Powers Report: The Enron scandal
The Enron scandal that occurred in 2001 has been cited as the biggest audit failure. The scandal would later lead to the bankruptcy and collapse of Enron Corporation. Enron was an American energy company that was based in Houston. It was the largest energy company in the United States. The scandal also led to the dissolution of Arthur Andersen, an accounting firm that was one among the largest five accounting firms in the world. The investigation began when the share price of the company declined sharply from $ 90.75 in the mid of 2000 to less than $1 in 2001 (Benston & Hartgraves, 2002).It was a shocking issue to the shareholders.
Description of the Related Party Transactions Reported on by Arthur Andersen & Co.
As one would say, integrity is the most important principle in the profession of accountancy, and the stakeholders of any company rely heavily on the work of accountants. The demise of Enron and Arthur Andresen contributed to drastic changes in the field of auditing and accountancy in general. The Power Report revealed the principal transactions that contributed significantly to the problem witnessed at Enron (Powers, Troubh, & Winokur, 2002).
The Chewco Transaction
The Chewco transaction was one among these transactions. Chewco Investment LP was a limited partnership that was managed by Kooper. The transactions with Chewco resulted in Enron filing inaccurate financial statements for four years, from 1997 to 2001. As a result, unjustifiable and unauthorized reports to Kooper were issued. From the year 1993 to 1996, Enron together with California Public Employees Retirement System (CalIPERS) formed a joint venture by the name Joint Energy Development Investment limited partnership (JEDI) (Powers et al., 2002). However, Enron did not consolidate JEDI in its financial statements. The impact of not following the non-consolidation rules was quite significant. Enron and Kooper would later decline to issue statements on why a structure in the form of a joint venture did not comply with the non-consolidation guidelines. The employees should have ensured that Chewco complied with the consolidation rules. The repercussions of this mistake were significant. On reviewing the transactions closely, Enron and Arthur Andersen came to a conclusion that Chewco did not conform to the special purpose entity (SPE) accounting guidelines.
The LJM Transactions
In the year 1999, the board approved Enron to enter into a business relationship with some two partnerships in which Fastow, the CFO of Enron, was an investor and manager. The transaction between Enron and the LJM Partnership resulted in financial results of Enron being increased by more than one billion dollars (Powers et al., 2002). The transaction also enriched Fastow together with his other co-investors in the partnerships by millions of dollars. The board approved the transaction between the Enron and these partnerships with the full set of knowledge about the consequences of conflict of interest on corporate governance. In between 1999 and 2001, Enron entered into more twenty different transactions with LJM partnership. Each of these transactions had significant flaws though the hedging transactions would later cause more serious harm to the company.
Description and Evaluation of the Flaw in the Accounting Firm
The failure of Enron was as a result of flawed auditing and accounting system. It became evident that Arthur Andersen, the then auditor of the company did not perform the audit of Enron with diligence. The following are the main flaws and audit issues surrounding Arthur Andersen
Lack of Independence and Commercialization
For an auditor to be effective and professional, there is a need to be independent of the client’s management. The auditor should evaluate the financial statements for all users. The auditing fee that Andersen received from Enron only amounted to less than 30% of the total fee (Benston & Hartgraves, 2002). It shows that most of the fee received from Enron were from consulting services. In this regard, Andersen seemed to act more of an internal auditor other than an eternal auditor. Andersen audit work was, therefore, flawed in this manner. One could easily ask whether Andersen could act effectively as an auditor while being a major consultant to Enron. Andersen chose to ignore the accounting issues facing Enron Corporation as it acted in the nest way to protect its client
Failure to Put Materiality into Consideration
Materiality is a major focus in any auditing task. An item is regarded as being material if it can influence the decisions of the stakeholders. Once Enron Corporation started restating its financial statements, investors began to raise concerns over materiality of the misrepresentations (Powers et al., 2002). However, Andersen quickly dismissed this by stating that the errors were immaterial.
Failure to Recognize Weak Internal Controls at the Clients Firm
It is the responsibility of the auditor to assess the internal control system of the client to determine the reliability of the accounting system. Enron also had of internal control issues, and it was quite clear that the internal control in the company was very weak. For instance, the CFO was exempted from the conflict of interest principle (Mesa, 2002). However, Andersen did not disclose this issue. Andersen itself has internal control issues. The accounting advice from the national office was highly disregarded by the audit team on site.
Proposed Checklist for Special Projects Performed by External Auditors to Limit Errors and Risks
The auditing flaw at Enron necessitated some positive changes in the field of accounting and auditing in general. To avoid the repeat of such an auditing flaw as the one witnessed at Enron, external auditors should perform audits a couple of items. These items should be put on a checklist and it should be ensured each item on the check listed has been audited (Mesa, 2002). The items include; internal control systems reliability, the materiality of transactions, conflict of interest, unique transactions such as joint ventures, special purpose entities (SPE), organization culture, business model adopted by the client, and auditor independence.
Proposed Rules or Laws to Prevent Similar Occurrences in the Future
Following this scandal, there multiple hearings which were conducted and that led to the enactment of the Sarbanes –Oxley Act in 2002 (Benston & Hartgraves, 2002). The main provision of this act provided for the establishment of a public Company oversight committee that was mandated with the responsibility of developing standards to be used in the preparation of audit reports for audit undertakings. The act also provided for the provision of independence of auditors as well as the member of the audit committee. The independence should be a matter of fact and appearance. The executives of public companies were also required to sign off on the financial reports issued by their companies. It was to ensure that the executives commit themselves that the information contained therein is true to best of their knowledge. These rules mostly govern the presentation and audit of company’s financial statements. The act also requires that company reevaluate their internal control systems and procedures so as to make sure that these systems either meet or exceed the expectations of the external auditors. Similarly, new requirements regarding disclosures were developed. Specifically, the disclosures outline the ‘reportable transactions’. The push to have consulting services and auditing services separated was another change that was geared towards ensuring that such a mistake does not occur again in the future.
References
Benston, G. J., & Hartgraves, A. L. (2002). Enron: what happened and what we can learn from it. Journal of Accounting and Public Policy, 21(2), 105-127.
Mesa, G. C. (2002). Enron aand the Powers Report: An examination of business and accounting failures. Morristown, NJ: FEI Research Foundation.
Powers, W. C., Troubh, R. S., & Winokur, H. S. (2002). Report of investigation by the special investigative committee of the board of directors of Enron Corp. Retrieved from https://mail.google.com/_/scs/mail-static/_/js/k=gmail.main.en.tMIUU-TxqHk.O/m=m_i,t,it/am=PiPeSMD83_uDuM4QQLv0gQrz3n9-d5HiZ889_H9nAojULwD-b_b_AP4P3ou2UA/rt=h/d=1/t=zcms/rs=AHGWq9Abc8VcnjuqFEMBZBqlUiKws2MKoQ
