Enron Case Study Assignment 1

Group Members:
Maryam Azmat SP17-BBA-041
Sheeza Khan SP17-BBA-030
Naima Nouman SP17-BBA-010
Ayesha Ikram SP17-BBA-004

Assignment 1
Date: 11/9/2020
Corporate Governance

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Enron Case Study Assignment 1

ENRON CASE STUDY

Preface
Enron Corporation was an American energy, commodities, and services providing company
based in Houston, Texas. Before its bankruptcy on December 2, 2001, Enron employed
approximately 20,000 staff and was one of the
World’s major electricity, natural gas,
communications, and pulp and paper
companies, with claimed revenues of nearly
$111 billion during 2000. Fortune, an American
business magazine, named Enron "America's
Most Innovative Company" for six consecutive
years. The story ends with the bankruptcy of
one of America's largest corporations. Enron's
collapse affected the lives of thousands of
employees, shareholders and other investors. At
the end of 2001, it was revealed that its reported
financial condition was sustained by an
institutionalized, systematic, and creatively
planned accounting fraud, known since as the Enron scandal. Enron has since become a well-
known example of willful corporate fraud and corruption. The scandal also brought into the
question of the accounting practices and activities of many corporations in the United States
and was a factor in the enactment of the Sarbanes–Oxley Act of 20021. The scandal also
affected the greater business world by causing the dissolution of the Arthur Andersen
accounting firm.

History of Enron Corporation

Birth of the Company

Enron began as Northern Natural Gas Company, organized in Omaha, Nebraska, in 1930 by
three other companies. North American Light & Power Company and United Light & Railways
Company each held a 35 percent stake in the new enterprise, while Lone Star Gas Corporation
owned the remaining 30 percent. The company's founding came just a few months after the
stock market crash of 19292, an inauspicious time to launch a new venture. Several aspects of
the Great Depression actually worked in Northern's favor, however. Consumers initially were
not enthusiastic about natural gas as a heating fuel, but its low cost led to its acceptance during
tough economic times. High unemployment brought the new company a ready supply of cheap
labor to build its pipeline system. In addition, the 24-inch steel pipe, which could transport six
times the amount of gas carried by 12-inch cast iron pipe, had just been developed. Northern
grew rapidly in the 1930s, doubling its system capacity within two years of its incorporation
and bringing the first natural gas supply to the state of Minnesota.
Public Offerings in 1940s
The 1940s brought changes in Northern's regulation and ownership. In 1941, United Light &
Railways sold its share of Northern to the public, and in 1942 Lone Star Gas distributed its
holdings to its stockholders. North American Light & Power would hold on to its stake until
1947, when it sold its shares to underwriters who then offered the stock to the public. Northern
was listed on the New York Stock Exchange that year.

Growth through Acquisitions

Northern continued expanding during the 1970s. During the 1970s, Northern became a principal
investor in the development of the Alaskan pipeline3. When completed, that pipeline allowed
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Northern to tap vast natural gas reserves it had acquired in Canada. In 1980, Northern changed
its name to InterNorth, Inc. Over the next few years, company management extended the scope
of the company’s operations by investing in ventures outside of the natural gas industry,
including oil exploration, chemicals, coal mining, and fuel-trading operations. But the
company’s principal focus remained the natural gas industry. In 1985, InterNorth purchased
Houston Natural Gas Company for $2.3 billion. That acquisition resulted in InterNorth
controlling a 40,000-mile network of natural gas pipelines and allowed it to achieve its long-
sought goal of becoming the largest natural gas company in the United States.

Rename to Enron
In 1986, InterNorth changed its name to Enron. Kenneth Lay, the former chairman of Houston
Natural Gas, emerged as the top
executive of the newly created firm that chose
Houston, Texas, as its corporate headquarters.
Lay quickly adopted the aggressive growth
strategy that had long dominated the management
policies of InterNorth and its predecessor. Lay
hired Jeffrey Skilling to serve as one of his top
subordinates. During the 1990s, Skilling
developed and implemented a plan to transform
Enron from a conventional natural gas supplier
into an energy-trading company that served as
an intermediary between producers of energy
products, principally natural gas and electricity,
and end users of those commodities. In early
2001, Skilling assumed Lay’s position as Enron’s
chief executive officer (CEO), although Lay
retained the title of chairman of the board.

Enron: Before Collapse

Enron’s 2000 annual report discussed the company’s four principal lines of business. Energy
Wholesale Services ranked as the company’s largest revenue producer. That division’s 60 percent
increase in transaction volume during 2000 was fueled by the rapid development of EnronOnline, a
B2B (business-to-business) electronic marketplace for the energy industries created in late 1999 by
Enron. During fiscal 2000 alone, Enron Online processed more than $335 billion of transactions,
easily making Enron the largest e-commerce company in the world. On the other hand Lay’s
position as the chief executive of the nation’s seventh-largest firm gave him direct access to key
political and governmental officials. In June 2001, Skilling was singled out as “the No. 1 CEO in the
entire country,” while Enron was hailed as “America’s most innovative company. Enron’s chief
financial officer (CFO) Andrew Fastow was recognized for creating the financial infrastructure for
one of the nation’s largest and most complex companies. In 1999, CFO Magazine presented Fastow
the Excellence Award for Capital Structure Management for his “pioneering work on unique
financing techniques.”

Enron’s Corporate Profile

Central Management of Enron Corporation

- Kenneth Lay: Chairman, and Chief executive officer

- Jeffrey Skilling: President, Chief operating officer, and CEO (February–August 2001)
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- Andrew Fastow: Chief financial officer

- Triton Dietrich: Chief accounting officer
- Rebecca Mark-Jusbasche: CEO of Enron International and Azurix
- Lou Pai: CEO of Enron Energy Services
- Forrest Hoglund: CEO of Enron Oil and Gas
- Dennis Ulak: President of Enron Oil and Gas International
- Jeffrey Sherrick: President of Enron Global Exploration & Production Inc.
- Richard Gallagher: Head of Enron Wholesale Global International Group
- Kenneth "Ken" Rice: CEO of Enron Wholesale and Enron Broadband Services
- J. Clifford Baxter: CEO of Enron North America
- Sherron Watkins: Head of Enron Global Finance
- Jim Derrick: Enron General Counsel
- Mark Koenig: Head of Enron Investor Relations
- Joan Foley: Head of Enron Human Resources
- Richard Kinder: President and COO of Enron (1990-December 1996); co-founder of
Kinder Morgan
- Greg Whalley: President and COO of Enron (August 2001– Bankruptcy)
- Jeff McMahon: CFO of Enron (October 2001-Bankruptcy)

Products of Enron Corporation

Enron traded in more than 30 different products, including the following:

 Products traded on EnronOnline

o Petrochemicals
o Plastics
o Power
o Pulp and paper
o Steel
o Weather Risk Management
 Oil and LNG transportation
 Broadband
 Principal investments
 Risk management for commodities
 Shipping / freight
 Streaming media
 Water and wastewater

Enron’s Financial Performance (1996-2000)

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Exhibit: 1 Enron Corporation 2000’s Annual Report Financial Highlight Table

(In millions except per share amount)

Conclusion
The Enron Scandal is considered to be one of the most notorious within American history. At
the time of Enron's collapse, it was the biggest corporate bankruptcy ever to hit the financial
world. The Enron scandal drew attention to accounting and corporate fraud, as its
shareholders lost $74 billion in the four years leading up to its bankruptcy, and its employees
lost billions in pension benefits.

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The Fall of Enron

In May 2001, Enron’s executive Clifford Baxter left the company, apparently in
uncontroversial circumstances. It was rumored that Baxter, who later committed suicide, had
clashed with Jeff Skilling (Enron’s CEO), over the righteousness of Enron’s partnership
transactions.

On 14th August 2001, Jeff Skilling resigned as Chief Executive, citing personal reasons and
Kenneth Lay became Chief Executive Officer. Skilling’s departure was prompted by
concerns over Enron's bungled accounting and bad management.

In mid August 2001, Sherron Watkins, Enron’s Corporate Development Executive, who was
later referred to as the “whistleblower” in the Enron scandal, wrote a letter to Kenneth Lay
warning him of accounting irregularities that could pose a threat to the company. This
development shocked investors who suddenly panicked. The lack of transparency sent a
selling wave in the market. Investors sold millions of shares, knocking almost $ 4 off the
price to less than $40 over the course of the third week of August 2001. In spite of the drop in
price, management still insisted all was well. Despite the air of impending doom, Kenneth
Lay found two banks willing to extend credit. But the worst of revelations were to come yet.

On 8th November 2001, the company took the highly unusual move of restating its profits
for the past four years. Enron effectively admitted that it had inflated its profits by concealing
debts in its complicated partnership arrangements (Special Purpose Entities).

On 9th November 2001, the humiliation of Enron appeared complete as it entered

negotiations to be taken over by its much smaller rival, Dynegy. The following graph shows
how Enron’s restated accounts.

Reported and revised income, debt and shareholder equity 1997 – 2000 following special
partnership revelations;
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Source: Enron/Powers Special Report

Enron filed for bankruptcy in December 2001 and filed a suit against Dynegy for pulling out of
the proposed merger. Enron’s share price collapsed from around $ 95 to below $ 1. Enron’s
employees lost their savings as well as their jobs. Mr. Kenneth Lay, the once renowned
visionary chairman of the firm, resigned in January 2002.

It appears now that the phenomenal success of Enron was a daydream and it seems to have sunk
into a financial predicament that is largely of its own creation. In just sixteen years, Enron grew
into one of America's largest companies; however, its success was based on artificially inflated
profits, questionable accounting practices and fraud. Several of the company’s businesses were
losing operations; a fact that was concealed from investors using off balance sheet vehicles or
structured finance vehicles.

Why Enron Fell from Grace

SPE

A special purpose entity, sometimes called a special purpose vehicle, is a legal entity created for
one very limited, particular task. Typically, SPEs are subsidiaries of a larger corporation.
Usually the task of a special purpose entity is to isolate risk. By setting up an SPE dedicated to
the acquisition and financing of specific assets, the parent corporation is protected in case of
bankruptcy, loan default or other loss on those assets. Another use for an SPE is managing a
single asset that has exceptionally complex financial transactions and requires numerous
permits for its operation, such as a factory or a power plant. By placing the asset in the SPE, it’s
easier to keep track of income and expenses associated with this entity. Plus, if the owner wants
to sell the asset, any required permits will transfer with the SPE, eliminating the need to assign
them over separately. This greatly simplifies a potentially difficult sale.

Accounting Issue

Enron was one of the first amongst energy companies to begin trading through the internet,
offering a free service that attracted a vast amount of customers. But while Enron boasted about
the value of products that it bought and sold online around $880 billion in just two years, the
company remained silent about whether these trading operations were actually making any
money.

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It is believed that Enron began to use sophisticated accounting techniques to keep its share
price high, raise investment against its own assets and stock and maintain the impression of a
highly successful company. These techniques are referred to as aggressive earnings
management techniques Losses from its books if it passed these “assets” to these
partnerships. Equally, investment money flowing into Enron from new partnerships ended up
on the books as profits, even though it was linked to specific ventures that were not yet up
and running. It now appears that Enron used many manipulative accounting practices
especially in transactions with Special Purpose Entities (SPE) to decrease losses, enlarge
profits, and keep debt away from its financial statements in order to enhance its credit rating
and protect its credibility in the market.

The main reason behind these practices was to accomplish favorable financial statement
results, not to achieve economic objectives or transfer risk. These partnerships would have
been considered legal if reported according to present accounting rules or what is known as
“applicable accounting rules”. One of these partnership deals was to distribute Blockbuster
videos by broadband connections. The plan fell through, but Enron had posted $110 million
venture capital cash as profit.

Although these practices were generally disclosed to Enron’s investors, the disclosure was
inadequate. This inadequacy may have stemmed from conflict of interest to avoid revealing,
the extent to which some top Enron executives were enriching themselves, which simply
represents fraud. Another explanation may relate to Enron’s governance whereby Enron’s
structured finance transactions were so complex that disclosure becomes necessarily
imperfect. Therefore Enron’s investors had to rely on their business judgment of Enron’s
management, but such reliance failed due to a tangled web of conflicts of interests. This
becomes crystal clear when it was known that most of the senior Enron executives, especially
Andrew Fastow, served as the SPE’s principals, receiving massive amounts of compensation
and returns, in order to skew their loyalty in favor of the SPEs.

The Crash of Enron

The shockwaves of the corporate crash resonated worldwide as investors around the world
demanded answers. Congressional hearings began in December 2001. Four of Enron's most
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senior executives (Andrew Fastow, Richard Buy, Michael Kopper and Kenneth Lay) pleaded
Fifth Amendment protection against self-incrimination and refused to testify.

In January 2002, the US department of justice announced a criminal investigation. For the
average layman, the collapse of Enron is a scandal of a major energy provider that used to be
the seventh largest corporation in America and became the biggest bankruptcy in the US
corporate history. As revelations of the Enron affair continue to tumble out, employees and
investors are furious at the way a senior executive behaved and at how auditors, analysts,
banks, rating agencies and regulators turned a blind eye to what was going on.

The Enron fiasco is an unprecedented situation. This was a company with an extraordinary
complex and risky business model that entered into highly questionable transactions. The
market capitalization of Enron had reached exceptional valuations relative to the realism of
the company’s ability to produce recurring excess cash flow. What finally brought the
company down is finalized? Internal policies, investment advisors, investment banks,
undetermined criminal activity, poor auditing, and poor rating probably all played a role in its
rapid demise.

Enron’s Auditor (Arthur Andersen)

Arthur Andersen, one of the world's five leading accounting firms, was Enron’s auditing
firm. This means that Andersen’s job was to check that the company’s accounts were a fair
reflection of what was really going on. As such, Andersen should have been the first line of
defense in the case of any fraud or deception.

Arguments about conflict of interest had been thrown at Andersen since they acted as both
auditors and consultants to Enron. The company earned large fees from its audit work for
Enron and from related work as consultants to the same company. When the scandal broke,
the US government began to investigate the company’s affairs, Andersen’s Chief Auditor for
Enron, David Duncan, ordered the shredding of thousands of documents that might prove
compromising. That was after the Securities and Exchange Commission (SEC) had ordered
an investigation into the speculative actions of Enron. Duncan said he was acting on an e mail
from Nancy Temple, a lawyer at Andersen, but Temple denied giving such advice. While
Andersen fired Duncan, its Chief Executive Officer, Joseph Berardino, insisted that the firm
did not act improperly and could not have detected the fraud. Berardino conceded that an
error of judgment was made in shredding documents, but he still protested Andersen’s
innocence.

Links with The Government (Bush Administration)

In spite of the fact that there are no suggestions currently that there were any illegal
connections between the current US administration and Enron officials, there are close links
that exist between Enron and the current administration at all levels whether personal, social,
financial, professional or political. According to reports, thirty five administration officials
have held Enron stock, some had six figure investments. Several, less senior officials, have
served as paid consultants for Enron.

According to the US Center for Public Integrity, Lay (CEO of Enron) and Enron donated
more than $ 500,000 to the Bush campaign, thus making Enron the President’s largest single
patron. Bush has championed some issues Enron considered important, such as deregulating
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utilities and limiting compensation awards. Bush has also favored more oil exploration and
drilling in spite of opposition from environmentalists.

As for the US Vice President, Dick Cheney, he is alleged to have met Enron executives four
times in 2001 to discuss energy policy. Cheney’s critics say that no company in the US stood
to gain more from the energy policies than Enron. Later the General Accounting Office, the
investigative arm of the US Congress, demanded that the Vice President releases documents
relating to the formulation of government energy policy but he resisted. It is also known that
Cheney was the former Chief Executive of an oil services company named Halliburton,
which built the Enron Field stadium in Houston, when Mr. Cheney was its Chief Executive.
Paul O’Neil, the current US Treasury Secretary, had been contacted by Lay who asked O'Neil
to encourage US banks to extend their credit to Enron, a request refused by O’Neil. SEC
Chairman Harvey Pitts was hand-picked by Lay for the position, due to his notorious
aversion to governmental regulation of any kind.

The Link of Enron with the British Front

Shock waves of the Enron scandal have been felt in Britain too, where Enron acted as a
sponsor of the two main political parties, Labor and Conservatives. The Labor party was
accused of taking Enron’s money in return for access to government ministers. The party had
apparently changed its policy on gas-fired power stations after being lobbied by companies,
including Enron. This was seen by some as possible evidence of Enron's influence on
government policy. However, the UK Government insists its links with Enron have neither
changed policy nor bought access to ministers. The row has renewed campaigners’ calls for
political parties to be funded by the state rather than relying on business donations.
A second front of allegations emerged over Labor’s close ties with Andersen, Enron’s
accountants, a company barred from government work for failing to prevent the DeLorean
car company collapse. This ban was later lifted, which has caused the rise of awkward
questions faced by the Labor party now. Furthermore, Lord Wakeham, a former Conservative
Cabinet Minister and a nonexecutive director in Enron. Lord Wakeham served on the audit
committee that was meant to oversee Enron’s auditing procedures, which is at the heart of the
scandal, and supposed to protect shareholders’ interests. In response to these allegations,
Lord Wakeham stepped down as Chairman of the Media Watchdog, the Press Complaints
Commission (PCC).

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The consequences of Enron Collapse

Enron stands for the greatest company scandal in the history of the US economy and has
become a symbol of corruption for the whole Western economic system.

• 4500 employees lost their jobs.

• Investors lost some 60 billion dollars within a few days; for many it meant losing their old-
age security.

• The pension fund for the company's employees was obliterated.

• Citizen’s trust in the American economic system was destroyed.

• Losses on the financial market amounted to the worst stock value loss in peaceful times.

• Banks were suspected of collusion.

• The auditing firm Arthur Anderson lost its accreditation.

• The rules for company financial reporting were drastically sharpened: Sarbanes-Oxley Act
(2002).

• The close ties of the company's founder, Kenneth Lay, to US President George W. Bush –
Lay was an important financial supporter of Bush – came under sharp criticism

The Victim: Employees and Pension Fund Holders

The collapse of Enron has left thousands of people out of work. Thousands lost their personal
investments and pensions after the scandal broke out and Enron's stock plunged. Many
employees had personal pension funds made up of Enron shares - a common situation in
America, where occupational schemes based on final salary payments are increasingly rare
and money purchase schemes, known as 401(K) plans, are the norm. Employees at Enron
were encouraged to do so by the company, which also forbade them from selling their stocks,
when the company share price came down. In contrast, many Enron executives were able to
cash in their share options when the company’s fate became clear.

Creation of Sarbanes-Oxley Act

In response to the auditing and accounting problems laid bare by Enron and other corporate
scandals, Congress enacted the Sarbanes-Oxley Act of 2002 (P.L. 107-204), containing
perhaps the most far-reaching amendments to the securities laws since the 1930s. Very
briefly, the Act does the following:

 Creates a new oversight board to regulate independent auditors of publicly traded

companies – a private sector entity operating under the oversight of the Securities and
Exchange Commission;

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 raises standards of auditor independence by prohibiting auditors from providing

certain consulting services to their audit clients and requiring preapproval by the
client’s board of directors for other non-audit services;

 Requires top corporate management and audit committees to assume more direct
responsibility for the accuracy of financial statements;
 Enhances disclosure requirements for certain transactions, such as stock sales by
corporate insiders, transactions with unconsolidated subsidiaries, and other significant
events that may require “real-time” disclosure;
 Directs the SEC to adopt rules to prevent conflicts of interest that affect the
objectivity of stock analysts;
 Authorizes $776 million for the SEC in FY 2003 (versus $469 million in the
Administration’s budget request) and requires the SEC to review corporate financial
reports more frequently; and
 Establishes and/or increases criminal penalties for a variety of offenses related to
securities fraud, including misleading an auditor, mail and wire fraud, and destruction
of records.

Punishment

Kenneth Lay

 Born April 15, 1942

Tyrone, Missouri, USA
 Died July 5, 2006

 Conviction(s) fraud, false statement

 Penalty died before sentencing, conviction vacated

 Status died of a heart attack before his sentencing

Jeffrey Skilling

 Born November 25, 1953

 Conviction(s) conspiracy, securities fraud, false statement, insider trading

 Penalty imprisoned 24 years and 4 months, fined $45 million

 Status in prison

 Occupation prisoner/Failed Businessman

 Spouse Rebecca Carter

Andrew Fastow

 On October 31, 2002, Fastow was indicted by a federal grand jury in Houston, Texas
on 78 counts including fraud, money laundering, and conspiracy.
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 On January 14, 2004, he pled guilty to two counts of wire and securities fraud, and
agreed to serve a ten-year prison sentence.
 He also agreed to become an informant and cooperate with federal authorities in the
prosecutions of other former Enron executives in order to receive a reduced sentence.
As of November 2006, Fastow is Inmate #14343-179 at the Federal Detention Center
(FDC) in Oakdale, Louisiana, with a projected release date of December 17, 2011

David Duncan

 Jan. 10, 2002: Arthur Andersen says its employees destroyed a "significant but
undetermined“ number of Enron documents
 David Duncan were cited as the responsible managers in this scandal as they had
given the order to shred relevant documents
 On April 9, 2002 he pleaded guilty; the maximum sentence for his crimes is ten years,
but since he pleaded guilty and became a witness for the prosecution he would have
presumably received a much smaller sentence.
The final blows came when Andersen was banned from US government work after being
indicted by a federal grand jury on the charge of obstruction of justice. This was coupled with
the case brought by the US Department of Justice against the Andersen UK office for joining
in the shredding of Enron documents. This caused Andersen UK practices to reopen merger
talks with other accounting firms in response to these claims made against the office. Both
KPMG and Deloitte had been interested in Andersen's UK business, but KPMG's interest
trailed off as more information became available about Andersen's financial situation and the
potential risk of litigation. Andersen UK agreed to join with Deloitte, Touché & Tohmatsu. In
addition, Deloitte reached agreements with Andersen partners in Spain, Portugal, the US and
Mexico.

What then is the Solution?

If there is any good that came from a situation like Enron, it’s that collectively as an investing
public, we are better versed on accounting fraud of this nature. The financial markets, the
analysts, the Securities and Exchange Commission, and the public accountants have all by
now absorbed many of the intricacies of SPE abuse. In short, we now know for what to look
and efforts an be focused accordingly. So how do we prevent another Enron from happening
again? The standard-setters and the gatekeepers, in spite of all the accounting and disclosure
reform, need to appreciate with what they are dealing. A deficiency or a perceived deficiency
in the accounting rules is not the problem. The problem is persons that seek to obfuscate,
omit, and fraudulently report financial information. Accordingly focus on ferreting out SPE
abuse should be primarily placed on the abusers themselves, not the SPEs formed to
perpetrate such abuse. Wide spread legislation and accounting reform merely casts a broad
net with the hopes that the abusers will get snared along with the rest of the fish.
But in the meantime those fish are burdened with the added cost of complex and complicated
compliance when they weren’t doing anything wrong under the old regime nor had problems
complying under the old regime.

So what is the alternative? The forefront of the approach should be a narrow and isolated
focus on SPE abusers. Although the matter has not been completely resolved, the evidence
suggests that actual SPE abusers represent a small pool of companies relative to the total
population of public companies. This could be achieved by the SEC and or other related gate-
keepers taking a “risk-based” approach toward the problem. First, the gatekeepers should

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narrow its scope by first focusing on those companies’ or industries that lend themselves or
could potentially lend themselves toward SPE abuse.

Those industries that tend to deal heavily in derivatives, intangible assets such as the buying
and selling of futures contracts, etc. would be good places to start. Additionally, those
industries or companies that stand to come under earnings pressure, i.e. having trouble
reaching financial forecasts or earnings targets, or seem to be engaging in creative ways at
maintaining earnings and revenue growth. The overarching idea is that since we have seen it
before (ala Enron), that accumulated knowledge is taken and applied going forward. It could
very well be possible that in terms of SPE abuse, the proprietary abuse that Enron perpetrated
was a local and isolated event. The SEC Report, though useful in the information it
contained, did little to address the question of whether or not there is widespread SPE and
off-balance sheet abuse. The Report merely focused on SPE and off-balance sheet use, which
is helpful but doesn’t tell the whole story nor tell the most important part of the story.

With all of this collective knowledge and insight as to the accounting fraud that Enron
perpetrated, it is reasonable to conclude that the SEC could derive some sort of search criteria
or “corporate profiling” of either industries or particular companies that show indicia for
potential SPE abuse. Those companies could then be targeted and special attention and focus
could be placed on those companies. Understand that the initial stages of such action would
be non-intrusive. The initial stages of the focus would merely involve a close and scrutinizing
look at those companies’ annual and periodic reports for evidence of SPE abuse or any other
type of financial reporting irregularities.

If such scrutiny raises red flags then the SEC could then perform an escalated inquiry into the
matter. If the escalated inquiry yields problematic accounting, then the next step would be for
the SEC to initiate a more aggressive fact finding inquiry. If accounting irregularities are
found, the indictment, prosecution and ultimate conviction should be a high profile event.
Such would then send a clear and unequivocal message to other similarly situated offenders
to make the proper adjustments in their financial reporting or face the same fate.

Conclusion
The issues dealt with in this paper are complex and trying to resolve these issues pose an
even greater challenge. But before real effective change can be achieved, we must first be
able to target the root of the problem. Complex problems tend to involve complex solutions.
The band-aid of legislation, more guidance, or “clearer” guidance if you will, will more than
likely result in nothing more than the tug and pull between standard-setters and issuers to
continue along this “move”, “countermove” approach that has gotten us to where we are
today. Until we are able to focus more narrowly on the problem and deal with it from that
more directed approach, we’ll probably be seeing more of the same. Better mousetrap, better
mouse.

Questions & Solutions

Q#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.

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Executives of Enron - Kenneth Lay, Jeffery Skilling, and Andrew Fastow were all accountable for the
catastrophe. The executives of Enron composed the big earnings and pushed up the stock prices for their own
advantage. When misstatements and indiscretionsappeared and were made vibrant to the public, the
executives of Enron lost the confidence of the stakeholders in the corporation and the crisis of confidence
spread. Arthur Andersen - The auditing firm did not present itself with the professionalism and responsibility
that an audit firm should. When the firm noticed that the amounts recorded on Enron’s financial statements
were misstated, it was ignored in order to continue receiving the enormous amounts of fees and payments
from the corporation. In doing so, the confidence that the public had in the company was diminished. SEC -
The government agency who allowed Enron to use Mark-to-Market Accounting practice. This kind of
creative accounting practice allowed the Enron CEO to perform his Ponzi scheme “legally” and led to the
sudden collapse of Enron.

Q#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.

“Internal Auditing” should be conducted within a company instead of having an outside audit firm to perform
the service. If an outside audit firm was hired then it will present a threat to the legitimacy of the internal
audits. An audit firm should not be “Designing Accounting Systems” for a firm while performing audit
services to the same firm. It is too easy for the audit firm to alter the accounting systems within a company, an
auditor can fabricate the financial situations of a corporation and make it appears to be more profitable or
more attractive to investors. An outside audit firm should not provide “Professional Consulting” and auditing
service to a same company. Auditors involved in the dealings of a business are at risk for becoming subjective
to the success of that organization. When an auditor is involved in such 21 happenings, 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.

Q#3. For purposes of the question, assume that the excerpts from the Powers Report
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.

Yes, Andersen’s involvement in the accounting and financial reporting decisions violated professional
auditing standards of the independence in mental attitude. Andersen’s interests were not independent of the
company, but the audit firm invested themselves in solidifying the security of the company and its success.
The significant amount of earnings that Andersen received when performing accounting services to Enron
goes against auditing standards.

Q#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:
i) The auditor must state in the auditor’s report whether the financial statements are presented in
accordance with GAAP.
ii) The auditor must bring to light an instances in which the GAAP were not consistent during the
current period.
iii) When informative disclosures are not adequate, the auditor must state so in the report.

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iv) 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. 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.

Q#5. Identify and list five recommendations that have been made recently to strengthen
the independent audit function. For each of these recommendations, indicate why you
support or do not support the given measure.

 The party to whom the financial services are provided must hire a committee who will look into the
decisions made by the Auditor from Enron in this way the committee will already have an idea what
the auditor is going to provide.
 The money being paid to the auditors must be disclosed to all the investors so that they have a clear
idea, if in any case such details are not disclosed, and there is a very high fees it leads to the idea that
something is not right.
 The firm’s auditor must report to the issuer’s auditor committee the information related to the
accounting activities because the internal auditors must have the access to information that the
external auditors provide.
 The accounting rules must be changed that if they are provided to non-audit services this will harm
the accounting firm independence, there must be independence in all accounting activities.
 Create rules that an accounting firm would not be autonomous if certain members of management of
that issuer had been members of the accounting firm's audit engagement team within the one-year
period preceding the commencement of audit procedures. In this way the auditing and accounting
firms will operate separately.

Q#6. Do you believe that there has been a significant shift or evolution over the past
several decades in the concept of “professionalism” as it relates to the public accounting
discipline? If so, explain how you believe that concept has changed or evolved over that
time frame and identify the key factors responsible for any apparent changes.

Yes, I believe that over the years the accounting principles have been changed. There is more
professionalism. In the past all the account ting activities were conducted manually, which lead to the risk of
loss of data and human error. The principles of accounting were not that clear with the rules made by GAAP
and GAAS new principles were made which lead to more efficient performance of the accounting activities.

Q#7. As pointed out in this case, the SEC does not require public companies to have
their quarterly financial statements audited. What responsibilities, if any, do audit firms
have with regard to the quarterly financial statements of their clients? In your opinion,
should quarterly financial statements be audited? Defend your answer.

The auditor must be responsible to audit the financial statements quarterly compared to the yearly
statements. In my opinion the quarterly auditing of the financial statement will help the firm make amends to
all the discrepancies made in the financial statements before the year ends all the miscalculations would be
known to the firm sooner.

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Assignment 1

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