Case 4.

1
ENRON CORPORATION AND ANDERSEN, LLP:
Created by (Auditing Class Batch 2015):
ANALYZING THE FALL OF TWO GIANTS Amellia Samantha / 008201500036
Jersey Purba / 008201500057
Samuel Alexander / 008201500028
Stephanie Angelica / 008201500095
 Introduction
Enron Corporation was an American energy, commodities, and services company based in
Houston, Texas. Enron's predecessor was the Northern Natural Gas Company, which was formed during
1932, in Omaha, Nebraska. It was reorganized during 1979 as the main subsidiary of a holding company,
Inter-North which was a diversified energy and energy related products company. During 1985, it bought
the smaller and less diversified Houston Natural Gas company. The company initially named itself
"HNG/Inter-North Inc. however was later renamed to Enron.
Employed approximately 20,000 staff
One of the world's major electricity, natural gas, communications, and pulp and paper companies.
Revenues of nearly $101 billion.
Named as "America's Most Innovative Company" for six consecutive years by Fortune.
 Enron’s Line of Business
Enron was originally involved in transmitting and distributing electricity and natural gas throughout the United States. The company developed, built, and operated
power plants and pipelines while dealing with rules of law and other infrastructures worldwide. Enron owned a large network of natural gas pipelines, which stretched ocean to ocean
and border to border.

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

1. Petrochemicals

2. Plastics

3. Power

4. Pulp and paper

5. Steel

6. Weather Risk Management

7. Oil and LNG transportation

8. Broadband

9. Shipping / freight

10. Streaming media

11. Water and wastewater

12. Principal Investments

13. Risk management for Commodities etc.

 Scandal
In 1990’s corporate self regulation in the United States of America had been widely thought to
have reached a high plateau of evolutionary success due to proliferating good practices and sophisticated
institutional monitoring. However, the bankruptcy of Enron shook the entire system. Some highlights
brought about when this scandal had been exposed were:
1. $30 million of self dealings by the chief financial officer
2. $700 million of net earnings disappeared
3. $1.2 billion shareholders equity disappeared
4. Over $4 billion in hidden liabilities
Many of Enron's recorded assets and profits were inflated or even wholly fraudulent and
Nonexistent. Debts and losses were put into entities formed "offshore" that were not included in the
company's financial statements, and other sophisticated and arcane financial transactions between Enron
and related companies were used to eliminate unprofitable entities from the company's books.
 Key Players of Scandal
Kenneth Lay
Enron founder and former CEO
Lay took up the reins at Enron in 1986. Prior to Enron’s collapse, he was credited with building
Enron's success. Lay resigned as CEO in December 2000, and was replaced by Jeffrey Skilling. In
August 2001, he resumed leadership after Skilling resigned. Lay resigned again in January 2002. He
Drew Down His $4 Million enron credit line repeatedly and then repaid the company with the enron
shares after becoming the focus of the anger of employees, stockholders and pension fund holders
who lost billions of dollars in this disaster.
Jeffrey Skilling
Former Chief Executive, President and Chief Operating Officer.
He joined Enron in 1990 from the consultancy firm McKinsey, where he had developed financial
instruments to trade gas contracts. He was also seen as a key architect of the company’s gas-trading
strategy. He resigned his post as Enron’s chief executive in August 2001 without a pay-off.
Andrew Fastow
Former Chief Financial Officer.
He was fired in October 2001, when Enron made losses amounting to $ 600 million. He was allegedly
responsible for engineering the off-balance sheet partnerships that allowed Enron to cover its
losses. He was also found by an internal Enron investigation to have secretly made $30 million from
managing one of these partnerships.
David Duncan
Enron’s Chief Auditor at Andersen
His job was to check Enron’s accounts. He is accused of ordering the shredding of thousands of
Enron related documents in an effort to hide them from the Securities and Exchange Commission.
Enron’s accounting firm –Arthur Andersen
Arthur Andersen, was Enron’s auditing firm.
It’s job was to check that the company’s accounts were a fair reflection of what was really going on.
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.
Andersen fired Duncan.
 1. What were the business risks Enron faced, and how did those risks increase the likelihood of material
misstatements in Enron’s financial statements?

Answer:
The business risks that Enron faced included foreign currency risks and price instability, which is
common for the energy industry. In addition, Enron faced pressure to perform well so that the
stock price would rise.
 2.
a. What are the responsible of a company’s BOD?

Answer:
The board of directors is appointed to act on behalf of the shareholders to run the day to day affairs of
the business. The board are directly accountable to the shareholders and each year the company will
hold an annual general meeting at which the directors must provide a report to shareholders on the
performance of the company.
 b. Could the BOD of directors at Enron, especially the audit committee have
prevent the fall of Enron?

Answer:
It is impossible to know whether BOD of Enron can prevent the fall of this company since there’s
fraud opportunity in this company, that can be seen through:
a. Former Chief Audit Executif Enron (Head of internal audit) originally
is Andersen's partner who is appointed as a public accountant of the company.
b. Enron's finance director comes from Andersen.
c. Most of Enron's accounting staff came from Andersen

But there’s something that can be done to prevent fraud:

• Establish or adopt audit standards, control quality, ethics, independence and other standards relating
to audits of public companies
• Investigate KAP and its employees, conduct disciplinary hearings, and impose sanctions if
necessary
• Carry out other obligations required to improve professional standards in the Firm
c. Should they have known about the risk and apparent lack of independence with Enron’s
SPE? What should they have done about it

Answer:
In the late 1990’s the company was experiencing unprecedented growth and leveraged high stock
prices in order to enter into a number of transactions known as “special purpose entities” (SPE’s).
With these transactions, Enron received borrowed loans that appeared as revenue, without any
liability on the balance sheet, and were guaranteed by Enron stock. The company’s board of
directors is supposed to act as shareholder representation and assist with policies and issues. The
board of directors could have taken a further look into the transactions that were occurring to
prevent the fall of Enron. They should have known about the issues with the SPE’s, especially the
amount of transactions including them, and put an end to continued transactions and make the
necessary corrections for the financial reporting.
3. In your own words, summarize how Enron used SPE’s to hide large amount of company debt.

Answer:
Enron created SPE’s (usually other LLP’s) in order to create cash inflow but did not record the
investments and related liabilities (the loans used to create the SPE). Enron used outside investors to
secure the new SPE’s. The new investors would bear the risk of the investment and Enron used its
company stock as collateral to entice the investors and saying that Enron would basically bear the risk if
the investment should turn sour. Enron used large investment bankers to take loans but these looked
more like hedging activities instead of debt. Once the stock price began to drop, and Enron was losing
money, they were unable to use their stock to cover the losses. To put it simply, a company sells a
product for a stellar price to another entity. However, that entity doesn’t have the cash flow to buy the
product. So, the seller issues a loan to the buyer in order to sell the product. Now if the buyer defaults
on the loan, the seller loses the cash it lent out and the product it sold. This is how Enron set up the
SPE’s, and they used the large investment banks to hold the loans that should have been reported on
Enron’s balance sheet
4. 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 those services of the same
client Develop separate arguments for why should not be allowed to perform non audit
services for their audit clients what do you believe?

Answer:
Issues : whether or not the auditors can be independent and exercise good professional judgment
when it comes to the audit

Arguments for why auditors should be allowed to perform these services for the same client
include: Auditors can increase audit realization by becoming more efficient during the external
audit since they would be basically auditing their own work.

Arguments for why auditors should not be allowed to perform these services for the same client
include: Auditors may not be able to act independently, and may not use the best professional
judgment when performing the external audit.
5. Explain how “rules-based” accounting standards differ from “principles-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 “principles-based”
standards. Are there dangers in removing “bright-line” rules? What difficulties might be associated
with such a change?
Answer:
Rule based accounting standards are difference from principle based standards in that rule based
standards are just that – rules. Meanwhile Principle based accounting standards are more like
guidelines and can be open to interpretation.

Principle based rules can prevent another Enron-like fiasco because it hold the accountant and
auditors to a higher standards than “just following the code”. Sometimes the code has loopholes,
which is what allowed Enron to create the SPE’s in the first place, and the company can rely on that.
However, if auditors are required to hold themselves to a higher moral and ethical code, then they
may not be swayed by a company’s questionable practices, even if they are following the letter of the
law. If “bright line” rules are not relied on at all, and only principle based rules are followed, then the
interpretation of these principles can cause issues such as aggressive accounting treatments such as
in the Enron case. If there are no hard rules, then companies can say that the aggressive accounting
treatments are not prohibited.
6. 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?

According to the business dictionary, a run on the bank is when individuals withdraw funds out of fear
that it will become insolvent in the near future. When Skilling blames Enron’s collapse on a classic “run
on the bank”, at first glance it seems that this definition fits what happened at Enron. However, Skilling
goes on to say that when everyone started to back away from Enron, Enron was solvent and highly
profitable, just not liquid enough (Beasly, Buckless, Glover, & Prawitt, 2012). This was not the case
though. George Kaufman, an economist at Loyola University Chicago explains: “The fable is that a run
can bring down a solvent bank. What a run does is: It causes an insolvent bank to be recognized as
insolvent” (Meyerson, 2006, para. 10). This is important because, while the withdrawals might have
expedited the collapse, it was not the actual cause, as Enron was on its way out already. The fact that Lay
sold over 93,000 shares and that Citigroup, JPMorgan Chase, and Dynegy did not go through with
“helping” Enron, shows that they knew Enron was, indeed, insolvent. In the case of Andersen, this
analogy does not work since clients started to drop the firm because they either felt that the firm was
involved in fraudulent activities, or that the mere appearance would damage their own reputation if
they stayed with Andersen. No fear of insolvency had any part; they just wanted to distance themselves
from a firm with a bad reputation.
7. 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?

When you look at the Enron and Andersen case, there are a lot of lessons that one can take away. These
include the fact that greed can often lead to people making irresponsible decisions and personal gain
through money should not be the driving force of how you make decisions. Enron executives personally
made millions off of the run-up in stock price and Andersen retained a $50 million plus client by not
reporting the facts. They did not take their integrity in consideration when committing these acts. If we
were to be involved or perceived to be involved in a situation where we worked for a company where
they were inflating invoices to show higher revenue when the customer was actually being charged too
much, this could adversely affect our career. Even if we were not directly involved or knowledgeable of
the situation, some may gain the perception that we are involved and it could lead to our termination
and loss of ability to obtain new employment. When people start to question your integrity, this can
cause a snowball affect where other people begin to do so as well and they no longer trust your work or
terminate your employment. In order to avoid these situations, always present yourself honestly and
avoid situations that may be questionable. The backup of facts or written documentation can help you
to avoid this and knowing when to involve higher levels or a third party when you discover illegal or
unethical behavior is crucial to maintaining integrity
8. Why do audit partners struggle with making tough accounting decisions that may be contrary to their
client’s position on an issue? What changes should the profession make to eliminate these obstacles?

Like any other business accounting firms want to make money. For that purpose, public accounting firms
are concern with making clients happy, providing them with the outstanding customer service. This is the
reason why auditors struggle with making tough accounting decisions that may be contrary to their
client’s position. Auditors don’t want to upset clients and risk losing money. To keep a good relationship,
auditors may not oppose to the client’s accounting choices, even if it is not following the accounting
standards. A change the profession could make to eliminate these obstacles is to first be dedicated to the
public interest. If the auditor suspects foul play in the financial statements, it should be reported to
management right away. This will help eliminate difficult decisions, if similar situations occur again,
because a guide base is set.
9. What has been done, and what more do you believe should be done to restore the
public trust in the auditing profession and in the nation’s financial reporting system?

After the accounting scandal of Enron and Andersen, Congress passed the Sarbanes-Oxley
bill, “to protect investors by improving the accuracy and reliability of corporate disclosures
and changing the way corporate boards deal with their financial auditors” (Peavler,
September 2016). The Public Company Accounting Oversight Board, PCAOB was created to
oversee audits of public companies and broker-dealers, while protecting investors and the
public interest. The PCAOB promotes informative, accurate, and independent audit reports
(About the PCAOB, 2016). To restore, the public trust in auditing profession and in the
nation’s financial system, auditors and companies should display their dedication to
disclosing accurate financial statement.