Case 1.1 Enron Corporation

03/14/2014 Zizhang Huang Enron Case 1. The Enron debacle created what one public official reported was a “crisis of confidence” on the part of the public in the accounting profession. List the parties who you believe are the most responsible for that crisis. Briefly justify each of your choices.

The board of directors of Enron. They focused too much on becoming the world’s biggest company. However they didn’t balance the conflict between their goal and stockholders’ interest. From the letter of Wherron Watkin, it mentioned that “Skilling’s abrupt departure will raise suspicions of accounting improprieties and valuation.” They just ignored. Thus when misstatements and irregularities emerged and were made clear to the public, the executives of Enron lost the confidence of the stakeholders in the company. Internal Audit Committee in Enron. One of the most important duty of internal audit committee is to analysis and give the guide or advice of the company’s internal control. However, from the scandal, we can see that it used a lot of SPEs to maintain a “paperwork” healthy. Enron scandal happened proves that the internal auditors were not performing the way an audit group should. Arthur Anderson. The independence of the outsider auditors should be questioned. They didn’t present itself with professionalism and responsibility. They already noticed the suspicious financial report. In order to keep this client, they chose to ignore the misstatement because they not only provided audit service but also almost half of its

revenue came from consulting service. Thus the confidence that the public had in the company was diminished. 2. List three types of consulting services that audit firms have provided to their audit clients in recent years. For each item, indicate the specific threats, if any, that the provision of the given service can pose for an audit form’s independence.

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Design the accounting procedures. They helped them alerting the accounting systems within the company. There will be an increasing threat for the independence. In this case, the creators of the accounting procedures fabricated the financial statements by using a complex procedure that users could not understand. Also the SPEs strategy indicated that some manipulation from the part of the audit firm that also with prior knowledge of accounting ethics, which at most times makes it more risky, given the legal involvement.

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Review the financial statement. Financial statements are an important to the company revenue and all the financial processes. The auditors have easier access to misstating financial reports and statements. Manipulations of these data may be disclosed if the auditors process an appropriate precise audit to decrease the detective risk. In this situation, a review service of financial statement would be an increasing threat of independence.

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Provide professional consulting services such as tax or other accounting procedures. This is obviously a great risk of independence of the audit firm. Those consulting service may have associated with the auditing service they provided. In this case,

the manipulation is also very likely and comes as one of the biggest threats to audit consultancy services and its credibility that can hurt the reputation of the audit firm. And they are not able to perform their duties as an external auditor to the best of their ability. Their opinions are subject to change based on biases.

3. For purposes of the question, assume that the excerpts from the Powers Report shown in Exhibit 3 provide accurate descriptions of Andersen’s involvement in Enron’s accounting and financial reporting decisions. Given this assumption, do you believe that Andersen’s involvement in those decisions violated any professional auditing standards? If so, list those standards and briefly explain your rationale.

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Independence. Andersen earned around $52 million from Enron during 2000, but only $25 million was payment in reference to the 2000 audit. Andersen’s interests were not independent of the company, but he invested himself in solidifying the security of the company and its success.

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Planning and supervision. Anderson should be supervised when performing the auditing service to keep independence. However the lacks of planning and supervision made Anderson become too involved in client accounting and financial reporting decision.

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Internal control evaluation. Anderson should have a sufficient understanding of the client’s internal control especially about their SPEs.

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Reporting. Because Anderson didn’t maintain its independence, they should issue a disclaimer of opinion on its financial statement.

4. Briefly describe the key requirements included in professional auditing standards regarding the preparation and retention of audit workpapers. Which party “owns” audit workpapers: the client or the audit firm?

Audit workpapers is the record of the audit procedures performed, relevant audit evidence obtained, and the conclusions the auditors reach. The key requirement includes: a) The auditor must state in the auditor’s report whether the financial statements are presented in accordance with GAAP.

b) The auditor must bring to light an instances in which the GAAP were not consistent during the current period.

c) When informative disclosures are not adequate, the auditor must state so in the report.

d) The auditor must state an opinion in regards to the financial statements. If the auditor cannot state an opinion, this much be noted in the report. If the auditor is taking any responsibility in relation to the financial statements, it must also be stated in the auditor’s report.

Basically, audit workpapers are the property of the auditor concerned in all circumstances. That is to say, the audit work papers belong to auditing firm. The auditor

does hold responsibility for the evidence and reports, and is to make sure that the information is not misused in any way.

5. Identify five recommendations made to strengthen the independent audit function following the Enron scandal. For each of these recommendations, indicate why you support or do not support the given measure. Also indicate which of these recommendations were eventually implemented. 

Establish an independent audit agency. I agree with that. The independence of the audit firm is the most important fact to the auditing procedures. It determines the detective risk of the procedures. An independent audit agency would be much easier to keep independent because they would not gain an additional profit from auditing service or even some other related service.

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Prohibit the provision of all non-audit service to audit clients. I partly agree with this. Non-audit service is a huge part of profit for auditing firm. Providing such service is decided by market not only audit firms. I agree with that government should have regulations to rule these services such as which service is prohibited, which is limited, which should be supervised. We cannot simply prohibit all these firms.

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Require that audit clients periodically rotate or change their independent audit firms. I agree with that. An audit firm would be dependent if they work as auditors for a specific company for a long time because their profit and “fellowship” would be

associated with their client. This recommendation would force the company keep their auditors independent. Because there will be expensive for these firms to sign a “ghost protocol” every couple years. 

Require independent auditors to work more closely with client’s audit committee. I agree with that. That would help both auditors and companies to improve the efficiency. For companies, they would know what auditors exactly want to know and provide such information. For auditors, they would further analysis their clients statements to avoid or decrease detective risk.

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Establish more explicit statutory requirements that prohibit client executives from interfering with the work of their independent auditors. I agree with that. The companies pursue an unqualified opinion. There would a loss if they don’t get an unqualified opinion. This would release the auditors’ pressures from companies. Thus this is a way to improve the independence of the auditors. I think most of them are eventually implemented except the first one. The PCAOB , although, is authorized by Sarbanes-Oxley Act of 2002, it’s actually not an independent auditing agency but a supervisor of the public companies and audit firms.