Describe about the Accounting contagion of The case of Enron?
The independence of the auditor refers to the freedom possessed by the internal or the external auditors from the parties which generally ahs a financial interest in the business which is being audited. In order to ensure an independent audit process it is essential that exists a proper amount of integrity and a purposive approach (Schilder, 1994). The entire concept of auditor implies that the work of the auditor us done in a free and purposeful manner. Independence of the internal auditor includes freedom from those parties who might be in a problem with the actual result of the audit (Monroe, 2002). With regard to independence of the external auditor it should be noted that the independence of the auditors in this case refers to the freedom from those parties that have issues if the results are published in the financial statements of the company (Blay and Geiger, 2012).
The primary objective of auditing lies in the improvement of the reliability of the financial statements that provides for the written and rational assurance from an independent source that the statements given are honestly made and they are according to the credential standard (Dowler, n.d.). In order to meet this objective it is essential that the auditors do not get influenced by the third parties or by the directors or the managers of the company or have conflicting interests (Steinhoff, 2002). This arises under the circumstances when the auditor himself or herself possesses shares in the company. Along with competence in technicality independence of the auditors is also very important so that the credibility of the audit opinion is established.
The scandal with regard to Enron which got revealed in the year 2001 had led to the fall of one of the largest American energy company as a result of bankruptcy. This company was based in Houston, Texas and it also lead to the dissolution of one of the biggest audit and accounting company, Arthur Anderson. The Enron scandal is primarily known for two reasons. Firstly this had led to one of the biggest bankruptcy reorganization in the history of America and secondly, it was also one of the biggest audit failures of all times.
During the 1990s, this company was considered to be one of the most innovative companies in the world. The company concentrated in building various power plants and also operated gas lines. However later it was observed that Enron become better known for their exclusive trading businesses. Enron purchased and sold gas and electric futures and along with that it also created fresh markets for some of the ‘oddball’ goods such as internet bandwidth, advertisers broadcast time and weather futures (Prebble, 2010).
With the growth of the trading business, the focus of the company shifted from the fixed assets to the more intangible properties such as the contract rights for the goods etc. Some of the fundamental elements such as budgetary were neglected (Dembinski, 2006). There did not exist any integrated plan for the company as a result of which the company gradually modified from operational purpose to investment purposes. Neither the management nor the auditors were ready for this sort of a transformation and as a result they could not identify the risks.
On the other hand Arthur Andersen was one of the most well known accounting and auditing firm in the world. They had a great variety of clients that included a number of famous companies such as Enron and WorldCom. Enron happened to be the second largest client of the company.
Researcher on this case had held that one of the primary reasons for the downfall of the company was the absence of truth and honesty amongst the management. The seniors in the company thought that it is essential for the company to be at the top in every department and also they would protect the reputation of the company as the most thriving executives in the country. The primary duty was to provide good faith and full exposure (Bixby, 2003). However, there is no such proof that states that the CEO of the company had previously told the employees about the rising of the stock and the eventual selling of the stock. Additionally, the employees also could not know of the stock sale which generally happens in other cases (Fusaro and Miller, 2002). When the investigation was conducted relating to the bankruptcy of the company it was then that the shareholders learnt of the selling of the stock.
It needs to be mentioned that Arthur Anderson was the auditor as well as the consultant for Enron. The case for bankruptcy for Enron was filed under Chapter 11 and this allowed the company to reorganize the company and it was a kind of protection from the creditors. When the investigation was carried on Enron attempted to recover the business by revolving of some of the assets. Later gradually the discrepancies with regard to the irregularities in accounting came up that resulted in the shift of attention from Enron to the auditing firm Anderson. Anderson came under scrutiny primarily as a result of the supposed accounting errors along with the auditing role that the company played and this gave rise a lot of controversies relating to the effect of the reputation of the auditor on the market price of the clients in case of any failure by the auditor (Krishnamurthy, Zhou and Zhou, n.d.). As a result of this scandal the reputation of the auditing company Anderson was under scrutiny.
The proper examination of the case shows that when circumstances are such that the officials of the company, the external auditors, the bankers or the legal counsels are surrounded with greed and absence of ethics it so happens that it becomes extremely impossible to prevent the financial loss for the company including the loss of the employees, creditors and shareholders. Nevertheless, it should be noted that the company did not omit any serious crime (Bierman, 2008). The primary mistake of the company was that it misled the others and could not interpret the financial position. In accordance to the laws of United States, misrepresentation or misleading action is not considered as a crime. Enron has committed a fraud and this was a crime under the United States laws (Li, 2010). However it must be noted that it is not easy to prove the criminal intention to defraud.
The auditing company Arthur Anderson was held guilty of obstructing justice since they had attempted to destroy the possible proofs of the fraud of the company by removing or destroying the related documents even after knowing that those documents can be used for the investigation department.
Some of the officials of the company were charged under major sections and some of them pleaded guilty to the crimes such as misleading of financial reports.
There existed no idea of ethical conduct within any one of the two companies. It is evident from their conduct that the companies have conducted breach of ethics. Ethics are related to a number of issues such as that of law, banking and other financial professions. Ethical issues however do not come under the ambit of criminal law and they happen to be totally different issue (Akhigbe, Madura and Martin, 2005).
Some of the primary mistakes that were conducted by the companies of Enron and Arthur were that firstly, the companies observed GAAP as rules and not as principles. Secondly, the GAAP was interpreted in a more insistent manner. Thirdly, the companies did not take into account the basics of GAAP that is the fairness principle and fourthly both the companies neglected the precedents that fairness should be emphasized on regarding the rules and that the economic substances should be stressed more than the legal form.
Some of the major issues with regard to the financial reporting in this scandal of Enron were firstly that the company failed to consolidate the entities. It also selectively used the equity ways for accounting and it failed to remove the effect of the transactions among the entities.
Secondly, Enron had not reported the debts in the balance sheet. As a result of great collaborations with the important banks money was borrowed through indirect or direct guarantees from the company. The cash gained would be beneficial for the company but it was not transferred to the company. Also these debts were not reported in the financial reports.
Further there were many investments made by Enron which were reported in accordance to the equity method. These companies were the investments were made were not SPEs. However when the investments ran into losses they were switched to SPEs and so these losses could not be reflected. Further the company did not report the SPEs on this method of equity and hence the losses were not reported (Baker and Hayes, 2004).
According to the regulations of the GAAP it is essential that equity method in accounting is used and that the result of the dealings with the SPEs and Enron be removed. Even though Enron had used the method of accounting selectively it did not remove the effect of the transactions from SPEs and Enron.
The laws that govern the auditing in the country is Generally Accepted Auditing Standards (GAAS). Till the year 2002 the auditing was entirely self regulated in the country. The standards and regulations were provided under the Auditing Standards Board. This was a technical board that was a part of the AICPA. Moreover, compulsory reviews were conducted for all the firms in auditing with the members of AIPCA that is directed by the Division of Firms by the AICPA and conducted by the AIPCA members.
In the year 2002 as a result of the increasing number of scandals with regard to the financial and auditing reports, the country adopted the Sarbanes-Oxley Act. The act provides for the creation of the Public Companies Accounting Oversight Board for the purpose of establishing proper standards for auditing that is approved by the SEC and for supervising the quality of the work done by the firms involved in auditing. Hence it can be stated that auditing of the public trading companies are presently regulated by the federal government of the country (Mayhew, Schatzberg and Sevcik, n.d.).
Conclusion
The above case is an excellent example of the failures in auditing primarily due to the lack of independence of the auditor. In this case the problems with the independence of the auditors are very clear. It is the duty of the auditors to inform the client of the accounts for their money. In the contemporary times it is observed that the companies are in the rush to report increasing gains and the markets and keeping a close watch to punish companies that do not and this further increases the pressure for independence of the audit so that the investors are well aware of the financial statements of the companies (Weirich, Pearson and Churyk, 2010).
With regard to the Enron Case it must be noted that the auditing company Anderson was given lot of luxuries by Enron. They were given a permanent place in the Enron office; they shared office birthdays and lunch parties with the Enron Colleagues. Further in most cases Anderson employees were hired by Enron. Hence all these activities tend to have an adverse effect on the independence of the auditor (Lehman, 2007).
It is a known fact that the independence of the auditor is important. However, question still remains that how this independence can be ensured without restraining the other activities. These recent auditing failures are enough evidence of the changes required in auditing. Moreover, there also exists some more problems relating to these such as connecting the fees of the auditor with the consulting fees and that seems to be a very common conflict. These kinds of arrangements should be made illegal. Therefore it is evident that the in order to make auditing an independent area it is important that proper regulations are brought forward that restricts any interference into auditing.
References
Akhigbe, A., Madura, J. and Martin, A. (2005). Accounting contagion: The case of Enron. J Econ Finan, 29(2), pp.187-202.
Baker, C. and Hayes, R. (2004). Reflecting form over substance: the case of Enron Corp. Critical Perspectives on Accounting, 15(6-7), pp.767-785.
Bierman, H. (2008). Accounting/finance lessons of Enron. Hackensack, N.J.: World Scientific.
Bixby, M. (2003). The Enron/Arthur Andersen debacle. Upper Saddle River, N.J.: Pearson Education.
Blay, A. and Geiger, M. (2012). Auditor Fees and Auditor Independence: Evidence from Going Concern Reporting Decisions*. Contemporary Accounting Research, 30(2), pp.579-606.
Dembinski, P. (2006). Enron and world finance. Basingstoke [England]: Palgrave Macmillan in association with the Observatoire de la Finance.
Dowler, F. (n.d.). Auditing, Accounting and banking. London: Pitman.
Fusaro, P. and Miller, R. (2002). What went wrong at Enron. Hoboken, N.J.: J. Wiley.
Krishnamurthy, S., Zhou, J. and Zhou, N. (n.d.). Auditor Reputation, Auditor Independence and the Stock Market Reaction to Andersen’s Clients. SSRN Journal.
Lehman, C. (2007). Independent accounts. Amsterdam: Elsevier JAI.
Li, Y. (2010). The Case Analysis of the Scandal of Enron. IJBM, 5(10).
Mayhew, B., Schatzberg, J. and Sevcik, G. (n.d.). The Effect of Accounting Uncertainty and Auditor Reputation on Auditor Independence. SSRN Journal.
Monroe, G. (2002). Auditor Independence: Problems and Solutions. Australian Accounting Review, 12(28), pp.2-2.
Prebble, L. (2010). Enron. London: A & C Black.
Schilder, A. (1994). Auditor independence. [Groningen, the Netherlands]: Wolters-Noordhoff.
Steinhoff, J. (2002). Auditor independence. [Washington, D.C.]: U.S. General Accounting Office, Financial Management and Assurance.
Weirich, T., Pearson, T. and Churyk, N. (2010). Accounting & auditing research. Hoboken, NJ: Wiley.
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