Arthur Andersen: Failure to Report Accurately

October 29, 2017 Accounting

Enron Corporation has been accused of cooking the books and overstating company profits in its financial reports. In addition, Enron’s trading business adopted mark-to-market accounting, which meant that once a long-term contract was signed, income was estimated as the present value of net future cash flows, even though in some cases there were serious questions about the viability of these contracts and their associated costs. Author Andersen provided both consulting and auditing services which created an inherent conflict of interest.

On one hand, Andersen was auditing an Enron financial recording system and strategy based for the most part on the advice of its own consultants. Evidence eventually surfaced that some internal conflicts had arisen within Andersen about some of the “aggressive” accounting practices introduces by the Chief Financial Officer, Andrew Fastow and Jeffery Skilling. As an audit firm, Author Andersen compromised itself as a professional audit firm when it failed to validate and make public the soundness of the financial reports of the Enron Corporation. The evidence available to us suggests that Andersen did not fulfill its professional responsibilities in connection with its audits of Enron’s financial statements, or its obligation to bring to the attention of Enron’s Board (or the Audit and Compliance Committee) concerns about Enron’s internal contracts over the related-party transactions. ” Bratton, William W. (May 2002). Although Andersen was equipped with internal controls to protect against conflicted incentives with their partners, they failed to prevent conflict of interest and failed to follow a number of leads presented by its own tax staff regarding Enron.

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The Arthur Andersen’s Dual Role at Enron case study also indicated that the larger accounting firms earns over three-times more in fees from consulting than accounting, which blurred the lines when it came to down to thinking about cutting off the hand that feeds you. In one case, Andersen’s Houston office, which performed the Enron audit, was able to overrule any critical reviews of Enron’s accounting decisions by Andersen’s Chicago partner.

In addition, when news of Securities and Exchange Commission (SEC) investigations of Enron were made public, Andersen attempted to cover up any negligence in its audit by shredding several tons of supporting documents and deleting nearly 30,000 e-mails and computer files. James Bodurtha, Jr. , argued that leading up to the downfall of Enron, “the primary motivations for Enron’s accounting and financial transactions seem to have been to keep reported income and reported cash flow up, asset values inflated, and liabilities off the books. ” (Bodurtha, James N. , Jr. Article, Spring 2003) Arthur Andersen was accused of applying reckless standards in their audits because of a conflict of interest over the significant consulting fees generated by Enron. The auditors’ methods of reviewing the financial transactions were questioned as either being completed solely based on receiving its annual fees or simply a lack of expertise in properly reviewing Enron’s questionable accounting practices. The accountants looked for new ways to save the company money, including capitalizing on loopholes found in Generally Accepted Accounting Principles (GAAP), the accounting industry’s standards.

An Enron accountant revealed they attempted to aggressively use the GAAP document to their advantage and added that the large number of rules had created the opportunity to manipulate the weaknesses of the system, which put them in the position they found themselves in (The Smartest Guys in the Room, 2005). For its role in the Enron debacle, Author Andersen was charged with obstruction of justice for shredding documents related to its audit of Enron, resulting in the Enron scandal. There were many stakeholders impacted by the scandal. Of course Author Andersen, the auditing and consulting firm and its employees are impacted.

The Enron Corporation because it is the primary business entity involved in the questionable practices, its employees who are impacted because of what the corporation they work for has done and the long-term impact this has on their future, shareholders who aspect the corporation to make the right decisions that keep its stocks and growth at a place that provide reasonable returns on their investments. The senior managers were also key stakeholders at Enron, Jeffrey Skilling (CEO), Ken Lay (chairman) and Andy Fastow (CFO) and have responsibility devising vehicles for deceptive financial practices.

The legal firm of (Vinson & Elkins) and Investment firm (Merrill Lynch) who were associated with Enron, as well as, the corporate community as a whole and last but not least, the board of directors who should have been monitoring more closely and questioning the activities associated with the unprecedented success of the firm initially. There are several courses of action that could be taken to limit and/or eliminate the potential conflict of interest that could exist when the same firm is conducting audit and consulting functions for the same company.

One course of action would be to increase public reporting by auditors. Another would be to ensure that there is adequate independence between auditors and /or consultants from management. In addition, I believe the Public Oversight Boards (POB) enforcement powers should be increased and given enhanced investigative power to investigate matters such as deciding whether an issue is a conflict of interest between auditing and consulting or how to maintain accounting independence from clientele management.

And finally the boards of directors need to pay closer attention to the behavior of management and the way the company is making money and treating its employees. There are several impacts related to implementing the above mentioned enhancements. Public reporting by audit firms would make it less likely that an auditing firm would attempt to conceal issues highlighted during an audit. To ensure that there is adequate independence between auditors and /or consultants from management requires development of comprehensive internal governance processes that engage board members who not afraid to question management practices more closely.

This has a significant impact on the long-term value of the shareholders’ investment. Enhancement of the Public Oversight Board will help assure regulators, investors and the public at large that audited financial statements of public corporations can be relied upon to oversee provide an accurate view of the financial health of corporations. My recommendation is to the business implements rules and policies which protect every stakeholder of the company. All new rules and policies should be fully disclosed to all stakeholders to ensure establish and ensure trust.

Secondly there should be an overhaul of the accounting regulations to prohibit ownership of both auditing and consulting services by the same accounting firm. Thirdly, the internal auditing team should be trained so that there is a strict adherence to proper codes of conduct that prevent unhealthy activities and promote accurate checks and balances of the accounts. Fourth, regulators should also tighten requirements for directors of corporations to be more proactive and ensure that there are no adverse repercussions for those who expose questionable behavior to public attention.

All of these to me are viable solutions, but in the final analysis, the solution to breakdowns in professional ethics and scandal lies in the attentiveness the board of directors and ethical integrity of executives. With the implementation of these recommendations, the company culture will improve and as a result, the company may be prevented from allowing and accepting fraud, as well as deter cheating or questionable practices that impact all stakeholders. (1,213)

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