March 2003

Ethical Accounting Practices and the Pressures on CPAs

By Walter M. Einhorn

Most of the recent sordid stories of corporate scandals involve senior management and CFOs that have manipulated the books to make their companies appear more profitable. The independence of outside CPAs becomes compromised when management places pressure on them to accept such representations at face value. CPAs should not allow these pressures to blur the line of ethical, legal, and moral standards. A respected leading practitioner in the industry for decades, the CPA must remain above reproach and maintain an impeccable standard of credibility.

Credit grantors see thousands of financial statements and business plans from companies seeking working capital. Evaluating and financing these companies requires attention to detail. To make sure their statements and business plans are meaningful, CPAs need to follow the golden rule: Always be factual and reasonable when evaluating a client’s presentations.
That sounds simple enough, but nearly all the dot-com scandals were rooted in inflated projections, signed off on by accountants that should have known better.

Being ethical and moral in the business world should be the rule, not the exception. Of course, there are no laws broken or ethical lines crossed by a company being optimistic about its future. It is, however, the accountant’s ethical duty to project honest and accurate information to shareholders and other interested parties.

I know of more than one case in which a CPA found himself at odds with a longstanding client who stubbornly refused to take the accountant’s advice, insisting that inflated projections be presented. The accountant was unable to persuade the client to be more financially realistic. The accountant faced a dilemma: sign off on numbers he did not see as realistic, or risk losing the account. Unfortunately, the company was able to find another CPA willing to overlook the overblown projections.

That doesn’t come as a total surprise. After all, the last several years have seen many instances where accountants serving public companies have been sloppy or worse. Afraid to rock the boat that was bringing in tremendous profits in the 1990s, many accountants were all too willing to overlook the simple “be factual and reasonable” rule.

While some companies—and by extension their accountants—may think playing fast and loose with the facts will help their businesses grow, the truth eventually catches up with them. And the consequences are all too familiar: businesses collapse, executives are arrested, and investors lose money as once-inflated stock prices plunge.

Sometimes the blame for poor financial statements and projections should be placed at the feet of the companies, rather than the accountants that they employ. For instance, recently a businessman came to me looking for a loan to start his business. The idea involved upgrading certain equipment commonly found in supermarkets. Upon closer examination, the business plan did not hold up. Besides the fact that the business relied on the endorsement of a high-profile sports star, it turned out the equipment to be upgraded (at a cost of $50 million) was owned by a third party. So the loan would be used to upgrade someone else’s assets. This proposition, when even preliminarily evaluated, fails completely.

Another example involves an entrepreneur who entered into a financial agreement to buy conditional sales contracts from a company that specialized in food delivery. The owner of the company knew he would have to make his profits look appealing in order to sell the food delivery contracts. In reality, however, his company was in financial distress. The owner of the food delivery contracts had created a Ponzi scheme in which he would use the new proceeds from financing to pay his old debtors and look like a profitable company. But in the game of financial musical chairs, the entrepreneur was left without a seat when the music stopped.

This tricky business atmosphere has many pitfalls that can lead a company from an apparent sophisticated business decision to financial ruin. In addition to the Ponzi perpetrator, the CPA certifying the financial statements could also be at risk. When making business decisions, it is the CPA whose business expertise should be relied upon to make sense of the enterprise.

Walter M. Einhorn, CPA, is the president and CEO of Sunrock Capital Corporation, a national asset-based lender headquartered in Philadelphia with offices throughout the United States. He is a former senior executive of Mellon Bank.
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