SECOND SEMESTER A182 2018/2019AUDITING AND ASSURANCE 1BKAA2013GROUP CCASE STUDY : Enron Corporation and Anderson, LLPAnalyzing the Fall of Two GiantsPrepared for:DR. SALAU ABDULMALIK OLARINOYEPrepared by:244735 ER SOON YONG246458 NURLIYANA HAZWANI BINTI RAHIM256018 MUHAMMAD AKMAL BIN SUHAIMI256127 HAFIZATUL IZZATI BINTI MOHD RIDZUNSubmission Date:5 MAY 2019What were the business risks Enron faced, and how did those risks increase the likelihood of material misstatements in Enron’s financial statement ?Enron faces the risk of currency instability and foreign currency risk. The business nature of Enron has led the company to be exposed to additional risks that caused pressure on corporate executives to practice aggressive financial reporting practices, and intentional material misstatement.
This risk awareness eventually resulted in the company bankruptcy. Enron undertook international projects relating to construction and management of energy capacity. This increased it business risk several fold. There was a strong possibility that Enron would not have cash to meet its operational needs. Consider this, Enron had to operate gas pipelines, pulp and paper plants, broadband facilities, international water plants and electricity generating plants.
Moreover, it was trading on the international financial markets for these products/securities. The risks that it would not have the cash flow to finance these operations increased.Enron acts as a speculative futures broker, which exposes the company to enormous energy and other commodity price risks. The company also offers financial hedge to its customers, exposing Enron to risks such as interest rates and strengthening foreign exchange risks. Enron is a major player in hedging and contracting for electricity supply, highly competitive business subject to price war and environmental concerns. Most of Enron’s businesses have been managed through the internet, exposing the company to the risk of technological failures. Given some of Enron’s business risks are realized, company management is under pressure to report healthy financial results. a) What are the responsibilities of a company’s board of directors?The board of directors play a important roles to protect the shareholder’s asset and provide a return on investment. Board of directors also need to make a decision which may effect shareholder’s benefit. Directors also held responsibility by shareholder and others if they negligent in their dutiesb) Could the board of directors at Enron especially the audit committee have prevented the fall of Enron? The fall of Enron could have been prevented by the board of directors. The board should responsible for the company’s financial reports. However, they are failed to disclose the off books liabilities to public, which led the Enron fall. What is more, the board and the audit committee do not question any of the high risk transactions. c) Should they have known about the risks and apparent lack of independence with Enron’s SPEs? What should they have done about it? They should have known about the risk and apparent lack of independence with Enron’s SPEs. They should recognize the high risk transaction with SPE will have huge effects on Enron. They also have opportunity to limiting the Enron uses the EPS.In your own words, summarize how Enron used SPEs to hide large amounts of company debt. Enron took the use of SPEs to utilize them with a variety of hard assets and liabilities, and very complicated derivative financial instruments, their own limited shares, the right to acquire stocks and related liabilities. As its financial dealing became more complicated, the company apparently also used SPEs to put the troubled assets that were falling in value, such as certain overseas energy facilities, the broadband operation or stock in companies that had been played to the public. Transferring these assets to SPEs meant their losses would be keep off Enron’s books. Enron hide large amount of company debt by selling assets to the SPEs, which had borrowed money in order to purchase the assets. Enron was responsibility to pay back the loans taken out by the SPEs. Enron was making a sale to itself, showing a profit on its books, and hiding the related loss in the SPE. The profits making by Enron actually is their own business losses. What are the auditor independence issues surrounding the provision of external auditing services, internal auditing services, and management consulting services for the same client? Develop arguments for why auditors should be allowed to perform these services for the same client. Develop separate arguments for why auditors should not be allowed to perform non-audit services for their audit clients. What do you believe?If the same consulting company is performing all these functions, there are great risks of missing things because of familiarity. If the same firm is performing internal and external audits, they may be inclined to examine loosely because of the familiarity with their own work. Additionally, managerial consulting could be advised in the interest of the auditing firm rather than the organization. In support of providing cross services, auditing firms should make sure to effectively implement separation of duties so that the same auditors are not double checking their own work and internal controls are existent and unbiased. Our team is in favor of providing cross services as long as the auditors are only working in specified areas and not duplicating their own efforts.Explain how rule-based accounting standards differ from principle-based standards. How might fundamentally changing accounting standards from bright-line rules to principle-based standards help prevent another Enron-like fiasco in the future? Some argue that the trend toward adoption of international accounting standards represents a move toward more principle-based standards. Are there dangers in removing bright-line rules? What difficulties might be associated with such a change?After the Enron scandal there has been ongoing debate whether rule-based or principle based accounting is more efficient. The rule-based accounting standards are based on detailed rules which accountants follow when preparing financial statements. Accountants usually prefer these standards, since the set rules increase accuracy and lower ambiguity regarding management decisions. Moreover, accountants can follow these set of strict rules and lower the possibility of lawsuits against them and their companies. The principle-based accounting standards are based on a set of objectives that ensure good quality reporting. In addition, there are examples which provide guidance for accountants and explanation of the objectives. Under principle-based accounting, accountants need to use their own judgement whether financial reporting tactics are appropriate or not. Furthermore, the guidelines, provided by the principles, can be practical under many different circumstances. Because of the recent accounting scandals, it is apparent that rule-based accounting has some disadvantages. Accountants can declare that financial statements have followed the rules, even if this is not exactly the case. Thus, bright-line rules leave loopholes and allow accountants to use them. Changing the standards to principle-based could prevent Enron-like fiascos due to increased comparability of transactions among companies regardless of the industry and the ability of accountants to choose the best way to account for and report a transaction. Nevertheless, there are inevitable difficulties and dangers to removing bright-line rules. If international accounting standards are adopted in the United States, then a judgement framework will need to be developed as a response to this change. In addition, companies will need to include the basis on which they have accounted for transactions and their reasons for decisions made. Another possible difficulty that could arise involves comparability – it could become difficult to compare one company to another. Such a change in accounting standards could potentially lead to dangers, such as the negative impact on derivatives and employee-stock options.Enron and Andersen suffered severe consequences because of their perceived lack of integrity and damaged reputations. In fact, some people believe the fall of Enron occurred because of a form of run on the bank. Some argue that Andersen experienced a similar run on the bank as many top clients quickly dropped the firm in the wake of Enron’s collapse. Is the run on the bank analogy valid for both firms? Why or why not?Run on the bank is withdrawing the funds or money from financial institutions due to lack of confidence about insolvency of banks among investors. In this case, the run on the bank means that withdraw money or investment of investors due to collapse of Enron regarding misstatement of their financial statement and integrity problem. Yes. The run on the bank analogy valid for both firms. Most of the investors, clients and suppliers suspend to doing business with Enron corporation because of public disclosure of diminishing liquidity, questionable management decision and other practice that destroy the trust among third parties. However, the most critical issue that causing run on the bank is their integrity problem and damaged reputations. People are curious about their insolvency problem, audit report, business practices and issues related to their business. Some of them are didn’t know the actual issue that involved by Enron Corporation, but they believe Enron Corporation’s trust and reputation become questionable and they wouldn’t working or invest with this kind of corporation. Therefore, people are escape or keep a distance from Enron Corporation to prevent any losses that might occurred due to Enron Corporation’s integrity. The stock price of Enron Corporation was started drop when the registration of Chief Executive Officer, Jeffery Skilling on August 2001. The people are curious that the six months term as CEO by Jeffery Skilling and started to criticize the business operation of Enron Corporation. On October 2001, Enron reported loss of $618 million and reduction of $1.2 billion on shareholder’s equity on third quarter of 2001. The stock price of Enron dropped significantly during the period. On November 2001, the company announcement stated that Enron had overstated $586 million over the previous four years and owed up to $3 billion of liability due to partnership operations. The stock price falls below than $10 from the earlier highest price $100 before Enron collapse. The stock even dropped to $ 0.40 due to Enron filed for Chapter 11 bankruptcy on December 2, 2011. This shows the process of investors withdraw the money or sell the stock due to the integrity problem occurred on Enron Corporation. The Anderson, LLP. facing run on the bank when Enron’s collapse. Anderson, LLP.’s reputation, trust and confidence damaged along with Enron corporation due to unethical and inappropriate accounting practices. More than 400 clients were fired Anderson, LLP. as their auditor and Anderson LLP. even cease auditing publicly owned companies. Enron’s collapse was affected the largest and famous international audit firm into oblivion.A perceived lack of integrity caused irreparable damage to both Andersen and Enron. How can you apply the principles learned in this case personally? Generate an example of how involvement in unethical or illegal activities, or even the appearance of such involvement, might adversely affect your career. What are the possible consequences when others question your integrity? What can you do to preserve your reputation throughout your career?The lack of integrity will affect the decision making by our surrounding people since they lack confidence towards us. In case of Anderson and Enron corporation, the investors and customers are not going to trust them and refuse to have business with them since their integrity and reputation become questionable. Enron corporation lose their suppliers, customers, investors and their business until they need to declare bankruptcy. Anderson, LLP. lose their reputation and business due to their unethical accounting practice. The investors and customers will not take the risk corporate with poor integrity company to avoid from unexpected loss event. Thus, integrity is the basic or important foundation to have a relationship with client, employer and family. Nobody will work or corporate with you if you don’t have integrity and moral value. For example, if I am an auditor for certain company and doing some unethical audit practices such as hide the business’s mistake, express the wrong opinion and refuse to disclose audit evidence, I will be sacked by my audit firm and charged under audit law and regulation. I might have problem in looking for new audit jobs because of my previous unethical actions. It shows that the only one unethical action that taken by yourself might affect both of your life and future. It is because that you are lose trust and confidence from others to work with you. When the people are question about my integrity, they will reject any relationship with me especially business relationship. This is because they wouldn’t believe me and wouldn’t take the risk to corporate with me. They might worry that I will take any unethical action and damage their business or reputation. Even some of them will refuse my kindness action since they wouldn’t believe me at all and think that I might have my own personal motive. It shows that we are no trustworthy when people are question about our integrity and they wouldn’t believe us at first without any explanation chance given to us. In order to preserve my reputation throughout my career, I will always remind myself to keep a distance from unethical practice and action. I will ensure the decision that I made always consistent and correct with high ethical and moral standard. I will explain myself regarding to any question that related to my reputation to avoid misunderstanding between me and others. It shows that we should take care of our reputation from time to time and clarify ourselves with strong evidence when our integrity become questions for others. Why do audit partners struggle with making tough accounting decisions that may be contrary to their client’s position on the issue? What changes should the profession make to eliminate these obstacles?Partners looking to maximize services they could provide to clients, namely consulting services, created a conflict of interest in the independence in the core relationship external auditor and clients. Some partners may be less inclined to make tough accounting decisions which impact clients, as they would fear losing the additional revenues generated by add on services such as consulting. In many cases revenues from consulting far exceeded revenues from the external audit attestation of the financial statements.Standards were created to greatly limit the types of add on services external auditing firms can perform. When enacting the standards, this lack of independence was taken into account to reduce the types of add on services to greatly reduce a partner’s hesitancy in making tough accounting decisions. A governmental regulatory agency was created to monitor external auditing firms’ compliance with standards, including this issue of auditor independence. This agency is the Public Company Accounting Oversight Board (PCAOB) which enforces professional standards, ethics, and competence of accounting firms.A Securities and Exchange Commission (SEC) rule was also enacted to require external audit firms to rotate primary audit engagement partners off of clients after approximately five to seven years. This rule was enacted to prevent too close of relationships between external audit firms and client management, which may cause independence issues. Further, reporting requirements by external auditing firms to their clients’ audit committees were mandated to include: critical accounting policies used; alternative treatments of financial information within GAAP that have been discussed with management; ramifications of the use of such alternatives, and the treatment preferred by the accounting firm; and other material written communications between the auditor and management.What has been done, and what more can be done to restore the public trust in the auditing profession and in the nation’s financial reporting system?Given the problems in the case of Arthur Andersen and Enron where both the external audit firm and management made unethical decisions which caused public trust to erode, these sweeping changes were necessary. In addition to the changes required of external audit firms, as discussed in question #8, the Act created additional requirements of companies related to the accuracy of financial reporting.The Act began requiring CEOs and CFOs to certify in the financial statements of public companies related to the accuracy of financial statements (report). Specifically, the certification requirements require certification that: they have personally reviewed the report; based on their knowledge, the report does not contain any material misstatements or omissions; based on their knowledge, the financial statements and other financial information included in the report fairly present in all material respects the company’s financial condition and results of operations; they are responsible for establishing and maintaining internal controls, and have designed and reviewed the effectiveness of internal controls to ensure that they receive material information in a timely manner, and have presented their conclusions about the effectiveness of internal control in a report based on their evaluation; that they have disclosed to the audit committee any fraud and all significant deficiencies in the design or operation of the internal controls which could adversely affect the issuer’s ability to record, process, summarize, and report financial data and have identified for the issuer’s auditor any material weakness in internal controls; and any fraud (material or immaterial), that involves management or employees who have a significant role in the issuer’s internal controls; and, they have indicated in the report whether or not there were any significant changes in internal controls or other areas that affected internal controls subsequent to the date of their evaluation, including any corrective actions taken regarding significant deficiencies and material weaknesses.Going forward, enacted laws (including the requirements of the Act should be periodically reviewed to determine if they have been adequate. In cases where further unethical behavior leads to misstatement of financial statements which mislead investors and other impacted parties, studies should be performed to determine if additional laws or standards should be enacted.Reference Business Dictionary. (n.d.) Run on the bank. Retrieved from HYPERLINK ” J. (2019). Bank Run. Retrieved from HYPERLINK ” M. (2006). Enron case centers on question of liquidity. Retrieved from HYPERLINK “