Ethics and Regulatory Issues
Related party transactions reported on by Arthur Andersen & Co.
Flaw in the accounting firm's logic
Checklist for special projects performed by external auditors
Checklist
Proposed rules or laws to prevent similar occurrences
Enron was one of the Wall Street's favorite blue chip stocks before an accounting scandal of the firm surfaced in 2000. The revelation that company has been misreporting its profits and losses during 1990s crashed the company's stock. The earnings and debt statements were not representative of the actual accounting transactions. Thus, a serious issue of bankruptcy ensued after this revelation. There were several ethical aspects of this issue as well. Following the details of accounting malpractices that the company through its accounting firm Arthur Andersen (Benston, 2003).
Related party transactions reported on by Arthur Andersen & Co.
Chewco Investments, L.P. ("Chewco"): Chewco was also a related party of Enron and it was effectively managed by one of the Enron's Global Finance employee called Kopper. Kopper reported the proceedings on this company to Fastow. The reduction in owner's equity and earnings statement was again large enough in this case as well. Chewco reduced Enron's income e by $28 million whereas it would have been $105 million. For four consecutive years, the shareholder's equity in Chewco was reduced by $258 million in 1997, $391 million in 1998, $710 million in 1999 and $754 million I n FY 2000. Conversely, the reported debt was increased by manifold such as $711 million in 1997, $561 million in 1998, $685 million in 1999, and $628 million in 2000. Inaccurate financial transactions were recorded to this conflict of interest. Unjustifiable financial windfall was received by Kopper and the financial statements of 1997 to 2000 were presenting the same fraudulent outlook (Powers, Troubh & Winokur, 2002).
LJM1 and LMJ2: These related parties were also given undue financial benefits as these related parties were managed by the employees of Enron such as Fastow. This shows that the company did not maintain ethical aspect of financial reporting and thus violated the principal rules and regulation related to financial reporting and corporate management.
California Public Employees' Retirement System ("CalPERS'): CalPERS was also a related party as Enron had partnered with CalPERS in a $500 million joint venture investment called Joint Energy Development Investment Limited Partnership ("JEDI'). This resulted in another conflict of interest. Enron did not consolidate the financial results of its partnership with JEDI and this resulted in huge impact on the earnings and annual report of Enron. Enron did not show JEDI's debt on the balance sheet of the company whereas contractual share was shown on the income statement.
The SPE accounting standards were severely violated in the case of Chewco buying the interest of CalPERS in JEDI. This not only violated the norms and ethics of conflict of interest but also benefited the employees of Enron enormously. While announcing the consolidation of Chewco and JEDI in 1997, the outcome was that reported net income of Enron was reduced significantly that was not anticipated earlier. Under Enron's Code of Conduct of Business Affairs were also violated in all the related party's transactions and this caused the bankruptcy of the firm in 2001.
Flaw in the accounting firm's logic
Criminal and civil investigations were initiated after the accounting fraud in Enron got surfaced. It was indicated that the accounting firm of Enron has also participated in the process of wrongly reporting the income and debt/equity statements of the company. It was revealed that Arthur Anderson did not force Enron to report the true findings of income statements and debt situation of the company. It was also indicated that there was a flaw in the logic of accounting firm as the company in fact participated in the process of misleading the general public regarding the profit and loss figures of Enron.
Arthur Anderson did not object to the firm's conduct in presenting fudged figures and wrongful backstage calculations on which the earnings were projected. The financial analysts that tracked Enron reported that the company will have significant growth in coming years. This was taken as a benchmark as serious violations in accounting reporting procedures were neglected. There were serious logic issues in Anderson's handling of the Enron case as the accounting firm shredded many important documents. Later, Arthur Anderson was convicted of shredding documents and obstructing the process of fair professional practices (Benston, 2003).
The accounting firm of Enron did not adopt rigorous standards in evaluating the financial performance of the company during 1997-2001. This was also helped by the conflict of interest as the company Enron was a major client of Arthur-Anderson and the accounting firm did not intend to lose such a client whose fees crossed millions of dollars annually. There were other flaws in the logic of accounting firm as well....
These included failure to intimate SEC regarding any irregularities in the reports presented by Enron and concealing the information from shareholders. Reducing the equity of shareholders on the basis of non-consolidation was also one of the major flaws in the accounting procedures adopted by Enron and assisted by Arthur-Anderson.
Checklist for special projects performed by external auditors
There are several standards of accounting practices for the external auditors to assess whether or not their client firms are following legal and ethical aspects of doing business. Following is a checklist of these standards that external auditors must follow to maintain transparency and minimize risk of misreporting in financial and earnings statements.
Checklist
The external auditor is obliged to follow the provisions of Generally Accepted Accounting Procedures (GAAP).
The external auditor should write the Statements on Auditing Standards (SASs). This should be codified in form of AU-C sections (International Federation of Accountants, 2009).
Forming an opinion: It is the responsibility of external auditor to form an opinion that whether or not the financial statements are presented fairly. Thus, external auditor should form an opinion with respect to the statements under review by using GAAP.
The external auditor should ensure and obtain reasonable assurance that financial statements are not materially misstated. This includes fraud or an error on part of management (International Federation of Accountants, 2009).
The reasonable assurance is obtained through collecting audit evidence that confirms that misstatements have not been made.
Throughout the procedure of planning and performing of audit, the GAAP requires the external auditor to exercise professional judgment and professional skepticism.
The professional skepticism means that external auditor should adopt a questioning mind while conducting the audit. The alertness of auditor towards conditions that may indicate possibility of misleading statements. The professional skepticism also means that the auditor should validate the presented information in documents through cross-checking and cross questioning. The audit evidence should be analyzed critically and any inconsistency should be investigated in detail. The assessment that whether or not the firm has placed enough risk management control in financial reporting is also part of professional skepticism. Since the principal anti-fraud role is played by the external auditors, it should be ensured that while conducting the audit, the external auditors do not succumb to any internal pressure and maintain highest level of professional integrity (International Federation of Accountants, 2009).
Professional judgment means that the auditor should apply the requisite professional skills and training to make informed decision regarding the financial statements.
There are several ethical requirements as well for the auditor to maintain while conducting external audits. The auditor while conducting audit should collect sufficient and appropriate audit evidence that minimizes the audit risk.
The auditor at all times during the audit process is obliged to ensure independence of his/her activities and objectivity of the tasks. The auditor should have the ability to challenge the management in case those inconsistencies are noticed.
Planning and execution of audit should include all the practices as recommended in GAAP. The laws of respective states should also be considered when conducting the audits as external auditors.
There exist conditional and unconditional requirements in GAAP. The external auditor should comply with the unconditional requirements in all circumstances and should not compromise the integrity of audit.
Mandatory requirements should also be met in all except rare circumstances.
The external auditors are required that the board and management presents the financial results in a fair manner and not to mislead the general public for encouraging investments in their company.
The auditor should obtain access to all the information that is accessed by the board members and the management of the company.
Any additional information that the auditor requires should also be obtained in order to maintain the professional skepticism and integrity of the process.
The external auditor should ensure that the annual report of the company carriers related notes with each of the following sections of the financial report.
The auditor has to ensure publication of related notes of Balance sheet, debt and equity statements, statement of earnings, statement of assets and liabilities, and the revenues and expense statements.
The auditor also needs to ensure that the organizations publish its financial statements according to multiple reporting units. Since many states of the U.S. require different reporting units to be adopted, it is the legal obligation of firms to comply with this condition. Auditor has a central role in making the…
