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Auditing scandals of Enron and Arthur Andersen
Why are ethics important in auditing
The Case of Arthur Andersen
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Recommended: Auditing scandals of Enron and Arthur Andersen
DEVELOPMENT OF AUDITING
In recent years the integrity of the auditing profession has been called into question, especially in the case of auditor independence. Perhaps the most spectacular of these was the Enron-Andersen scandal which saw the collapse of auditing giant Arthur Andersen and sent tremors throughout the auditing industry.
In 2001, Andersen was the fifth largest auditing firm in the world and had a reputation for outstanding auditing integrity based on a history of some 100 years in business. In contrast by the end of 2002 it had all but disappeared from the auditing radar. There were definite red flags being raised in regards to the standard of the audits being conducted at Andersen; the company was involved in lawsuits relating to two other clients, Waste Management and Sunbeam in 2001. Andersen was also in charge of the audit for WorldCom which was another major scandal that raised questions on auditor independence.
It was however Andersen’s relationship with Enron, in particular their actions in shredding documents and deleting of emails in the thousands including documentation relating to the Enron engagement prior to the US Securities and Exchange Commission (SEC) investigation into Enron, that was to be its downfall. The industry could not allow such a blatant disregard of auditor independence to go unpunished and Andersen was barred from conducting and reporting on SEC-registered companies, thereby ending its auditing practice. (Soltani, 2007, pp. 556-562)
Whereas the Enron/Andersen scandal related to definitive action taken by Andersen in conspiring with Enron a later scandal involving HealthSouth Corporation and Ernst & Young raised other problems with auditor independence. Again issues arose with auditor independence this time when taking a risk based approach to auditing. HealthSouth’s fraudulent activity was conducted in the area of contractual adjustments, and while Ernst & Young conducted “analytical type procedures” in this area, HealthSouth management knew that the auditors did not look at increases of less than $5,000 and therefore kept the balance-sheet entries below this level. That Ernst & Young acknowledges that they were aware management knew of this criterion and didn’t adjust their procedures accordingly raised questions regarding the integrity of the audit. Further when planning the audit, Ernst & Young meet with the companies executives and took them at their word when they stated they were not aware of any instances of fraud. In their planning papers it was stated that the HealthSouth system for generating financial information was reliable and its executives were ethical.
However, circumstances changed “in cases in which an auditor fails to establish that applicable auditing standards were followed” (Zack 2011). Since WoolEx Mills’ auditors failed to properly identify the fraud risks that caused the material misstatements, they would be in breach of professional duty to shareholders. Litigation would mostly be pursued by WoolEx Mills’ shareholders, WoolEx Mills, third parties impacted by the auditors services, creditors, and other parties who rely on WoolEx Mills financial statements. Each plaintiff would have the right to sue the auditors for their negligence in performing the audit with due diligence. To prove a breach of contract, WoolEx Mills would need to provide the engagement letter as proof that the auditors did not peform the duties agreed upon. Additionally, WoolEx Mills’ auditors would be charged with either gross or ordinary negligence based on their deviation from proper auditing standards. Since the auditors failed to test the company’s internal controls, they would be found guilty of gross negligence. The auditors would be guilty of ordinary negligence if they forgot to complete a section of the vertical analysis of the Income Statement (Zack 2011) (Krishnan & Shah
The Enron Scandal, which unrolled in October 2001, lead to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the de facto dissolution of Arthur Andersen, a large audit and accountancy partnership firm.
Throughout the past several years major corporate scandals have rocked the economy and hurt investor confidence. The largest bankruptcies in history have resulted from greedy executives that “cook the books” to gain the numbers they want. These scandals typically involve complex methods for misusing or misdirecting funds, overstating revenues, understating expenses, overstating the value of assets or underreporting of liabilities, sometimes with the cooperation of officials in other corporations (Medura 1-3). In response to the increasing number of scandals the US government amended the Sarbanes Oxley act of 2002 to mitigate these problems. Sarbanes Oxley has extensive regulations that hold the CEO and top executives responsible for the numbers they report but problems still occur. To ensure proper accounting standards have been used Sarbanes Oxley also requires that public companies be audited by accounting firms (Livingstone). The problem is that the accounting firms are also public companies that also have to look after their bottom line while still remaining objective with the corporations they audit. When an accounting firm is hired the company that hired them has the power in the relationship. When the company has the power they can bully the firm into doing what they tell them to do. The accounting firm then loses its objectivity and independence making their job ineffective and not accomplishing their goal of honest accounting (Gerard). Their have been 379 convictions of fraud to date, and 3 to 6 new cases opening per month. The problem has clearly not been solved (Ulinski).
In the predicament of David Duncan, the lead audit partner at Arthur Anderson the Accounting Firm for Enron, underscores the penalty that accountants may face under professional accountability. Duncan had pleaded guilty to obstruction of justice when he was involved in the connection with document shredding.
The auditors were more concerned with keeping the WorldCom account and should have been unbiased and independent in their decisions. Andersen even undercharged WorldCom as he looked at is as a bond in their long term relationship. Andersen’s “more efficient” method of auditing after WorldCom’s operation expansion skipped detailed individual transactions for
With every business activity come opportunities for fraudulent behavior which leads to a greater demand for auditors with unscathed ethics. Nowadays, auditors are faced with a multitude of ethical issues, and it is even more problematic when the auditors fail to adhere to the standards of professional conducts as prescribed by the American Institute of Certified Public Accountants (AICPA). The objective of this paper is to analyze the auditors’ compliance with the code of professional conduct in the way it relates to the effectiveness of their audits.
Integrity in the accounting profession involves adhering to the rules and principles of the profession. This includes remaining free of conflicts of interest and maintaining client relationships in which the accountant can remain objective in discharging his or her responsibilities. This requires independence in fact and in appearance as mandated under section 1.200.001.01, Independence Rule the AICPA Code. In other words, no one should be able to view the accountant as being biased with respect to a client’s financial reporting due to an improper client relationship. Lack of integrity in accounting practices has been, and continues to be, a key element in the downfall of many institutions which has hurt the public trust in the accounting
Within the current crisis of confidence in the public accounting profession after the Enron debacle and series of high profile failures of financial services firms, the issues about ‘audit expectation gap’ have never been more important. Though it would take an enormous amount of effort to address these issues, I will argue that tremendous amounts could be done in order to close the gap down. In this essay I will discuss some of these issues and in particular the strategies to reduce the gap.
Enron and Arthur Anderson were both giants in their own industry. Enron, a Texas based company in the energy trading business, was expanding rapidly in both domestic and global markets. Arthur Anderson, LLC. (Anderson), based out of Chicago, was well established as one of the big five accounting firms. But the means by which they achieved this status became questionable and eventually contributed to their demise. Enron used what if often referred to as “creative” accounting methods, this resulted in them posting record breaking earnings. Anderson, who earned substantial audit and consultation fees from Enron, failed to comply with the auditing standards required in their line of work. Investigations and reports have resulted in finger pointing and placing blame, but both companies contributed to one of the most notorious accounting scandals in history. There remains much speculation as to what steps could and should have been taken to protect innocent victims and numerous investors from experiencing the enormous loses that resulted from this scandal.
Corporate governance changed drastically after the case of Andersen Auditors, Enron’s auditing service showed that they contributed to the scandal. Andersen was originally founded in 1913, and by taking tough stands against clients, quickly gained a national reputation as a reliable keeper of the people’s trust (Beasley, 2003). Andersen provided auditing statements with a ‘clean’ approval stamp from 1997 to 2001, but was found guilty of obstructing justice by shredding evidence relating to the Enron scandal on the 15th June 2002. It agrees to cease auditing public companies by 31 August (BBC News, 2002).
Prior to 2000, Enron was an American energy, commodities and service international company. Enron claimed that revenue is more than 102 millions (Healy & Palepu 2003, p.6). Fortune named Enron “American most innovative company” for six consecutive years (Ehrenberg 2011, paragraph 3). That is the reason why Enron became an admired company before 2000. Unfortunately, most of the net income for the years 1997-2000 is overstated because of unethical accounting errors (Benston & Hartgraves 2002, p. 105). In the next paragraph, three main accounting issues will identify for what led to the fall of Enron.
Enron was on the of the most successful and innovative companies throughout the 1990s. In October of 2001, Enron admitted that its income had been vastly overstated; and its equity value was actually a couple of billion dollars less than was stated on its income statement (The Fall of Enron, 2016). Enron was forced to declare bankruptcy on December 2, 2001. The primary reasons behind the scandal at Enron was the negligence of Enron’s auditing group Arthur Andersen who helped the company to continually perpetrate the fraud (The Fall of Enron, 2016). The Enron collapse had a huge effect on present accounting regulations and rules.
4) . One of the largest bankruptcies in history was enabled by accountants hiding debt and destroying the evidence to avoid implication (Buckstein, part 2 pgs. 1, 2, and 3). These unfortunate events led to the need for increased scrutiny and regulations, including the Sarbanes-Oxley Act (Buckstein, part 3 pg 1). This legislation inspired the creation of the Canadian Public Accountability Board (CPAB) (Buckstein, part 3 pg 1). These changes have led to an increased awareness of the need for auditor independence as well as higher standards for accounting and business in general (Buckstein, part 3 pg 1). While these measures have helped to reassure the public, there is still the question of why Accountancy is not a protected
As soon as the Securities and Exchange Commission announced that it was investigating the Enron scandal, Enron began to shred any documents relevant to the investigation. Even the accounting firm that provided auditing for Enron, Andersen LLP, began to shred files as well.
Auditing has been the backbone of the complicated business world and has always changed with the times. As the business world grew strong, auditors’ roles grew more important. The auditors’ job became more difficult as the accounting principles changed. It also became easier with the use of internal controls, which introduced the need for testing, not a complete audit. Scandals and stock market crashes made auditors aware of deficiencies in auditing, and the auditing community was always quick to fix those deficiencies. Computers played an important role of changing the way audits were performed and also brought along some difficulties.