Auditing of Enron Corporation

Auditing of Enron Corporation

Responsible Accounting and Enron Questions

There were numerous parties associated with Enron who were responsible for creating the "crisis of confidence" in the accounting profession. At the top of the list would be Enron's executives themselves: Jeffery Skilling, Kenneth Lay and Andrew Fastow all broke numerous rules, regulations and laws that govern accounting principles in order to increase their revenue on the income statements and in turn raise their stock prices. Among the most grievous accounting sins committed were the failing to recognize Enron's true revenue, in which revenue numbers were inflated using mark-to-market accounting; falsifying earnings so that the stock prices would stay high; and committing insider trading in order to benefit even further from their deception.

A second party that caused just as much chaos in the accounting profession was the accounting giant Arthur Andersen. As Enron's own committees discovered, the then-respected firm failed to handle the company's financial irregularities ethically, and instead chose to ignore and avoid the irregularities instead of raising the problems with Enron's board. Andersen was making tens of millions of dollars from Enron every year through both its consulting and auditing services, which created a large conflict of interest; accounting firms should work independent of those who pay for their services. Lastly, and most shockingly, Andersen's employees shredded thousands of documents relating to Enron once the scandal broke, thereby committing a devastating obstruction of justice.

Finally, the Security and Exchanges Commission failed to discover and investigate Enron's misdeeds until it was far too late. Granted, the SEC did not have the power it holds now, under the Sarbanes-Oxley Act, but its unwillingness to investigate Enron's unbelievable growth on paper did nothing to help the situation.

2. There are three main consulting audit services currently provided by audit firms: the operational audit, the financial audit and the internal audit. Each service plays a different role in helping a company improve its efficiencies and maintain a positive relation with third parties.

The first service type, the operational audit, is made for the client's management team, and involves an analytic review of the company's operations in the past, present and future. It assists the management team with determining weaknesses in the company, and can go on for an indefinite amount of time. The threat against independence lies in the fact that the company itself pays the auditing firm to provide the consulting service, and a high enough price may tempt the auditors to scale back any large criticisms, especially if management indicates that they will be releasing the report to shareholders as a ways of showing how well the company is run. This is unlikely, however, and an auditing firm conducting an operational audit on its own should not feel its independence threatened too strongly.

However, if the same firm is then asked to do a financial audit -- which is a historical analysis of a company's financial statements for a third party, such as investors -- the firm's independence will be threatened, as it must conduct the audit impartially, but it already has a financial relationship with the company. This many cause the auditors to fear losing the company as a client, and creates a risk that they will not manage the financial audit appropriately. In this case, an auditing firm with no past relations with the company should do the financial audit.