Submitted to:

Ms. Kristine June

Uy, CPA
Submitted by:
Canoy, Jerreleane
Mae
Flores, Cherry Jean
Lendio, Mariciela
Mangbanag, Gellie
Vale
Yanson, Yeda Mae
ACCTG 9 8:3011:30 TTH

The audit professions primary purpose is to provide a true and fair view of
the financial reports of the company and whether they can be relied on. It is also
the responsibility of the audit firm to provide various services to its client with
integrity and objectivity. But with the major debacle of the Enron firm; there was
question mark on this profession. The firm went bankrupt mainly due to fake
financial statement, insider-trading, money laundering, etc. these activities were
carried out even when it was audited regularly. This resulted in new regulation for
A
CASE STUDY ON ENRON CORPORATION
the preserving the independence of the audit firm. As the independence of audit
firm is very crucial to build trust and credibility in the audit report presented to the
public. This resulted in prohibiting some of the services to the client, mandatory
rotation of the auditors, reporting to the auditors committee etc. this all efforts will
lead to presentation of true and fair picture of the financial performance of the firm
that has been audited by the audit firm.
The Enron scandal was related to bankruptcy of Enron Corporation that was
revealed in the year 2001. This was an American company dealing in energy and
headquartered at Houston, Texas. This case is recognized as the biggest audit
failure and was disaster for employees, defrauded investors, investment bankers,
accountants and its executives. This debacle was largely due to Enrons nontransparent financial statements that were not clearly demonstrating their
operations and finances. Additionally, companys unethical practices and complexity
of the business model added to the crisis. Their major objective was to show
income and cash flow as up, inflated value of the assets, and omitting liabilities
from the books.
These practices
resulted
in
hiding true and
fair information
from the public,
resulting in the
downfall of the company. Thus the management fostered the preparation of fake
balance sheets. Mainly four parties were responsible for this crisis. First one is
Kenneth Lay, the former chairman of the Houston Natural Gas. Lay as Chief
executive wanted to make Enron (Page 6, Par 1), he revealed that his ultimate goal
was for Enron to become "the world's greatest company". Also, Lay has too much
trust towards Skilling and Fastow as he became responsible for the crisis as
approval of the actions of Skilling and Fastow was done without inquiring about the
details. He was also involved in money laundering, making false statements to
auditors, lenders and investors (Page 9, Par 2). In order to maintain a high credit
rating, they are motivated to window dress their financial statements in order to
sustain Enron's stock price at high level (Page 9, Par 3). Furthermore, one of his
mistakes is appointing skilling on the condition by using the mark-to-market
accounting method for its long term contracts that will help the company to book
profit as soon as the deal was finalized (Page 10, Par 1). The result of these actions
brought the Enron to become the world's greatest downfall the opposite of ultimate
goal of Lay. Second is Jeffrey Skilling, known for making brassy, if not tacky
comments concerning his firm's competitors and critics, is a CEO of Enron is also
responsible to the crisis they are facing until now. Skillings contribution to the
company is undeniably admirable at the same time discreditable strategies. One of

the strategies implemented by Enron was found to be unethical (Page 6, Par 2). It
says that numerous elected officials and corporate executives criticized for allegedly
profiteering by selling electricity at the inflated prices. This activity has an
unreasonable profit on the sale of its product. Apparently, because of the need to
sustain Enrons stock price at high level, they need to window dress its financial
statements, the creative use of SPEs and also made extensive use of other
accounting gimmicks (Page 10, Par 2) and Skilling is included to this activity. All this
done by Skilling are the reasons to the wreckage of the company. The third is
Andrew Fastow, the CFO of the Enron at that time and is also one of the people
behind in this crisis to the company. His contribution to the downfall is controlling
the partnerships [SPEs] - keeping hundreds of potential losses off its book for the
stock price to be in their highest point (Page 9, Par 4). Furthermore, without a CFO
accounting gimmicks would not be possibly done. For this, Fastow earned millions
out of its investment he contributed to the financial problems to the SPEs to
become solvent (Page 9, Par 5). Also alleged by creating a corporate culture that
fostered, if not encouraged, "rule breaking" and responsible of having a lack of
internal controls (Page 10, Par 3). Undoubtedly, he is one of the masterminds why
Enron is suffering of this crisis. The forth individual responsible for the crisis was
Arthur Andersen who was responsible for the critics charged; that the enormous
consulting fees accounting firms earned from their audit clients jeopardized those
firms' independence and its obvious that Andersen helped Enron cook the books
(Page 12, Par 3). In addition, Andersen was responsible for the crisis involved in
destroying significant but undetermined number of documents relating to Enron and
its finances (Page 13, Par 3). The acceptance of all management said positions and
helping Enron's auditors, management, and accountants lead to the crisis of Enron.
External Auditing is defined as an unbiased examination and evaluation of
the financial statements of an organization. Generally, the auditor has the
responsibility to plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement, whether caused
by error or fraud. Because of the nature of audit evidence and the characteristics
of fraud, the auditor is able to obtain reasonable, but not absolute, assurance that
material misstatements are detected. The auditor has no responsibility to plan and
perform the audit to obtain reasonable assurance those misstatements - whether
caused by errors or fraud, that are not material to the financial statements are
detected. With regards to the case study of Enron Corporation, SEC clearly does not
require public companies to have their quarterly financial statements audit. Thus
the responsibility that lies with audit firm solely lies within the clients demand,
which at times is subject to manipulation and the likes. For the sole concern of
audit firm, their audit responsibility sticks to the limits as defined. That is to say as
per client preferences, whether or not it calls for quarterly financial statement.
However, auditing quarterly financial statements is one main avenue for auditor to
review as well as for the regulated agencies to consider the pros and cons of the
financial statements, whether be it quarterly, half yearly of the annual financial
statements for the sake of the stake holders delight.
Quarterly financial statements need not to be audited in our innocent
opinion. Yes, there are lots of advantages one major is that given the shortest
possible time in which the working papers are prepared, it is also subject to errors.
Hence, when audit are carried out, restatement can be drawn and adjusted, and

also it does not compromise with corporate ethics or so. Nonetheless, we believe
that it is not practical for business organizations to practice auditing their quarterly
financial statements. The key word is INTERNAL CONTROL - with proper internal
control, the financial statements at the end of the accounting period has the bigger
probability of being presented fairly and reliably; just like a domino, the audit
report will be likewise. It is a common knowledge to people with a background on
audit that auditing financial statements is costly hence it is not practical for
business organizations, doing so would entail them paying a much higher cost to
the audit firms. But honestly, it does not matter if the financial statements are
audited quarterly or annually, the result of the presentation and audit report of the
financial statements all belongs to the hands of the management and of course the
accountants involve. They have always a choice either to use their power honestly
or be engulfed by greed for money and use it inappropriately. As in the case of
Enron Corporation, if only the management and the auditing firm did their jobs
honestly, their companies (Enron Corporation and Arthur Andersen and co.) would
have not faced that tragic downfall.
From the case study given and assimilating the Excepts 3, there is clear
indication that notable decision when it matter to auditing and all its process
involving Enron are attended from Andersen's end. Thus, advices and
recommendation of Andersen' also make way to the board of the company.
However, when it again concern to professional auditing standards and its
compromise or its violation there is probable factor. From the excerpts it is learned
that Andersen's have failed to bring attention of Enron internal Audit and
Compliance committee, which bring back the question of professional auditing
standards that are violated in all circumstances.
Some of the standards that amount to accounting procedures at the very first
instance can be laid emphasis to the notion of accounting ethics itself that bears a
conscience stamp in principle. However, Andersen's failed obligation with its audit
firm goes against the very reason of accounting ethics. Moreover, noncompliance
and coordination with Enron internal auditor in reaching a decision also amounted
to violation of decisions. Add to it, overcoming proper financial accounting also
violated the very notion of professional auditing standards. Moreover, in economic
sense, the large lump sum amount charged by Andersen's for its professional
dispatch also did not translate into effectiveness in auditing process and
procedures, which again violated the professional standards and business ethics is
all essence. Moreover, auditing from the end of Andersen also did not take into
account to review the disclosure from various parties, which again bring back the
question of violating professional auditing standards for reason known and unknown
by the Andersen's executive and CFA.
Finally and the most important facet of violation in accounting standards can
be laid emphasis to the matter concerning Andersen's certified and trained
accountant that did brought the measure of objectivity and perspective to all the
transaction carried out during the phase before the Enron bankruptcy. Moreover,

Andersen accountant are also not in a position to understand all the critical features
related to Enron audits and its processes. However, the revelation that Andersen's
advice its client that paid a huge amount for professional service can be reasoned
to be rational factor and the question of professional violation in accounting
standards.
The Enron crisis has put the question marks on the audit firms
independence. The audit firms independence is the fundamental need to gain public
confidence in the auditors report reliability, and credibility of the information and
value communicated to investors, employees, creditors and various other
stakeholders. It is also necessary for ethical decision in conjunction with integrity
and objectivity. The independence of audit firm is very crucial to strengthen and
improve fairness of accounting and financial reporting practices. The independence
of the audit firms are affected by threats like self-interest, advocacy, intimidation,
self-review, familiarity or trust. The relationship arises due to contractual
relationship between audit firm and the client could be influenced by the any person
to misrepresent audit outcome and it can be due to self-interest, or advocacy
threats. The providing of audit services, lengthy audit tenure with the client,
developed personal relationship with the audit client and its employees, leads to
threat for the auditor firm.
For the debacle to the independence of the audit firms, regulatory authorities
have prescribed several recommendations for practice. Sarbanes-Oxley Act, 2002
was passed to strengthen Auditor Independence. Highlighted some of the
importance recommendation such as Mandatory audit partner rotation in which it is
mandatory to rotate and review partners every five years. It also prohibits the audit
firms rotate back to client before five years. It furthers states that other partners
with significant relationship role must be rotated in seven years. The audit firm
having less than five clients are exempted from this rule but they have to undergo
review by a Board (SEC 2003). We support this recommendation, as it will break
the long-term developed relation between the audit firm and the audit client. As
relationship build will act as barrier in the independence of the audit firm. This will
result in influence through the management and employees on the preparation and
analysis of financial statement and in turn representing unfair audit report. Second
is the prohibition of certain audit services, that is, audit services should not be
provided to the audit clients, as it would impair the firms independence. The audit
firm should not provide bookkeeping services related to the financial statements;
designing and implementation of financial information services, management
functions, investment banking services, internal audit, legal services that are not
related to the audit and actuarial services. All these are quite reasonable as
involving in these services will lead to conflict of interest. This will result in
perception that the work done is correct and don not need any further investigation.
Third is establishing audit committee where auditors are required to report
information on timely basis to the audit committee. This reporting should include all
the critical accounting principles and policies used by the client, alternative
accounting treatments and its potential consequences, discussed with the
management and written communication by the auditor to the management
including schedule of unadjusted audit references. This step will help to enhance

the relationship between the auditor and the audit committee. Moreover,
appointment of independence partner will help to review the relationship between
the firm and the client, the closeness between them and the interest of both. Forth,
audit firms should not function as a part of the management or as an employee of
the audit client, that is, dual employee. As this will lead to conflict in interest and
can lead to hindrance in the independence of the audit firm. It prohibits the auditor
to work for their audit clients as CEO, CFO, Controllers, which has major
responsibility to oversee financial reporting activities. As well as the former auditors
are allowed to join the position with above roles only after waiting period of one
year. Lastly, it should not be the promoter of the audit client stock or financial
interest because this will lead to advocating clients position even if the client is
incorrect for the fact that, auditor will be receiving fees for providing this service.
This may lead to presentation of miss-represented data.
Thus, with the help of following recommendations, independence of the
auditor can be protected resulting in presentation of ethical, true and fair financial
position of the firm to various stakeholders; as well as preserving the objectivity
and integrity of the audit profession.
In summary, top officials at Enron abused their power privileges. They
manipulated information while engaging in inconsistent treatment of internal and
external constituencies. These leaders put their own interests above those of their
employees and the public, and failed to exercise proper oversight or shoulder
responsibility for ethical failings. Sadly, the followers were all too quick to follow
their example.
Mark-to-market accounting mixed with the use of SPEs made Enron look
financially healthy when it actually was bleeding, bleeding severely. Misleading
information was given to the investors due to the accounting system, which
eventually lead to decreasing stock price when the information about this started to
surface. We think this was just a matter of time rather than a question about if they
would get away with it. Sooner or later more and more of the bad investments had
to be questioned because of its great sizes and also because at some time it had to
show that there were short of real cash in the company. We think the downfall of
Enron was caused by several factors.
Among many are the points we have chosen to present in this paper, the
mark-to-market method, the competitive working environment and the use of
special purpose entities. Not to forget is the importance of the people behind this,
Lay, Skilling, Fastow and Mark. The Enron scandal is not only a story about complex
accounting it is also a story about the people who made it possible. People that
made decisions affecting not only themselves or the 21.000 employees at Enron,
but also America as a whole.