Eight thousand years before the coming of Jesus Christ, the financial practice of bookkeeping was utilized to track assets and properties of empires on clay tablets using livestock and cowrie shells as a medium of exchange. As time has progressed, evolution has enhanced the of practice financial transactions through automated systems and cryptocurrencies. With advancements in technology and growth in the U.S. economic market, the value of tangible and intangible assets has resulted in an increase in the modern cultural notion of entitlement. As this becomes a growing concern amongst financial analysts, auditors, and business professionals, accounting standards are in need of their own audit and revision to tighten gaps and loopholes especially since the United States is considered a benchmark internationally.
For my research, I conducted a study that examined the United States accounting standards specifically looking at historical events such as the Enron scandal and the Paradise Papers where firms and institutions have taken an individual sense of entitlement and applied it to their business practice to put themselves better off than the overall market or respective industry. Research for this study was conducted through peer-reviewed articles from EBSCOhost Business Complete database provided by the University of Dayton and external articles from Forbes Magazine and Mic Network. In addition, financial reportings and market valuations from the firms utilized as examples for taking advantage of loopholes in the Generally Accepted Accounting Principles (GAAP) were obtained from Bloomberg Terminal in the Hanley Trading Center. Lastly, concepts of business ethics and generally accepted accounting standards were obtained from Nicholas A. Gillette’s senior thesis, former Clermont College Senior Scholar, who conducted his own study on this exact issue.
For a fundamental understanding of accounting standards in the United States, the governing body that oversees all financial transactions and regulations is the Securities and Exchange Commision (SEC). The SEC oversees the governing board of the FASB, or Financial Accounting Standards Board, who are responsible for for establishing the Generally Accepted Accounting Principles or more well known as GAAP. GAAP are a set of rules and practices that explain regulations on what measures of financial information a firm needs to disclose at the end of each quarter and fiscal year. These guidelines set a precedent goal for each firm that conducts financial transactions within the country’s border to produce relevant and faithful representation of financial activity over a particular time period. However, within these set of governing laws loopholes do exist and allow firms to benefit and avoid losing significant income and heavy tax deductions. Stephano Medina, contributor to the Mic Network, analyzes some of the worst loopholes that firms have taken advantage of that are completely unrecognized by the FASB such as antitrust monopolies, patent agreements, carried interest, and corporate lobbying (Medina). These loopholes have seen much attention with rise in speculation and appearances in financial literature referencing the biggest financial reporting scandal in history to that of Enron.
In 2001, Enron, an natural gas and energy bubble corporation, that filed for bankruptcy after reporting falsified financial statements and records to gain leverage from auditor Arthur Anderson (Akhigbe 187). Enron was in a very competitive industry where the success of any firm in that sector was reliant on how much of a natural resource they could find, expand, and profit from. Resulting in a decline of stock price and over-aggressive stated earning, Enron had taken advantage of the loophole of what accountants call “mark-to-market” reporting. Mark-to-market reporting is a “technique for financial instruments in a well-developed market and specific closing prices are obvious” that allow reported earnings to be manipulated (Giroux 1213). Enron’s CEO, Mr. Jeffrey Skilling, had utilized this type of reporting to where Enron’s “contracts would be valued at market or fair value rather than the more typical historical cost where the income would be spread over the life of the contract and roughly match actual cash flows” (Giroux 1213). The loophole of mark-to market allowed Enron to sign long-term contracts and report large gains of actual, liquid cash before any natural gas or energy supplies were delivered and transacted. This practice led to a sense of greed and entitlement resulting in Eron continually overstating their actual cash flows and eventually filing for bankruptcy. Not only did this loophole create a backfire on the company, but also to their investors.
Another part of Enron’s fraudulent activity is how they mislead their investors. Enron at its peak in the summer of 2000 was trading at ninety dollars per share, which at the time was fairly high and was listed in the Standard & Poor’s 500 Index. As Enron reported more and more aggressive earnings, investors began to saw promising growth and investment returns. One of the key financial pieces of data that investors in the stock market look at is how a company grows in revenue whether that’d be the company as a whole, products they have in the market, or the release of new products and how they will perform compared to competitors. In addition, investors look at how much debt a firm takes on and if the worst economic reality would happen to that firm, could all of their current assets and holdings pay it off? In the case of Enron, the company had understated its actual debt and overstated revenue gains to boost investor confidence that the firm was maximizing shareholders wealth and increasing overall returns annually (Akhigbe). By falsifying the actual economic reality of Enron, Skilling and other Enron executive management demonstrated that as the newly “crowned kings” of the energy sector that their incentive was to act in their own self-interest rather than the interest of the overall firm and investors. Investors had to settle for $7.2 billion among the millions of shares they issued and a loss of $90 per share if traded at its peak (CERNUȘCA 38). Enron’s actions reiterate that “ethics in accounting are essential to producing financial statements that encourage public confidence” (Gillette 53).
As a result of this scandal, the financial loophole of mark-to-market was closed up by the institution of the Sarbanes-Oxley Act in 2002. The Sarbanes-Oxley Act is directed towards the auditing of public accounting firms (eg. Pricewaterhouse, Deloitte, etc.) to produce more accurate financial disclosures and strengthen corporate compliance with the government (Sarbanes-Oxley Act 2002). This act prevents falsified revenue and income reportings so corporations can expect more accurate taxable income and investors can gage a realistic future enterprise value. By closing this financial loophole requires corporations to demonstrate transparent results and kingly qualities that do what is in best interest for the overall company, not themselves.
In November of 2017, thirteen million four hundred thousand electronic documents were unveiled of offshore financial holders and their clients’ holdings. The major law firm that was found responsible for covering and moving large clumps of corporations revenue into offshore accounts was Appleby, “a Bermuda-based law firm that caters to businesses and the wealthy elite” (Drucker). One of the major corporations exposed in this document release was the technology superpower Apple. Apple, Inc. is known for its highly successful and quality assured products of the iPhone, security software, and applications of one-touch payment processing. After the death of Steve Jobs, Apple’s founder, the company has had a lot of speculation revolved around its financial activity and product development. Apple released its newest iOS software for all of its products called iOS 11 which turned out to be a major red flag to investors and the technology sector after many consumer reports of device crashes and a security breach in the software’s firewall settings. Also, Apple retracted the release of its new smart speaker, HomePod, that was supposed to be the hot holiday product of 2017 to compete with Amazon’s echo and GoogleHome. Not only has Apple been lacking in its quality assurance of its products, but also has been skeptical in its financial activity.
After the release of the Paradise Papers, Apple and other corporations have been taking advantage of the loophole in US financial regulation that I have named “minimize to maximize”. This loophole allows corporations without any regulation or transaction fee to move portions of revenue earnings and income into foreign subsidiaries avoiding paying billions in taxes from what they actually earned during a fiscal year. Corporations minimize how much revenue they actually earned to maximize their profits that are placed in offshore accounts. Apple hired Appleby to evade the corporation from losing over two-hundred and forty billion dollars due to government taxes (Drucker). Since Apple sells their products internationally, the company has hid there offshore profits well into two categories, Apple Operations International and Apple Operations Europe. Apple Operations Europe was held in Irish subsidiaries that were alleviated to the title of “stateless” that allows Apple to avoid paying any tax penalty for holding money in Ireland (Keena).
Apple’s actions demonstrate a lack of kingly qualities and possession of acquisitiveness. By moving profits overseas, Apple was not willing to do what is just and right by paying their actual share of taxes hence violating kingly qualities of honesty and civic duty. As “kings” of the technology sector, Apple did not report their earnings honestly and displayed the attribute of acquisitiveness by having the desire to retain more money than they actually would have after paying billions in taxes. Since the disclosure of the Paradise Papers is a very recent development, Apple has yet to face any penalty and investigation is still ongoing. However, this release demonstrates how loopholes in the US accounting standards permit and raise the level of acquisitiveness and entitlement mentality amongst corporations.
In the conclusion of this study, research has demonstrated that firms such as Enron and Apple have taken advantage of loopholes in U.S. financial system and governing boards like GAAP and the SEC. Given more time allocation, I would conduct future research on how firms respond to interest rate hikes for 2018, and their response to President Trump’s new tax policy cutting corporate taxes to twenty percent. In addition, it would be very interesting to investigate other firms outside of the information technology and energy sectors that take advantage of tax-evasion loopholes and see if there are other irregularities in regulated reporting principles.
Particularly progressing with this current loophole in tax-evasion, solutions to closing this loophole should require firms to identify where they hold liquid assets and investments to properly report taxable income. The US government should have the wherewithal after the release of the Paradise Papers and other companies that evade paying their actual taxes on income that there needs to be regulation on how much a firm can invest in foreign subsidiaries or moving capital to foreign exchanges. Lastly, in an ethical sense, firm executives, seen as kings of the business world, need to demonstrate kingly qualities of honesty and selflessness to be successful in their industry rather than placing themselves on a pedestal with the cultural mentality of acquisitiveness and entitlement. As consumers in the U.S. economy, we need to stress the importance of financial literacy and business ethics especially to millennial generations who hold the outcome of closing and preventing future financial loopholes. With these loopholes in GAAP and the financial regulation system, this is a clear sign that action needs to be taken to revise standard principles and set a fair standard on corporate tax responsibilities.