Enron Crisis of Confidence Case Analysis

ACCT475 Principle of Auditing

Professor: Ralph Cecere, CPA, CA

May Bai 260658887

Case 1: Enron

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.

Kenneth Lay, Jeffery Skilling, and Andrew Fastow, the executives of Enron, were the primary for this crisis. The corporate culture and the corporate strategy play a key role of how the company is going to operate. These executives created dominant coalition’s values of greed and win-at-all-cost among themselves and in Enron, which encouraged employees to make aggressive accounting decisions when they audit for the clients to build stronger relationship and pressure Enron’s employees to promote consulting services at the same time.

Moreover, the executives manipulated the earnings and pushed up the stock prices in order to increase their own compensation. The CFOs invented limited partnerships called SPEs for their clients to fulfill their needs of raising capitals and to able to avoid showing debt amount on their balance sheet.

As the auditor of Enron, Arthur Andersen not only failed to identify the frauds, misstatements and manipulations made within the financial statements of Enron, but also gave consent to Enron to continue abusing accounting methods in favor of their own benefits such as mark-to-market accounting method for its long-term contracts involving energy commodities. For example, the financial analyst discovered that notes receivables were not supposed to be recorded under asset section on the balance sheet.

Therefore, Andersen largely contributed to the trust crisis towards public accountants specifically.

As an independent government agency with a mission of protecting investors and maintaining a fair market, SEC and FASB failed provide enough guidance for accountants to follow in the accounting and reporting for SPEs, while endorsing the 3% rules. They indirectly motivated the accounting irregularities, which created uproar for stakeholders.

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.

1. Reviewing and auditing financial statements. Threats exist when the auditors get involved in the preparation of financial statements, which is bookkeeping services.

2. Designing and inspecting Accounting Procedure. If the auditing firm design accounting procedure and offering auditing services to the client at the same time, threats on independence of the audit firm would occur since the auditors would alert the client about their financial risks and assist the client by creating complex accounting procedures to confuse the public users.

3. Providing consulting services such as tax and other accounting procedures. Risks occur when the auditors, who are too involved in a business would become biased to the success of their client and lost their objectivity and independent position, especially when the client corporation’s success might determine the possibility of continued business relationship. Andersen is a perfect example of getting too intimate in Enron’s success and eventually involved in Enron’s frauds.

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.

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?

The key requirements included in professional auditing standards regarding the preparation and retention of audit work papers are:

1. The auditors must prepare the auditing report according to Canadian GAAP.
2. The audit paper should include a clear auditing objective in terms of audit assertion, a year/ period end full extent of the text to provide sufficient audit evidence for users.
3. The auditor should address an opinion regarding to the financial statements that is subject to unbiased, based on the facts stated in the audit report
4. The audit paper should disclose any inadequate or insufficient financial information and any involvement in the preparation of financial statements
5. The auditor must

The auditing firm, in principle, has complete ownership of the audit paper, considering the professional accounting ethics and principles. The auditor is not allowed to disclose any information to the third party without the consent of the client, unless special circumstances exist under ISA 230.