Accounting: Enron Case Analysis

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Introduction

Governments and regulators are persistently enhancing the aspect of auditor independence regimes with the main objective of regaining trust and strengthening the independence of outside auditors. The establishment of the standards policies and practices for accounting has for a long time based on a self-regulative system and a principle-based model. In the United States, the Security and Exchange Commission (SEC) and the American Institute of Certified Public Accountants have the sole responsibility of regulation and evaluation of the auditing practices adopted in the country (Smith et al 2009). The companies’ acts usually serve to offer adequate regulatory approaches that auditor and company adhere to. With this respect, the SEC requires that all public corporations should have outside auditors to undertake the auditing process. This implies that an outside auditor is supposed to offer opinions regarding the precision and reliability of the company’s accounting statements, taking into consideration the principle of objectivity, lack of business, and avoiding the engagement in activities that are likely to result in a lack of auditor independence (Haines 2004). As a result, auditors are required to display utmost ethics and honesty in the code of duties, which requires auditors to display integrity, objectivity, and independence.

Enron Fraud Scenario

The regulatory oversight that resulted in the Enron fraud is a violation of the aspect of auditor independence as evident by Andersen having an office space in Enron’s headquarters that was permanent. This served to reveal a lack of auditor independence (Hill and Cronk 2010). In addition, there is a possibility that Andersen overlooked Enron Corporation’s compliance with the required accounting policies, procedures, and practices. In addition, Enron Corporation had relied on the auditing services from Andersen, resulting in him familiarizing himself with the corporation’s accounting policies and practices. The Enron scandal served to reveal the significance of auditor independence; as a result, the fraud served to question the efficiency and the adequacy of the present audit independence regulatory frameworks. The auditing procedures before the Enron fraud were sufficient to ensure that there is high audit quality, but in some cases fails to identify misappropriations (Smith et al 2009).

Changes in accounting Regulations

There have been significant changes in accounting regulations after the collapse of the Enron Corporation with the main objective of ensuring the veracity of the financial statements. This is because most corporations faced accounting issues and poor quality of audit procedures. One of the new accounting regulations after the collapse of the Enron Corporation is the Sarbanes-Oxley Act passed in 2002 and incorporated numerous strictures on audit and accounting policies and practice (Smith et al 2009). According to the Sarbanes-Oxley Act, accounting firms have the sole responsibility of auditing committee of the boards and that auditors are not supposed from providing other services that are not related to auditing such as management, investment advice, broker, and so on. In addition, audit partners are to be rotated within five years, and auditors are prevented for one year from the acceptance of employment within their client firms in positions such as Chief Executive Officers, Chief Financial Controllers, and so on. The Sarbanes-Oxley Act also requires the establishment of an auditor oversight board by the SEC review (Hill and Cronk 2010). This act has been effective in increasing the oversight of the accounting profession by the establishment of an oversight board as stated above. The act has also helped enhance the corporate governance obligations of public corporations, which has helped in increasing the precision of financial statements (Haines 2004). The act also aimed at increasing the disclosure of auditing information and off-balance-sheet transactions undertaken by the company. The imposition of strict criminal penalties in case of violations of the accounting regulations outlined in the act and the present Federal security laws has helped in reducing the auditing failures, which has contributed significantly to the elimination of regulatory oversights during audit practices (Hill and Cronk 2010).

Another regulatory oversight during the collapse of Enron Corporation is the potential interference by the United States government in the regulatory process. This serves to eradicate the self-regulatory system and has received immense criticisms from regulators and professionals citing the complexity of the SEC and AICPA rules. This is perceived to result in more confusion and impose a challenge on the audit practicing community in the United States.

Significant changes have also been implemented at the SEC after the collapse of the Enron Corporation (Smith et al 2009). The Sarbanes-Oxley Act served to streamline the changes to enhance the effectiveness of the accounting profession at large. The change at the SEC after the collapse of Enron includes a revision of the requirements that outlines the requirements to be met when offering non-audit services. The SEC thought that the newly implemented standards and guidelines offer adequate safeguarding steps that are aimed at eliminating the compromising of audit independence (Haines 2004). In addition, the SEC hopes to revise the standards and guidelines every now than to address new challenges that may impede audit independence, precision, and accuracy of the reporting of financial statements. After the Enron fraud, SEC significantly revised its auditor independence requirements with the main objective of analyzing the efficiencies of the existing standards and constantly suggests adjustments to the rules (Hill and Cronk 2010).

Analysis

There are diverse speculations regarding the perpetrators of the Enron fraud, as a result of cumulative practices of unethical business practices. One of the most significant perpetrators of the Enron fraud was Arthur Andersen, who had been the company’s auditor since its establishment. Andersen’s role in Enron fraud can be significantly attributed to the auditing failures, whereby he failed to highlight the imminent dangers of the accounting practices and policies implemented by the company, which ultimately resulted in bankruptcy. This is because the public lost confidence in the auditor’s accuracy, which transformed to a fall of the company’s stock price in the capital market. In addition, Andersen violated most of the SEC requirements for auditor independence (Ellen and Dana 2009). The Enron senior management team is also responsible for the onset of the Enron fraud by concealing the losses imposed by the off-balance sheet transactions and partnerships. The senior management also relied on Anderson’s high-risk accounting policies and procedures to obtain favorable financial statements, while at the same time hiding the company’s debt that totaled approximately USD 8.5 billion. The senior management also chose to ignore the increasing risks associated with not complying with the accounting standards (Haines 2004). The Audit Committee members of the corporation were informed of the high-risk accounting elements adopted by the company such as the highly structured and related party transactions. The board did not object to the actions undertaken by Enron and did not recommend investigations to be conducted on the accounting policies deployed by the Enron Corporation. CFO Jeff Skilling, CEO Kenneth Lay, and Timothy Belden also helped in triggering the Enron collapse through setting up off-balance-sheet partnerships and transactions (Ellen and Dana 2009). It is arguably evident that the Enron collapse can be attributed to audit failures, meaning that auditors must detect and prevent fraud. The conflict of interest rests mainly with the client’s need to maintain positive reputations and have favorable financial statements. The auditors, on the other hand, fear that they are likely to lose a client if they provide comprehensive accounting information. In addition, there is a possibility that a lower audit engagement fee is likely to be offered in the period. As a result, auditors are under immense pressure, placing them in a difficult position to reveal all financial information or disclose accounting information that has been selected in the interest of the clients. It is therefore important for auditors to take into consideration that they hold their accountability to the interests of the stakeholders and other entities that may use the company’s accounting information. To have these challenges, the auditing independence regulatory framework needs to be tightened and ensure that firms comply with the established rules (Ellen and Dana 2009).

There is also an urgency for regulatory bodies to revise their rules and implement strict compliance requirements. The significant challenge associated with the proposed regulatory reforms is the lack of their ability to handle the core problems imposed by auditor independence. Irrespective of the toughness and strictness of the rules, it is the auditors who have an ethical obligation of adhering to the rules. If the guidelines, standards, and rules are established without taking into consideration the aspect of independence abuse and failure of markets, they are likely to be ineffective. This implies that regulatory bodies should recognize the various factors of motivation for auditors. In addition, regulatory bodies should recognize the audit quality drivers when establishing regulatory frameworks. It is important to take into consideration the fact that rules can be manipulated and that people have the free will and incentives to manipulate the rules (Hill and Jones 2007).

Summary and Conclusion

To combat the auditing failures, auditor’s independence must be protected, which can be effectively achieved by the adherence to the law and accounting standards by the auditors; failure to do so, they are faced with the risks of undertaking the legal liabilities associated with giving misleading and misinterpreted information to the various users of the accounting statements. Auditors are usually caught in a compromising position that compels them to withhold important information that may jeopardize the reputation of the client; this should be done only when the guidelines and accounting standards are taken into consideration (Smith et al 2009). This implies that external auditors have to take into consideration the fact they hold their accountability to the interested parties who use the company’s financial statements including the shareholders, investors, and key stakeholders. The auditors need to take note that they have no obligation to their clients. Therefore, significant enforcement of the accounting and auditing policies, procedures, and practices are essential to ensure that there is an efficient implementation of the rules with the main objective of eliminating auditing issues associated with a lack of auditor independence (Ellen and Dana 2009). This entails the use of disciplinary actions by the use of legislation. In addition, the board plays an integral role in supporting the effectiveness of the auditing process by avoiding the creation of an environment through which the auditors can be exploited by the interests of the client. In addition, the internal control systems are usually at the directives of the board, implying that they have a significant role in ensuring that the process of auditing is undertaken appropriately by the established accounting guidelines and standards

References

Crumbley, D., Heitger, L., & Smith, G. (2009). Forensic and Investigative Accounting (5th ed.). Chicago: CCH.

Ellen, G., & Dana, L. (2009). Essentials of Business Communication. New York: Cengage Learning.

Haines, S. (2004). ABCs of strategic management: an executive briefing and plan-to-plan day on strategic management in the 21st century. New York: Cengage Learning.

Hill, C., & Jones, G. (2007). Strategic Management: An Integrative Approach. Boston: Houghton Mifflin Co.

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