In a 2–3 page paper, address the following items:
Provide a summary of the primary accounting and financial reporting improprieties in your selected case. Your summary must include whether there were any penalties or legal consequences for the company's senior management or the financial statement auditors.
Identify two probable key deficiencies in the auditor’s risk assessment methods. Explain how each of these deficiencies allowed the accounting irregularities to escape detection.
Provide a recommendation for audit gathering and evaluation procedures that would help prevent future financial statement misstatements. Provide a rationale for your recommendation.
Cite two quality resources to support your writing. Choose sources that are credible, relevant, and appropriate. Cite each source listed on your Source page at least one time within your assignment. For help with research, writing, and citation, access the Strayer Library or review library guides.
This course requires the use of Strayer Writing Standards (SWS). The library is your home for SWS assistance, including citations and formatting. Please refer to the Library site for all support. Check with your professor for any additional instructions.
The specific course learning outcomes associated with this assignment are:
Analyze a company’s financial position and business risks relative to an audit.
Develop conclusions about risks, control tests, and substantive procedures for a given client using analysis and calculations.
Full Answer Section
- Special Purpose Entities (SPEs): Enron created off-balance sheet entities to hide debt and inflate profits. These SPEs were supposedly independent companies, but Enron maintained significant control over them.
- Mark-to-Market Accounting:
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Enron aggressively used mark-to-market accounting to value assets, even for illiquid assets with uncertain future values. This inflated reported profits in the short term but created significant risk of future write-downs.
- Revenue Recognition: Revenue was recognized on incomplete or fictitious transactions to meet financial targets.
Consequences for Senior Management and Auditors
The fallout from Enron's collapse was immense.
- Senior Management: Enron's CEO, Kenneth Lay, and CFO, Andrew Fastow, were convicted of fraud and conspiracy. They received significant prison sentences.
- Auditors: Arthur Andersen, Enron's auditor, was found guilty of obstruction of justice for shredding documents related to the Enron audit. The firm subsequently surrendered its auditing license.
Deficiencies in Auditor Risk Assessment
Two key deficiencies in Arthur Andersen's risk assessment contributed to the undetected fraud:
- Overreliance on Management Assertions: The auditors placed too much trust in management's representations about the financial statements. They failed to perform sufficient testing to verify the accuracy of these assertions.
Source: Albrecht, W. Albrecht, C., Glover, S., & Romney, M. (2018).
Auditing: A Business Risk Approach (11th ed.). John Wiley & Sons.
- Ignoring Red Flags: There were numerous red flags throughout the Enron engagement, such as the complexity of SPEs and the aggressive use of mark-to-market accounting. The auditors failed to adequately investigate these red flags and assess the potential for fraud.
Source: Public Company Accounting Oversight Board (PCAOB). (2002).
Report of Investigation by the Public Company Accounting Oversight Board Regarding the Audit of Enron Corporation by Arthur Andersen LLP for the Years 1997 through 2001.
https://pcaobus.org/news-events/speeches/speech-detail/lessons-from-enron-the-importance-of-proper-accounting-oversight_45
These deficiencies allowed Enron's management to manipulate the financial statements without sufficient scrutiny from the auditors.
Recommendation for Improved Audit Procedures
To prevent similar failures, I recommend a stronger focus on analytical procedures during the audit process. Analytical procedures involve comparing financial statement data to industry benchmarks, historical trends, and expectations derived from the understanding of the client's business.
Rationale for Recommendation
Analytical procedures can be a powerful tool for detecting potential misstatements. By comparing financial data to various benchmarks, auditors can identify unusual fluctuations or relationships that may indicate fraudulent activity. For example, unexplained increases in revenue or decreases in expenses could warrant further investigation.
Additionally, analytical procedures can be performed throughout the audit process, not just at the completion stage. This continuous monitoring can help identify red flags earlier and prevent them from being overlooked.
Conclusion
The Enron scandal highlights the importance of a robust audit process. By strengthening risk assessment procedures and emphasizing analytical procedures, auditors can play a more effective role in preventing and detecting financial statement fraud. This will help protect investors, creditors, and other stakeholders from the devastating consequences of accounting irregularities.
Sources
Sample Answer
Enron: A Case Study of Accounting Fraud
Introduction
The collapse of Enron in 2001 stands as a stark reminder of the devastating consequences of accounting irregularities. This paper examines the accounting improprieties at Enron, the impact on stakeholders, and the failures in the audit process that allowed the fraud to persist.
Summary of Accounting Improprieties
Enron engaged in a complex web of accounting manipulations to inflate profits and hide mounting debt. Key tactics included: