1. The Enron debacle created what one public official reported was a “crisis of confidence” on the part of the public in the accounting profession. List the parties who you believe were most responsible for that crisis. Briefly justify each of your choices.
Various parties were responsible for the Enron crisis. To begin with, Jeffrey Skilling, the CEO of the organization, was among the most responsible parties for the company’s crisis. He contributed to the downfall of the corporation by hiding the financial losses of the company, as well as other organizational operations. In this respect, the CEO embraced the market-to-market technology of accounting whereby the losses of the company were hidden by transferring them to the corporation that was off the books with a view to ensuring that the losses could not be reported (Collings, 2011). Skilling also hired a staff of executives who participated in hiding huge debts, which resulted from failed deals and projects, by using accounting loopholes in addition to poor reporting as far as finances were concerned.
In addition, Andrew Fastow, the company’s chief financial officer, was among the most responsible parties for the crisis. He played a huge role in misleading the board of directors and the company’s auditing committee to participate in high-risk practices of accounting. Fastow came up with a devious plan of making the image of the company appears to be in the good state despite the fact that the organization was incurring significant losses. With the help of other executives of the company, he fueled the hiding of the accounting realities of the company by hiding huge debts and toxic assets of the organization from both the investors and creditors.
Apart from the above-mentioned individuals, Arthur Andersen, the company’s accounting firm, played a huge role in the Enron scandal (Knapp, 2013). Despite the fact that the company was involved in illegal practices, Arthur Anderson approved them. It ignored various issues of ethics that were going on in the organization as it was under the pressure of the company’s executives, thus contributing to the Enron scandal.
2. List three types of consulting services that audit firms are now prohibited from providing to clients that are public companies. For each item, indicate the specific threats, if any, that the provision of the given service could pose for an audit firm’s independence.
There are three types of consulting services that audit firms are now prohibited from providing to clients that are public companies. First, these types of consulting services include bookkeeping or other services that are related to the records of accounting or the financial statements of the client that receives the auditing services. If these services are provided, the independence of the auditors becomes questionable, as they are considered having more knowledge of the public company, hence giving room for inaccuracy in the process of auditing.
The second type of services that are prohibited from providing to clients by audit firms includes legal and expert services that are not related to the process of auditing. As such, services that can be provided by various other firms are currently prohibited from being provided by audit firms to public companies. They include management consultancy, tax advice, and consultation in human resources. These services can only be provided by audit firms if they have been chosen by the public companies in the tender process incidentally. Under this condition, the process of auditing and the consultation services that are provided by the audit firm are purely incidental (Jennings, 2014). If the above-mentioned consultation services are provided, they present various threats to the independence of the audit firm. In particular, the audit quality becomes questionable as the audit firms might be too close to the public companies. Therefore, their objectivity can be compromised.
The third type of prohibited services includes the services in designing and implementing systems of financial information. Audit firms cannot design a financial information system for a public company or contribute toward its implementation as their independence can be compromised. For example, the audit firms can be corrupted by the public company and, therefore, end up having a negative influence on the process of auditing.
3. For purposes of this question, assume that the excerpts from the Powers Report shown in Exhibit 3 provide accurate descriptions of Andersen’s involvement in Enron’s accounting and financial reporting decisions. Given this assumption, do you believe that Andersen’s involvement in those decisions violated any professional auditing standards? If so, list those standards and briefly explain your rationale.
In tandem with the above assumptions, it is believable that Andersen’s involvement in Enron’s decisions violated professional auditing standards. One of the most significant auditing standards that were violated related to the disclosure of information. It is basically explained by SAS No. 32 of the auditing standards where the auditor’s report may not necessarily contain the information that is deemed immaterial (Thibodeau & Freier, 2013). Nevertheless, there is always key information that must be disclosed that Anderson’s involvement withheld. This information was concerning transactions with Raptors failing to be disclosed in the required manner. Proper accounting requires the effective disclosure of this information, hence ensuring it is available for the required use among the concerned stakeholders.
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Another auditing standard that was violated related to the independence of auditors. By allowing the audit team to be involved in structuring Raptors, Andersen’s involvement violated their independence. When conducting an audit, it is vital that auditors are left in a situation where they are able to make independent decisions without necessarily being interfered with. It means that there were higher chances of them making subjective judgments from their audit work at the company.
More so, Andersen’s involvement violated the standard of professionalism. In their operations, auditors are expected to be highly professional but, in this case, Andersen failed to adhere to the professional standards regarding the financial statements of Enron. It did not inform the board at Enron about the internal controls of the related-party transactions, hence going against the desirable audit principles (Collings, 2011).
4. Briefly describe the key requirements included in professional auditing standards regarding the preparation and retention of audit work papers. Which party “owns” audit work papers: the client or the audit firm?
As far as the requirements of the standards of professional auditing are concerned in regard to the preparation and retention of audit papers, the auditor is required to prepare the audit documentation concerning each client engagement as required by the standards of the Public Company Accounting Oversight Board (PCAOB) (Fearnley et al., 2011). The documentation of audit should also be prepared in details with a view to providing a clear understanding of its objective, source, and conclusions that are reached. The organization should also be followed in audit documentation in order to present clearly the findings and issues that are significant in the auditing process. The preparation of the audit documentation should provide evidence for the reconciliation of accounting records with the financial statements. The work papers provided by the audit firm should also provide evidence that the process of auditing was actually conducted, thus demonstrating evidence of timing, the outcomes of the performed procedures, obtained evidence, and the conclusion reached. Conclusively, the process of documentation can take various forms such as electronic or paper forms.
With respect to the retention of the audit work papers, the relevant documents that should be retained include the procedures that were performed in regard to the information provided, as well as the consultation and resolution records concerning differences in the professional judgment of the engagement team or those consulted. The audit firm should retain the audit documentation for a period of seven years starting from the date the auditor issues permission to use the auditor’s report in the issuing of financial statements of the company (Fearnley et al., 2011).
5. Identify five recommendations made to strengthen the independent audit function following the Enron scandal. For each of these recommendations, indicate why you support or do not support the given measure. Also indicate which of these recommendations were eventually implemented.
Following the Enron scandal, there were various recommendations that were made to strengthen the independent audit functions. Firstly, there was the recommendation of the establishment of the PCAOB that would have the responsibility of developing the standards with respect to the preparation of audit reports. The board would also be responsible for preventing companies, which were concerned with public accounting, from providing services that were related to auditing. In my opinion, this recommendation was necessary, as it provided the required standards that audit firms had to follow. In addition, this recommendation was eventually implemented because the PCAOB was established and it has currently set the standards for the preparation of audit reports.
Another recommendation made was a change in the regulation of stock exchanges (Collings, 2011). I totally support this recommendation, as the regulation of stock exchanges will ensure that public companies compete favorably in the stock market exchange and do not gain their competitive advantage by using dubious ways.
The mandatory rotation of auditors was another recommendation made after the Enron scandal. This requirement provided for the rotation of the auditing team of a particular audit firm after having served in the firm for a period of five or seven years. I believe this is a good recommendation as it ensures that the auditing report is not compromised in any way because of the knowledge and experience of the audit team involved.
It was also recommended that the independence of an accountant should not be guaranteed on the condition that during the process of auditing, the accountant was compromised by being compensated for the provision of other services that did not relate to the process of auditing (Thibodeau & Freier, 2013). In my point of view, this recommendation is crucial because it promotes transparency in the process of auditing.
The fifth recommendation made was that the auditing committee should approve all the services regarding the process of auditing. I strongly support this recommendation as it provides room for the audit firms to be aware of the objectives of the process of auditing and the requirements.
6. Do you believe that there has been a significant shift or evolution over the past several decades in the concept of “professionalism” as it relates to the public accounting discipline? If so, explain how you believe that concept has changed or evolved over that time frame and identify the key factors responsible for any apparent changes.
There has been a significant shift or even evolution over the past several decades in the concept of professionalism as it relates to the discipline of public accounting. Since the evolution of accounting, many changes have taken place in the field (Fearnley et al., 2011). For instance, the Securities and Exchange Commission was created in 1934 because of the Great Depression that was experienced in the United States. In respect to this commission, publicly traded companies had the responsibility of filing periodic reports. The reports are then certified by the accounting profession members. The responsibility of setting the standards of accounting was placed in the hands of the American Institute of Certified Public Accountants.
In 1973, the Financial Accounting Standards Board was created, which now has the responsibility of establishing the standards of accounting. The accounting profession highly thrived in the 20th century, as can be witnessed due to the emergence of large accounting firms that expanded their provision of services, such as the provision of various forms of consulting services (Thibodeau & Freier, 2013). This was very different from the traditional forms of accounting. The double entry system has been transformed into the current accounting framework with the view to making transactions clearer and more understandable. This revolution in the discipline of accounting has contributed to professionalism in this field. There are set rules and regulations that ought to be followed by the public accountants.
7. As pointed out in this case, the SEC does not require public companies to have their quarterly financial statements audited. What responsibilities, if any, do audit firms have with regard to the quarterly financial statements of their clients? In your opinion, should quarterly financial statements be audited? Defend your answer.
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Audit firms have the responsibility of ensuring that their clients make certain quarterly certifications with respect to the internal control of the company over financial reporting. The SEC requires audit firms to review the interim financial information. The audit firms also have the responsibility of comparing the last quarter financial statement auditing with the current year’s quarter financial statement auditing. This quarterly financial statement auditing provides an opportunity for the audit firms to evaluate their objective in regard to the auditing process of a particular company (Collings, 2011).
As far as I am concerned, quarterly financial statements should be audited because, by auditing the quarterly financial statements, the company is in a position to highlight its revenues, as well as expenditures, for a quarter of that financial year as provided by the company’s budget. In this respect, the company is able to have an evaluation of whether the finances are being spent well or not. It also provides room for improvement as the company is able to identify the mistakes that were made in the financial year in respect to the use of finances and, therefore, rectify them. Quarterly financial statements should also be audited as they give time for the auditors to provide accurate financial information throughout the financial year as the auditing is accurately done while taking into consideration the collection of information that is crucial in financial reporting (Jennings, 2014). This type of auditing also provides room for a company to evaluate if it budgeted enough finances in regard to the particular financial year. It also learns more about the standards of auditing as the audit firm is required to meet specific provisions to conduct the process of auditing. Conclusively, the quarterly financial statement auditing should be conducted as it has various benefits to companies and audit firms.