Auditing Problems of Enron and Arthur Andersen - Case Study Example

The Case of Enron and Arthur Andersen Introduction From a moral standpoint, the massive greed, lack ofethics and collusion among the auditors, company officials, legal counsel engaged, investment firms and bankers of Enron, the greatest losers were shareholders, creditors and employees of the company. No amount of regulation would have been able to shelter these groups of people from the dealings that went on behind closed doors in the company. The financial losses that shareholders and employees who had their pension funds invested in the company underwent did not end up in profit for the company. The greed that was evident did not benefit any one party at all. When the company shares lost ground in trading, the Securities and Exchange Commission (SEC), the Texas State Board of Public Accountancy and the US congress were on hand to instigate reforms that had the aim of ensuring that occurrences like those at Enron could not occur again. Arthur Andersen, the auditor at Enron, could be said to have received what it deserved in terms of being forced out of the market place due to bankruptcy. Additionally, the audit firm became a template of negative audit firms. The US federal government crafted regulatory legislation that is being taken up by other countries to prevent such occurrences in the future. For example, Mexico adopted those regulations in 2006 popularly referred to as the Sarbanes-Oxley Act. Discussion Enron as a corporate entity was not guilty of any major crimes that were blatantly obvious. On the most part, the company was indicted for misleading the outside forces charged with consulting for it and also misrepresented its financial situation1. These misrepresentations and falsehoods cannot entirely be considered as crimes. On the contrary, fraud can be considered as a crime but the very act of proving a criminal intent to defraud is very difficult. On the other hand, Arthur Andersen was convicted of a repeated single crime which entailed the obstruction of justice. This was largely due to the destruction of Enron documents that the audit firm continuously did. The shredding of those documents, which the accounting firm was well aware could be used in an SEC investigation, was in itself a crime. The case of Enron led to a number of individuals that were charged with different tasks to be charged with serious crimes with some of them pleading guilty to some. Mostly, many pleaded guilty with conspiracy to mislead that they did by presenting unfair reports on the company finances. Both Enron and Andersen had total disregard for any ethical conduct that was expected of them. There is no need for detailed presentation of the breaches in ethics as they were pretty blatant. This discussion is not focused on ethics despite the fact that legal ethics, financial analysis ethics and banking ethics were totally disregarded. Since the breach of ethics is not a crime, it is not pertinent to dwell on it. Enron is clearly in violation of the guidelines that are laid out in the Generally Accepted Accounting Principles (GAAP)2. There are three instances of the breach of GAAP that are notable in the conduct of Enron. The first is that the Special Purpose Entities´ (SPEs) accounts were incorrect. The equity method of accounting was selectively utilized in the SPE accounting as well as the failure of consolidation and failure of the elimination of the impacts associated with the transactions carried among the entities. The second is that there was partial disclosure of accounts and the last is that the financial reporting was not fair. In doing the above, Enron and Andersen can be thought of having viewed GAAP as being merely rules and not regulations. They also leaned towards the interpretation of GAAP in a more aggressive manner than normally envisaged. Additionally, they disregarded the fairness principle that is central to GAAP and in doing this, they ignored the fact that fairness is emphasized more that rules as well as accounting that focuses on the economic substance rather than the legal form. The fact that Andersen shredded evidence indicates that the firm was aware of the under dealings that were going on at Enron. Therefore, the firm was aware that the courts would bar it from auditing SEC registrants. In a move aimed at preventing a conviction that would have blacklisted it, the firm announced that it was planning to go out of business. Ultimately, its license to practice accounting was revoked in Texas for its ethical and professional misconduct. Audit firms nowadays offer non-audit services which have grown in the scope; an expansion that rapidly took hold in the last 20 years of the 20th century. After the scandal at Enron, which led to its collapse and the fall of Arthur Andersen from grace, the major audit firms dumped their consulting arms in the wake of increased sceptism from the public regarding auditor independence. Big advisory fees were cited as the major reason for doubt in the tainting of audits. In the year prior to the collapse of Enron, the company had paid $27 million for consulting compared to the $25 million that it had paid the auditor for audits. Critics used this relationship between Enron and Andersen to cite that audit firms were going easy on their large consulting clients3. Non-audit services offered by audit firms include bookkeeping and other affiliate services that are related to the maintenance of a company´s financial statements and records of accounts, the design and implementation of financial information systems and involvement in aspects of human resources. Bookkeeping entails the records of sales, purchases, receipts, income and payments that are made by companies or individuals on behalf of them. Bookkeeping is the precedent to accounting. Therefore, audit firms can be involved in the creation of the actual records that they are meant to audit. The process of bookkeeping does not merely involve the systems like single-entry and double-entry but rather encompasses all transactions that are carried out in the course of business operation. Obviously, there is a conflict of interest that is depicted in one creating the very records that one is meant to audit. It is the classical case of being both the judge and jury. The independence of the auditor is not guaranteed in the provision of this service, as ultimately, wrongful bookkeeping cannot be remedied by the auditor who was involved in keeping the wrong records. Additionally, unfair reporting cannot be avoided in such an occurrence. The SECs Revision of Independence Requirements encompasses four basic principles. The principles indicate when an auditor is not independent. The first is the existence of a conflicting or mutual interest with the client being audited. Second is the auditor accounting own work. Third is the functioning of the auditor as part of the management or employee of the firm that it is auditing and last is the action of the auditor as an advocate of the firm being audited. Therefore, an auditor taking part in bookkeeping is in conflict with the interest of the firm and therefore, its independence is compromised under the second principle.4 In mitigating such an impasse, a different auditor will have to be employed so as not to contravene the SEC guidelines. Audit firms also design and implement financial information systems for their clients as part of their non-audit services. This involves the implementation of ways of record keeping, financial reporting and other information systems that will be reflected during audits. The involvement of the audit firm in the installation of a “system that is or will be used to generate information that is significant to the audit clients financial statements taken as a whole”5 is in contravention of the guidelines that are set forth by the SEC and as such compromises the independence of the audit firm in question. Audit firms that were surveyed vehemently opposed the notion that the provision of these services in any way compromised their independence. The mitigation of such a conflict of interest can either be by way of refraining from the provision of such services or utilizing an external auditor to perform an audit on the records produced by such a system. The third service provided by the audit firms involves aspects of human resources. The specific services that are considered as being in contention are hiring, recruitment and designing compensation schemes. In the most part, the provision of these services in regards to people who have influence in the company to be audited like managers, directors and officers is the source of interest. The SEC proposes a rule that seeks to challenge the independence of audit firms that are involved in advising their clients on their “affiliates´ management or organizational structure, when the auditor develops employee evaluation programs, or when the auditor conducts psychological or other formal testing of employees.”6 The independence of a company envisages "any professional employee involved in providing [on behalf of an accounting firm] any professional service"7 to the clients. The SEC requires that the determination of the independence of the audit firms be done with conclusive evidence detailing all relationships and accounts between the firm and clients. Read More