Enron Scandal, Auditors' Importance, Lessons: An Essay.

In a recent interview with ABC news, the now former Chairman of the Australian Securities and Investment Commission (ASIC) Greg Medcraft warned that:

“We don't want to have another Enron. And the key to not having another Enron is making sure auditors do their job and to get assurance that financials are free of material misstatement" 

Enron was an energy, commodities, and services company based in Texas, USA. It was founded in 1985. Prior to its bankruptcy on 3^rd December, 2001, Enron employed close to 30,000 staff and was a significant electricity, natural gas and communications company, which had reported revenue of nearly US$101 billion during the year 2000.

By the end of 2001, it was revealed that Enron's reported financial position was manipulated by a systematic and preconceived accounting fraud, known since as the “Enron Scandal”. Enron has since become known as an infamous case of audacious corporate fraud and corruption.

The scandal also brought into question the accounting practices and activities of many corporations in the USA and was a factor in the creation of the Sarbanes–Oxley Act of 2002. The scandal also led to the demise of the accounting firm, Arthur Andersen, which was Enron's auditor.

In more recent times, according to ASIC, based on samples of key audits performed by Deloitte, KPMG, PWC and Ernst & Young, over an 18 month period up to December 2016, 23% had not provided reasonable assurance that accounts were accurate or free of misstatements.

As stated in the Accounting Professional and Ethics Standards Board (APESB) APES 110 Code of Ethics for Professional Accountants, under Section 100 Introduction and Fundamental Principles,

“A distinguishing mark of the accountancy profession is its acceptance of the responsibility to act in the public interest.”

When sub-standard audits are performed and reasonable assurance cannot be reliably ascertained, there are consequential risks for key stakeholders, including auditors. In light of this, perform the following key assignment tasks:

1. Perform a key stakeholder analysis for an ASX listed company. Explain how the key stakeholders would be affected if material misstatements are not properly identified, disclosed or adjusted for in the finalised financial statements. What are the key risks posed to each key stakeholder you have identified?

2. Consider the concepts of independence and “whistleblowing” in relation to auditors. How do these concepts relate to the public interest requirements mentioned in the APES 110 Code of Ethics for Professional Accountants document?

3. What lessons can auditors learn from the Enron scandal and in particular from the behaviour of Arthur Andersen?

4. With reference to the APES 110 Code of Ethics for Professional Accountants document and the ASIC website, research “audit quality” and discuss what auditors need to do to address the “warning” noted in the statement made by Greg Medcraft above.

Background and Implications

At the time to take the investment decisions, key stakeholders of the business organizations consider the report of the auditors to judge the truthfulness and fairness of the companies’ financial statements (Bentley, Omer and Sharp 2013). In the process of auditing, the responsibility on the auditors is to carry out the systematic as well as methodical inspection and examination of the companies’ financial statements so that any kind of material misstatements can be identified as materiality free financial statements provide the key stakeholders with the true information about the financial performance and position of the organizations (Abernathy et al. 2013). For this reason, it is needed for the auditors to maintain the audit quality by complying with the regulations and standards of auditor independence and professional scepticism. Moreover, the famous Enron collapse has provided the auditors with certain major lessons that the auditors can use to increase the audit quality (Lennox, Wu and Zhang 2014). This report discusses about the public interest requirements of auditors by focusing on the standards and principles of APES 110. After that, this report also sheds light on the major auditing lessons that can be obtained from the collapse of Enron.

Investors and Finance Providers: It can be seen from the appendix that Woodside Petroleum considers their investors and finance providers as a key group of stakeholder and the company ensures effective engagement with them for maintaining a cordial relationship (files.woodside 2019). This stakeholder group collects the necessary financial information about the company from their financial statements and other sources with the aim to make effective investment decision about the company’s resources. In this position, improper identification, disclosure and adjustments of material misstatements can create the risk of affecting the investment decision of these stakeholders (Christensen, Glover and Wolfe 2014).

Joint Venture Participants: According to the appendix, joint venture participants are another key stakeholder group of Woodside Petroleum as the company ensures reliability and safety of supply, product quality, cost and delivery and others for maintaining a good relationship with these stakeholders (files.woodside 2019). Now, in the presence of materially misstated financial statements, the profitability of the company can be majorly affected that can eventually affect the business performance. This total situation creates risk of business loss for the joint venture participants (Knechel and Salterio 2016).

Suppliers and Contractors: According to the appendix, supplies and contractors are considered as a key stakeholder group in Woodside Petroleum and the company works together with them in an environment where the existence of joint ownership can be seen (files.woodside 2019). It is needed for the suppliers and contractors to take the credit decision about Woodside Petroleum by measuring their liquidity position to repay the credit. Risk of ineffective credit decision can be created when these stakeholders get incorrect financial information about the company for the presence of material misstatements in the financial reports (Cao, Chychyla and Stewart 2015).

Key Stakeholders and Auditors' Responsibilities

Employees: As per the appendix, employees can considered as one of the most important key stakeholders of Woodside Petroleum and the company ensures the presence of a productive work environment for them (files.woodside 2019). It is possible for the employees to create career development opportunities in the company when the company is performing well financially. However, the presence of material misstatements in the financial statements affects the financial progress of the company and creates the risk of a non-productive work environment within the organization (Lobo and Zhao 2013).

Auditor Independence

One can describe auditor independence as a major medium that puts the obligation on the auditors to perform the audit in the most objective as well as correct manner. Auditor independence refers to the independence of the internal as well as external auditors from the parties that may have certain financial interests in the audit clients (Guénin-Paracini, Malsch and Tremblay 2014). The main two requirements of audit independence are that the auditors must maintain the integrity of the profession and the auditors are needed to conduct audit in the most objective manner. It is required for the auditors to stay as independent in appearance and independent in mind. Maintaining the audit independence leads to quality audit (Kouakou, Boiral and Gendron 2013).

Whistleblowing

Whistleblowing is considered as a crucial aspect in auditing. Whistleblowing is considered as the process to report the unethical business operations of the companies by the internal staffs with the assistance of wither the internal regulatory authorities or the external regulatory authorities (Smith 2013). It needs to be mentioned that the responsibility to establish and operate effective Whistleblowing procedures lies with the executive and reporting of the boards. In addition, the internal auditors play a crucial part in the whole Whistleblowing process (Smaili and Arroyo 2017).

Public Interest Requirements of APES 110

Public interest requirements can be considered as the aspect or the condition where the professionals are needed to consider the broader demands of the profession as they are needed to take into account the fulfilment of the interest of the public and the same aspect is also applicable for auditing profession (apesb.org.au 2019). It provides the necessary safeguards to the internal whistleblowers of the company with the help of the following standards.

As per “APES 110, Section AUST210.11.1”, the ne auditors are needed to approach to the existing auditors of the client so that they can gain the information on the nomination of audit and the new auditor needs to obtain this information in the permission of the audit client, otherwise, the new auditor cannot approach the existing auditors of the companies (apesb.org.au 2019). After the approval of the permission, the auditor is needed to ask the current auditor in writing about the information related to nomination. However, the nomination needs to be declines when the client does not approve the permission. This regulation is crucial for the safeguards of the whistleblowers (apesb.org.au 2019).

Lessons from the Enron Scandal

It is mentioned in “APES 110, Section 100.1” that public interest requirement is important for the auditors in the presence of the fact that the auditor must ensure the fair and true view of the company’s financial statements for the public and it is called pubic interest requirements (apesb.org.au 2019).Thus, it is a major restriction on the auditors to put extra focus on satisfying the needs and demands of the client. These are the crucial factors that the auditors are needed to take into account for maintaining the overall public requirements of the profession.

Lessons from Enron Collapse

Standards:The manipulative works of the management of Enron as well as the audit partner was a crucial reason for the company’s collapse where different accounting manipulations can be seen like off-balance sheet finance, illegal gains and others. Hence, the lesson that can be obtained from the Enron collapse that there is a desperate need for the problem free accounting and auditing standards and maintain the adherence to the global standards is the main way to achieve this (Gordon 2015).

Financial Manipulation: It can be seen from the information obtained from the Enron case that the auditors were appointed by the senior management team of the company with the aim to accomplish financial manipulation with the assistance of the auditors for the fulfilment of self-interest. This aspect indicates towards the lesson that the government agencies must be responsible for the auditing of the companies instead of the private firms. At the same time, in order to ensure that the fact that there is not any self-interest threat of audit indepdence in the audit process, it must be ensures that there is not any non-audit services and consultation services to the audit clients from the side of the auditors (Merkel 2017).

Auditors’ Motivation:It can be seen from the Enron collapse that there needs to have certain motivations for the auditors in the form of certain incentives as penalties do not work as motivation for them. In this aspect, theuse of auditors’ insight can be ensured for promoting the overall quality of the audit operations. Sarbanes-Oxley Act has been introduced for this particular reason which puts the restriction on the companies not disclosing the audit inspection report (Elkins 2014).

Role of Auditor Independent Oversight:As per the earlier discussion, independent oversight of the auditors can be utilized for enhancing the overall quality of the audit operations.In that case, there must be the presence of the needed competencies of the auditors in case the auditors need to apply auditor independent oversight.  At the same time, the collapse of Enron indicates towards the importance of audit inspection program where the respective authorities will inspect the judgments used by the auditors for the development of audit opinion whether there is any material misstatements in the financial statements or not (Johnson, Swicegood and Williams 2013).

Pleasant Relation between Auditor and Audit Committee: the collapse of indicates towards the fact that it is needed for the business organizations to ensure the true and fair disclosure of the financial information as only them auditor independent insight can increase the audit quality. For this reason, it is required to have association as well as coordination between the external auditors and the audit committee. This particular awareness can be enhanced by organizing different kinds of audit forums for the auditors and audit committee members (Lachman 2014).

Impact of Internal Audit: The collapse of Enron has shown the audit profession the significance of internal audit in regaining the faith of the shareholders. Internal audit plays a crucial part in the development of effective financial reporting. For this reason, at the time of performing the audit operations, it is needed for the external auditors to discuss with the internal auditors about the strengths and weaknesses of the company’s financial reporting. This aspect assists the auditors in gaining the required audit evidence from the financial statements (Lachman 2014).

Arthur Andersen

At the starting point, it needs to be mentioned that the appointment of Arthur Andersen was done by the management of Enron so that they can get ease in the process of the manipulation of the financial books of the company. Arthur Andersen was responsible for providing their opinion that the financial information of the companies are true and fare and they are not impacted by any material events or incidents. It needs to be mentioned that the key shareholders of the company considered the report of Arthur Andersen for the investment decision in the company. However, the collapse of Enron shows the failure of audit responsibility by Arthur Andersen (Ardiana 2014).  It is visible from the Enron scandal that that Arthur Andersen was involved with the company by the means of business relationship and some of the audit members of Arthur Andersen received job from Enron. It implies that there was a development of the self-interest threat of audit independence in the presence of financial as well as non-financial interest of Arthur Andersen in the business of Enron. At the same time, some of the audit members of Arthur Andersen in Enron destroyed certain crucial documents related to the audit of the company before the investigation of federal government agency occurred. These aspects indicate that Arthur Andersen did not perform the audit of Enron in responsible manner by complying with the required standards and regulations (Clikeman 2013).

It is necessary for the audit companies and the auditors to ensure the performance of quality audit as it is a major requirement of this profession. The Australian Securities and Exchange Commission has mentioned that audit quality can be considered as those substances that assist the auditors to achieve the audit objective that is to acquire the sufficient evidence on the fact that whether the financial statements of the companies are free from material misstatements (asic.gov.au 2019). It is needed for the auditors to report the material misstatements found in the audit process in the auditor’s report. In one of the meetings with the ABC News, the outgoing chairman of ASIC, Greg Medctafthas warned the total audit community of Australia that the high necessity is to enhance the audit standards by the auditors of big four audit firms as enhanced audit quality can be considered as major medium for defeating the corporate collapses (abc.net.au 2019).

As per him, the need for the auditors is to carefully audit the financial accounts of the large Australian corporations in case they do not want the reoccurrence of Enron like scandals in the country. In addition, it is also needed for the Australian auditors to adhere to the fundamental and ethical principles of auditing so that they can acquire the required audit evidence about the presence of material misstatements in the financial statements (Gunny and Zhang 2013).As per APES 110, Section 2, communicating the correct opinion on the straightforwardness and equality of the financial statements is one of the prime responsibilities of the auditors (apesb.org.au 2019). The Australian auditors are needed to ensure the conduct of quality audit in the presence of full responsibility and accountability.This aspect will ensure the maintenance of the required audit quality.

It needs to be mentioned that the name of the big four audit firms in Australia are KPMG, Deloitte, PwC and E&Y. Greg Medcraft has mentioned that ASIC collected the big four audit firms’ key audit samples for the period December 2016 and the result was not favourable as the big four audit firms failed in 23% cases in providing the required audit assurance (abc.net.au 2019). This large failure mainly came from the lack of ability of the Australian auditors in facing the complex audit situation and this particular inability of the auditors came from the lack of scepticism of the auditors. It can be seen from the collapse of Enron that accounting fraud was a major reason for the collapse of the company. The collapse of Enron put negative impact on the long standing business reputation of Arthur Andersen due to the major involvement of the audit firm in the manipulation of financial accounts. Hence, the auditor must not involve any kind of fraudulent activities of the audit clients for personal benefits (Tepalagul and Lin 2015).

At the time of the application of the safeguards for the reduction in the audit threat, the responsibility of the auditors is to assess the whole situation in order to gain insight on the fact that whether it is possible to apply the audit safeguards in those situations or not. Application of the correct safeguards provides major assistance to the auditors in the reduction of audit threats under the safe level. As per APES 110, Section 290.155, the audit safeguard related to the audit firm rotation may not work in the specific situation when the company has only few members with the needed acquaintance and understanding to perform audit (apesb.org.au 2019). However, the application of the safeguard of regular independent external review needs to be applied in this situation. One interesting fact that can be obtained from APES 110, Section 100.1 that auditing is considered as such a profession where the auditors accept the responsibility to act in the best interest of the public and they must not exclusively satisfy the demands of the audit client and the employer (apesb.org.au 2019).

Thus, it can be said based on the above discussion that it is needed for the Australian auditors to enhance the standards of their audit quality by complying with the needed regulations and standards and these needs to be done by considering the warning note of Greg Medcraft (abc.net.au 2019). After that, the auditor must have the required skills, experience and knowledge with the aim to perform the audit in the most objective manner. Most importantly, the auditors are needed to adhere to the public interest requirements of APES 110 due to the fact that it reduces the possibility of self-interest threat of auditor independence (apesb.org.au 2019). One of the most important need for the auditors is to ensure the fact that they have complied with all the regulations and principles of APES 110 throughout the audit operations as this compliance ensure the maintenance of the overall audit quality and reduction of the audit independence related threats  (apesb.org.au 2019). Lastly, it is needed for the Australian auditors to part their ways from the involvement of fraudulent activities in the presence of self-interest (Tepalagul and Lin 2015).

Conclusion

This particular report can be considered as a major tool for gaining insight or knowledge on the fact that what are the necessary aspects that need to be considered with the aim to maintain the audit quality and the public interest requirements of audit profession. Improper recognition, discloser as well as adjustments of material misstatements in the financial statements can lead to the risk of improper decisions by the company’s key stakeholders. After that, the report states that auditor independence and the process of whistleblowing plays a crucial role in unveiling the unethical business operations in the organizations and for the protection of the whistleblowers, APES 110 has introduced certain regulations like obtaining information about the audit nomination and others. The content of the above discussion indicates towards the aspect that the collapse of Enron has provided the auditors with certain major lessons that the auditors need to consider with the aim to increase the overall audit quality. It can also be seen from the above discussion that the Australian auditors are needed to consider the warning of GergMedcraft on serious note in order to avoid the reoccurrence of Enron like scandals in Australia. With the aim to avoid this, it is needed for the Australian auditors to conduct audit operations after ensuring the compliance with the required auditing standards and regulations with the aim to find material misstatements in the financial statements.

References

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