Auditing and Assurance

Enron: Then and Now

Name: Mohammed Salman

Registration No: H00173156
Course Code: C39AU-S1
Lecturer: Dr. E. Ndiweni
Tutor: Ms. J. Kearns
Word Count: 1580 (Excluding references & in text citations)
Table of Contents
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Introduction__________________________________________________________________3
Enron: Then and Now__________________________________________________________3
Corporate Governance_________________________________________________________4
Financial Reporting Standards___________________________________________________5
Conclusion___________________________________________________________________8
References____________________________________________________________________9

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Introduction
An audit failure primarily occurs when audit companies do not abide by the principles to comply
with the International Standards of Auditing. As a result, they fail to give a true and fair view
regarding a firms financial statements. Many large companies have collapsed due to the biased
judgments on audit reports and poor knowledge regarding the audit process. (Erickson, Mayhew
and Felix, 2000)
However, financial scandals and audit failures persist due to the pressure to compete and meet
the short term market expectations regarding finance and share price performances. All big firms
offer bonuses and shares to the employees who maximum the profit of the firm. This leads to
pressure among the members which causes them to engage in unethical practices. By delaying
investments and selling assets, a company may resolve its operations to reach certain goals in the
given time. However, as long as the market pressure exists, the companies are expected to resort
to solutions which would boost up their performances. (Chaney & Philipicht, 2002)
There are various reasons that contributed to the downfall of Enron. The misuse of power,
unethical practices and greed led Enron to become bankrupt. The objective of this essay is to
analyze how the weak corporate governance and internal control, poor financial reporting
standards and the limitations of external auditors played a major role in Enrons deterioration and
concludes with an evaluation of whether such a scandal could happen in the UK today.

Enron Corporation
In the year 1986, Enron was formed by Kenneth Lay after the emergence of Houston Natural Gas
and InterNorth. Jeffrey Skilling, the CEO of the company had managed to hide debts of millions
of dollars incurred because of unsuccessful deals and projects with the help of executives who
had made false financial reports and special purpose entities (Stice and Stice, 2006).

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Corporate Governance
Kenneth Lay and Jeffrey Skilling had the ultimate power of decision making. Lay had the power
to remove any occupant of the vice chairman who could be a threat to him or his power. Skilling,
on the other hand was given the power to eliminate his rivals and terrify his subordinates. Lay
and the workers enjoyed special privileges but they were temporary as it was the cash borrowed
from the firm. Enron officials protected their interests and cheated the people by manipulating
information (Deakin and Konzelmann, 2004). Enron forced its workers to invest in the
companys stocks, but when the company was in a crucial state the workers were denied selling
their shares, therefore they betrayed workers who lost their jobs and retirement savings. Greed
was the main reason for the unethical behaviors of both the managers at Enron.
A company with an inactive board and disinterested management is likely to have an inadequate
internal control structure. Enrons weak internal growth system was one of the first factors which
led to the downfall of the company (Johnson, 2003). Boyd suggests that a substantial
contribution to the Enron collapse came from the failings of Enron's audit firm, which was itself
affected by a general build-up of tensions related to conflicts of interest. Arthur Anderson, the
external auditor of the company had performed some of the internal audit work which is
certainly not permitted in the auditing policy, having the differences between the functions
performed by an external and internal audit (Adams, 2003).
The managers at Enron were unsuccessful in identifying the risks that their areas of concern in
the company could face due to unorganized regulations for the employees and develop regular
control practices. The board of directors at Enron was unaware or unable to understand the
importance of secure internal controls or was incapable of implementing an essential control
system due to inadequate knowledge (Eichar, 2009).
The Sarbanes-Oxley act implemented a rule that every annual report of a company should
contain the measures taken by the management for initiating, maintaining, assessing and
effectiveness of appropriate internal control structure and procedures for financial reporting at
the end of the year and if there are any material weaknesses in internal control over the financial
reports of the management. (Zhang, 2007)
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Financial Reporting Standards

The trading at Enron consisted of long term contracts with other firms. The present accounting
rules imply the current values to record transactions for forecasting future earnings by the
management. The mark to marketing accounting helped the management in forecasting energy
prices and future interest rates. Enron was mainly dependent on structured finance transactions
that shared ownership of cash flows and risks dealing with external investors and lenders
building up special purpose entities (SPE) which were used for funds and managing risks
involved with assets (Healy and Palepu, 2003).
If a manufacturing company does not find a janitorial company for outsourcing its janitorial
services, it resorts to splitting its own janitors and starts their own janitorial services. Special
purpose entity (SPE) is formed when a separate janitorial company is established successfully
and is counted as an individualistic company. Enron misused the (SPEs) formed as they were not
independent from the company. The energy trading companies were capable of outlining revenue
equal to the total dollar of the trades that they generated rather than concentrating on the
commissions on those trades; this was known as gross revenue reporting. Enron misused the
concept of gross revenue reporting and accounted to 95 billion dollars in revenues (Stice and
Stice, 2006).
According to the SOX, the requirements of managers and chief executives are dealt with
corporate responsibility of financial reports. It is the responsibility of the managers to ensure that
the report does not contain any false information of a material fact or eliminate an efficient
material fact required to make statements (Clark, 2012). An external auditors main objective is
to express an opinion about a companys financial statement to the extent of reviewing its
internal controls. In certain cases an auditor may find it more beneficial concentrating on the cost
to audit specific financial transactions and avoid any dependence on controls. This measure is
applicable but it results in reliance of external auditors at controls (Guxholli, Karapici and Dafa,
2012).

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The external auditors mainly concentrate on financial controls which consist of 3 efficient areas
of control, the others focusing on operational and administrative controls. It is not the duty of
external auditors to incorporate control areas within the scope of controls examined for financial
statements. The internal auditors look after such control areas. Several companies resort to
external auditors to conduct internal audit tasks because they are not satisfied with their internal
audit staff, who do not have a proposition to improve their performance (Locatelli, 2002).
An audit committee is set by and within the interests of board of directors in order to supervise
the accounting and financial reports of the producer. Public firms that resort to perform audits
must inform the audit committees of certain procedures that would help in setting high auditing
standards. The audit committee should be capable of identifying crucial accounting rules and
measures to be taken in order to imply these policies. Unconventional treatments of financial
reports amongst acknowledged accounting principles should be discussed with management
executives of the issuer; consequences of using alternative treatments and disclosures, and the
preference of the registered public accounting firm (Knechel, 2013).
The written communications between the public firm and the management of the issuer are to be
focused upon so that both the parties do not end up having unadjusted differences. The members
of the audit committee are expected to act independently and do not have any conflict of interest.
A member of the committee, the board of directors or any other member of the committee board
should not misuse the position given to them by accepting any consultation or compensatory fee
from the issuer or be an official at the issuers office or any supplementary (Mitra, Song and
Yang, 2015).
It is necessary that an audit committee consists of at least one financial expert who has abundant
knowledge of financial accounting standards. To make more appropriate decisions the person
appointed should preferably be a public accountant, controller or an auditor. These requirements
are sometimes time consuming and become costly, but they prove to be helpful in prospering the
management and auditors future as well as generate transparent financial disclosure for all
stakeholders (Lindherg and Seifert, 2011).

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Conclusion
The Sarbanes Oxley Act was set up in response to the collapse of Enron to certify a companys
accuracy and financial reporting standards. The act has set standards and regulations to
strengthen the internal controls of companies, enhance disclosure for off balance sheet entities
and most importantly reduce the disagreements between the firm and the auditors. According to a
new survey, after nearly completing 13 years, the money and time required to observe the acts
disclosure requirements have increased for companies and has reduced international
competitiveness. Even if the act consists of strict rules; it does not have specific rules about
implementing the system the act imposes. In order to follow these rules the companies have to
pay large amounts of money.
The investors are negatively affected in the long run. When companies are faced with new big
expenses they are forced to acquire money from other parts of the business which affects the
profitability of a company in a negative way. If these measures are not followed strictly such a
scandal will happen again in the UK as it carries the risk of inappropriate opinion given by the
auditor which is the main auditing risk faced by the auditing firms. For example, Tesco suffered a
loss of 6.4 billion recorded in UK, as a result of overestimated expected half yearly profits
which amounted to quarter of what was estimated for the period. Even though Sarbanes Oxley
has been successful in reducing the risk of corporate frauds, there might never be a way to
eliminate it completely.

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References
1) Adams, E. (2003). Corporate Governance after Enron and Global Crossing:
Comparative Lessons for Cross-National Improvement. Indiana Law Journal,
78(723), pp.774-777.
2) Boyd, C. (2004). The Structural Origins of Conflicts of Interest in the
Accounting Profession. Business Ethics Quarterly, 14(3), pp.377-398.
3) Chandra, U., Ettredge, M. and Stone, M. (2006). EnronEra Disclosure of Off
BalanceSheet Entities. Accounting Horizons, 20(3), pp.231-252.
4) Chaney, P. and Philipich, K. (2002). Shredded Reputation: The Cost of Audit
Failure. Journal of Accounting Research, 40(4), pp.1221-1226.
5) Deakin, S. and Konzelmann, S. (2004). Learning from Enron. Corporate
Governance, 12(2), pp.134-142.
6) Eichar, S. (2009). Effectiveness of SOX. Pp.1-31.
7) Erickson, M., Mayhew, B. and Felix, W. (2000). Why Do Audits Fail?
Evidence from Lincoln Savings and Loan. Journal of Accounting Research,
38(1), p.165.
8) Guxholli, S., Karapici, V. and Dafa, J. (2012). Audit as an Important Tool of
Good Governance. International Journal of Management Cases, 14(2), pp.7881
9) Healy, P. and Palepu, K. (2003). The Fall of Enron. Journal of Economic
Perspectives, 17(2), pp.9-16.
10)

Johnson, C. (2003). Enrons Ethical Collapse. Journal of Leadership

Education, 2(1), pp.45-56.

11) Knechel, W. (2013). Do Auditing Standards Matter?. Current Issues in

Auditing, 7(2), pp.A1-A9.
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12)

Lindherg, D. and Seifert, D. (2011). A Comparison of U.S. Auditing

Standards with International Standards on Auditing. The CPA Journal, pp.1720.

13)

Litan, R. (2002). The Enron Failure and the State of Corporate

Disclosure. Brookings Instituition, (2), p.2.

14)

Locatelli, M. (2002). Good Internal Controls & Auditor

Independence. The CPA Journal, pp.12-15.

15)

Mitra, S., Song, H. and Yang, J. (2015). The Effect of Auditing Standard
No. 5 on Audit Report Lags. Accounting Horizons, 29(3), pp.507-527.

16)

Stice, E. and Stice, J. (2006). Motivation on day one: The use of Enron
to capture student interest. Journal of Accounting Education, 24(2-3), pp.88-94.

17)

Zhang, I. (2007). Economic Consequences of the Sarbanes-Oxley Act of

2002. Journal of Accounting and Economics, 44(1), pp.74-115.

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