL currently taught by K. Ramesh

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Developing the Building Blocks: An Example

Designing corporate governance

How good governance is part of good organizational design

What is the role of accounting and auditing?

Redesigning corporate governance

How companies are redesigning deficient governance?

What is the role of accounting and auditing?

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Organizational Architecture: Three Legs of Organizational Design

Assignment and control of decision-making authority Link authority with the knowledge and experience needed to make good decisions Measurement and control of performance evaluation Accurately and consistently gauge shareholder value creation Incentives and control (Compensation) Develop compensation systems that provide decision makers with appropriate incentives and controls
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Brickley, Smith and Zimmerman

Enron: A Case in Point

Authority without control (Opportunity)

Delegating too much decision making authority deeper into the company without retaining proper control at higher levels

Short-sighted performance evaluation system (Incentives)

Focus on near-term earnings growth

Large compensation to its top performers based on near-term earnings growth (Pressure)

Encourage excess risk taking when there is no penalty for losses

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Linking Brickley, Smith and Zimmerman to the fraud triangle

Rules for Redesigning Corporate

Governance Systems

Corporate Objective Board Structure Compensation

Procedures, Structure, Monitoring, and Reporting

Communication with the Market Independent External Auditors Management Controls and Enterprise Risk Management Shareholder Rights/Corporate Control
Adapted from Fuller & Jensen, and Jensen & Murphy
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What the course is about

Examine the various aspects of corporate governance functions

External audit, auditor independence and fraud detection Internal auditors and enterprise risk management Board of directors and audit committees SEC reviews of filings and enforcement activities Management and the controllership function

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What the course is about (contd)

Evaluate how these functions have performed historically

Examine recent corporate accounting scandals

Identify, evaluate the systems, policies, procedures, and controls that can be employed to promote good corporate governance and ethical decisions

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Part I: Big Picture and Regulatory Environment

What is corporate governance and what is the state of U.S. corporate governance? Corporate Governance, Organizational Architecture and Ethics Securities Laws, the Role of the SEC and the Sarbanes-Oxley Act Rules-Based versus Principles-Based Accounting Standards
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Part II: External Audit and Risk Assessment

Strategic Risk Assessment and Corporate Fraud A Review of Fundamentals of Financial Statement Analysis External Audit and Fraud Detection: Auditing Standards External Audit and Fraud Detection: A Case Study External Audit and Fraud Detection: Practice Understanding Audit Failures

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Part III: Accounting Control

Internal Control and Enterprise Risk Management A Case Study on Breakdowns in Organizational Culture & Management and Failures in Control and Information Use Audit of Internal Controls under Section 404

Developed assignment based on PwCs Auditing Alchemy Inc. case

Plan is to teach the case in an integrated fashion across ACC 321, ACC 814 and ACC 852.

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Part III: Assorted Topics

Corporate Communications:

A Case Study on Governance and Investor Communication Challenge

A Case Study on Responsibilities of Accountants Professionalism and Ethical Behavior

Ethics:

Bias in Audit Judgment and Earnings Management

Review of Academic Research

A Case Study on Conflicts of Interest
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Management of Professional Services Firms

Part IV: Application to a Recent Scandal

Enron: Corporate Governance and the Role of Intermediaries Understanding Enron through the Accounting Lens Transaction Structuring and the Management of Financial Reporting: Enron Corp., JEDI and Chewco

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How were the students evaluated?

Number % of Points Group presentation 2 9% Group memos 3 27% Group case write-up and presentation 1 14% Individual mid-term and final take-home exams 2 36% Class participation 14% Total 100%
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Group Presentations and Memos

Group Presentations

Sarbanes-Oxley Act Rules-Based versus Principles-Based Accounting Standards

Why do audits fail? Evidence from Lincoln Savings and Loan A Case Study on Failures in Control and information Use: The Barings Collapse Transaction Structuring and the Management of Financial Reporting: Enron, Chewco and Jedi

Group Memos

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Case Presentation and Exams

Group Case Presentation

Comprehensive fraud detection study

Financial statement analysis, earnings quality and credit risk assessment, accounting covenants and earnings management incentives, fraud triangle, estimation of economic damages from accounting fraud, outline of expert report on GAAP and GAAS problems

Sample Exams

Based on a AICPA case study

Corporate governance audit of Warnaco Group with particular attention to Board membership and composition, management incentives and performance evaluation, earnings quality and earnings management, related party transactions, and potential conflicts of interests.
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Emphasis on Communication Skills

Coordination with the departments Communications Center

Objective of the Center is to support the department in developing both the written and oral communication skills of students in the Departments M.S. program by establishing best practices guidelines for written and oral communications.

Assistance with memos and write-ups as well as in case presentation

Review draft memos/write-ups and draft presentations Videotape practice presentations and provide feedback
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Guest Speakers

Corporate Americas Perspective

Vice President and Controller of a Fortune 100 company and member of EITF Audit committee member of Tyco, Apple and MGM Grand

Board of Directors Perspective

External Auditors Perspective

Senior audit partner of a Big-4 firm

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Plans for the Future

More emphasis on SEC regulation and enforcement Integrate COSOs new ERM framework Develop additional case materials linking governance, accounting and incentives Etc.
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Final Thoughts: The Role of Corporate Culture and the Gatekeepers

Regulation is a blunt and only partly effective tool in the governance field... That is not to say that regulation doesnt have a vital role to play Many of the provisions of the SarbanesOxley Act such as officer certifications, bans on loans to officers, mandated audits of internal controls and others have substantially improved the regulatory structure in areas where too many boards historically failed to act[However, government] regulation is less and less efficient when issues become more subjective and less clearcut In contrast, boards of directors, outside auditors and outside counsel are the gatekeepers of behavior standards who are able to prevent damage before it occurs if they are alert, and above all if they are willing to act when necessary.
Restoring Trust, Report on WorldCom, Richard C. Breeden, August 2003
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Contact Information

About our curriculum revision efforts

Tom Linsmeier: tjl@msu.edu

Requests for ACC 852 syllabi and/or full citations for articles referred to in this presentation

rameshk@msu.edu

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Extra Slides

Not included in oral presentation

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Questions From the Recent Scandals

Was U.S. corporate governance broken? What changes have been made to fix the system?

Mandatory Voluntary

Would these changes make a difference? Is teaching corporate governance a mere fad? Is SOX the flavor of the period?
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Accounting and External Governance

Accounting information used by

Shareholders

To buy and sell shares of stock To evaluate performance of Board and senior management

Suppliers of financial, physical and human capital, and customers

To negotiate supply or purchase contracts To monitor financial viability and future business prospects To evaluate the competitive landscape To collect taxes To regulate business affairs (banks, utilities) To monitor legal compliance (anticompetitive laws)
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Competitors

Government

Shareholders, Auditors and External Corporate Governance

Business Corporation
Senior Management

Shareholders Influence the hiring and firing of Board members Board of Directors Provide strategic guidance Hire and evaluate senior management and auditor Independent Auditor Monitor and certify internal control & financial reporting systems of the company
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Board of Directors Audit Committee

Independent Auditor

Shareholders

Internal Governance
Business Corporation

Business Decisions
Decision Management Decision Control

Senior Management

Employees

Enterprise Risk Management Controllership Function

Initiation Implementation Ratification Monitoring
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Mandated Governance: Historical Perspective

The stock market crash 1929-1933 The Securities Act of 1933 Mandatory Public Disclosure of Accounting Information The Securities Exchange Act of 1934

Creation of the SEC

Mandatory Auditing

GAAP

APB

FASB

Reviews & Enforcement

AICPA Standards for Auditing Established by Professional Accountants

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Financial Accounting Rules Established by Private Sector

Mandated Governance: Current Environment

Recent Accounting Scandals

Sarbanes-Oxley Act
Corporate Responsibility

PCAOB

Auditor Independence

Enhanced Financial Disclosures

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