Siño, Ferl Diane S.

BSA31

CASE STUDY:

List down at least three things that "went wrong" with Enron. This can include internal
control flaws, accounting flaws, and any other flaws you have noted. Explain each section
in not less than 5 sentences.

1. The corporate governance of Enron is entirely flawed.

The top management intentionally turned a blind eye to what is happening to the
company even if they are already aware of the organization's misconduct and anomalies.
They also lie about the company's true health and operations and made decisions for their
own personal interests. They even helped cover up discrepancies in financial statements
since an increasing stock value was also profitable for them due to compensation
schemes. And when some of their business and trading ventures began to perform poorly,
they tried to cover up their own failures than to come up with better solutions and
strategies. Moreover, the board of directors did not pay attention to the off-books
financial entities with which Enron did business, and they lack independence. Also, the
BODs were heavily deceived by management, and they did not have full access to
information, and the information they received was falsified or incomplete.

2. They hide millions in dollars in debt and losses through unlawful accounting practices
and techniques like subsidiary accounting, derivatives, and third-party investors.
The company employed a mark-to-market accounting method wherein when
companies have outstanding energy-related or other derivative contracts (either liabilities
or assets) on their balance sheet at the end of a particular quarter, and then they must
adjust them to fair market value. However, this method can be manipulated since MTM is
not based on actual cost but based on fair value. Through this accounting method, Enron
was able to hide its losses and make the business appear more profitable than it was,
which mislead its investors. They would build a project such as an energy plant and
 immediately put the profits on its financial books, even when the company had not even
made a dime. Moreover, Enron used off-balance-sheet special purpose entities (SPEs) to
hide its high debts and toxic assets from creditors and investors. Enron abused the
practice by using SPEs as dump sites for its troubled assets. Transferring those assets to
SPEs meant that they were kept off Enron's books, making its losses look less severe than
they were. These SPEs were run by Andrew Fastow, who is Enron's CFO at that time,
and this should not be the case because it creates a conflict of interest. So, Enron's
complex accounting and employment of different techniques made it difficult to see how
Enron was making money.

3. The connivance between the external auditor and Enron's management also played a
crucial role in contributing to the Enron fiasco.
Arthur Andersen served not only as Enron's external auditor but also as a
consultant of the company, and this doesn't seem right because if you are already the
external auditor, you should not provide any consulting services for your client. After all,
it creates a conflict of interest. Also, the accounting firm Arthur Andersen LLP and
partner David B. Duncan are the ones who oversaw Enron's accounts. As one of the five
largest accounting firms in the United States at the time, Andersen had a reputation for
high standards and quality risk management. However, they have been blinded by money
because Enron is one of their largest clients, and they think they cannot afford to lose
such a client. So, even though they saw many irregularities and malpractices inside the
organization, they chose to shut their mouths and compromise their standards. They even
continued to approve deals for Enron, although there are many cautions presented to
them. And when Enron's downfall happened, they shredded all the documents related to
Enron in order to prevent them from being used against them in the court, which was a
clear obstruction of justice.

Reflecting back on Code of Ethics for Professional Accountants, what could have prevented
these flaws from happening? Explain.
 These flaws could have been prevented from happening if only Enron dedicatedly
employed the Code of Ethics within the organization and if only Arthur Andersen practiced the
fundamental principles. The Code of Ethics is essential to ensure that the company and its
employees are doing their jobs ethically and preventing any misconduct. Suppose the
management only became straightforward and honest with the actual condition of the company's
operations and did not conceal any discrepancies. In that case, they could have saved the
company from downfall by utilizing different ethical strategies to make the company profitable.
Additionally, the Board of directors should be more focused on their jobs and practice objectivity
by not allowing any conflict of interest or any bias within the organization. Also, BODs and
management should not act for their own personal interests.

Furthermore, if irregularities and misleading statements came to the external auditor's

knowledge, he should do something about it, requiring the management to correct and disclose
any misstatements. Even though they would lose a big client, Andersen should not help Enron
cheat on its financial statements. They should not have issued "clean" audit opinions on Enron's
financial statements and should have maintained their integrity. The auditor should also become
more objective by not conspiring with the client or lowering his standards just to earn big money.
Neither should they let their firm and Enron have any conflict of interests by providing a mix of
services nor should they be engaged in an intimate relationship with Enron by being the external
and internal auditor at the same time. Such acts and practices affect their professional and
business judgments and cause a lack of objectivity while conducting audits and providing
professional services to the client. Moreover, Arthur Andersen and David Duncan should have
maintained professional competence and due care while providing professional service for
Enron. They should have ensured that Enron receives competent professional service by giving
proper assessment and opinion on Enron's financial statements and affirming that it complies
with the applicable technical and professional standards. And if they knew that the company is
not complying with the standards and fraud was discovered, they should disclose those to the
appropriate public authorities according to confidentiality principle. Even though that
information was so confidential to the company, the auditors should still adhere to the laws
which require them to disclose such infringements. Besides, they should have practiced
professional behavior by not promoting any kind of fraudulent acts of Enron's management,
which deceived investors. Because such actions would taint and discredit the accounting and
auditing profession. They should have acted accordingly, fulfill their public interest
responsibility, and comply with the relevant laws and regulations, as well as the Code of Ethics.

If you are David Duncan (Audit Partner of Arthur Andersen for Enron), what would you
have done differently? Explain.

If I were David Duncan, there are a lot of things that I would have done differently. First
and foremost, I know that I have the responsibility to maintain the highest professional
accounting and auditing ethics and to lead the auditing team in a responsible, unbiased manner.
As soon as I learned about the company's misconduct and anomalies, I would immediately talk
to the top management regarding that matter and disclose everything that I've found out. I would
reprimand them for their unfair practices. If they won't listen to me and do not take any of my
advice to them, I would have to disclose the company's illegal or scrupulous actions immediately
to the authorities. As an auditor, it was my duty to ensure that the audit reflected the company's
records' actual state and propose recommendations for sustainable growth. Also, I am responsible
to the stockholders to disclose the company's financial status's true nature to help them in their
decision-making. If I were Duncan, I wouldn't consistently ignore the cautions that were
presented to me, and I won't tolerate any malpractices of the company. Since I am already aware
that Enron has high audit risk, I won't be complacent, especially in conducting proper audit
procedures and substantive tests. I will make sure that I will obtain sufficient evidence to ensure
that the company is complying with the standards and the laws and regulations. I would also do
my best to give an audit opinion that would reflect the company's real status and exercise
professional skepticism in my audit. I will handle everything with professional due care and
won't do anything recklessly because I am working not just for my client and my firm but also
for the public interest. Also, even though I knew that Enron was one of my firm's largest clients
and would bring significant revenue to my firm, I still won't compromise my standards and
integrity. I won't issue an unqualified opinion since the company has many misconducts and
malpractices, especially in preparing financial statements. If I fall into that trap, I should not call
myself a CPA anymore because a true CPA won't engage in such activities knowing that it
would not just taint our own selves but also the accounting profession. Overall, my responsibility
to the accounting profession was guided by the professional ethics for accountants, including
integrity, objectivity, professional competence and due care, confidentiality, and professional
behavior to maintain the accounting profession's positive image.

References:

https://www.scu.edu/ethics/focus-areas/business-ethics/resources/lessons-from-the-enron-
scandal/

https://www.mint2save.com/enron-bankruptcy-reason-of-collapse-facts-conclusion/#:~:text=By
%20the%20end%20of%202000,December%202001%20amid%20all%20crises.

https://www.investopedia.com/updates/enron-scandal-summary/

https://www.britannica.com/event/Enron-scandal
https://bizgovsoc8.wordpress.com/2013/11/17/arthur-andersen-the-rise-and-fall/#:~:text=Arthur
%20Andersen%20had%20violated%20the,as%20much%20profit%20as%20possible.

https://www.journalofaccountancy.com/issues/2002/apr/theriseandfallofenron.html