1. What were the business risks Enron faced, and how

did those risks increase the likelihood of material

misstatements in Enron’s financial statement?

• The business risk that was faced by Enron :

• Enron launching Enron Online, a Web-based commodity trading site.

It was handling more than $1 billion in transaction daily. The use of

technology was good for company. However if the systems fail, it

will lead to business risk.

• Company will use of unreliable information because of the business

risk. This will lead to material misstatement.

Risks of Hardware & Data(Technology)

•Enron acted as an intermediary and getting profit

arbitraging price differences.

•As an intermediary it not easy for Enron to predict the

price. The price on these types of market is fluctuated. This

will increase the likelihood of material misstatement in

Enron’s financial statement.

Risks arise when the price is instability

• Enron was involved in included guaranteeing borrowed funds with high stock prices and reporting the borrowed funds as revenue, and never reporting the liabilities.

• Enron put much pressure on itself to continue to look highly profitable and attempted to continue to increase the stock valuation.

• So more investors to put more money into the company, which greatly increase the likelihood of material misstatements.

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High Degree of Leverage

a) What are the responsibilities of a company’s board of directors? (b) Could the board of directors at Enron – especially the audit committee – have prevented the fail of Enron? (c) Should they have known about the risks and apparent lack of independence with Enron’s SPEs? What should they have done about it?

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a) What are the responsibilities of a company’s board of directors?

• The board of directors play a important roles to protect the shareholder's asset and provide a return on investment.

• Make a improtant decisions which may effect shareholder's benefit.

• In addition, directors also held liable by shareholder and others if they negligent in their duties.

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(b) Could the board of directors at Enron – especially the audit committee – have prevented the fail of Enron?

• Company ‘s board of directors failed to prevent the fall of Enron. In fact, the board could prevent the fall of Enron by taking several steps to improve corporate governance.

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(c) Should they have known about the risks and apparent lack of independence with Enron’s SPEs? What should they have done about it?

• The audit commitee should known about the risks and apparent lack of independence with Enron's SPEs.

• The audit commitee have the opportunity to restrict the extent to which Enron used the EPS. Slow the fall of Enron or even prevent it.

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In your own words, summarize how Enron used SPEs to hide large amounts of company debt.

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.• Enron was able to hide large amounts of debt by keeping the debt

off the company’s books using SPEs. Special purpose entities (SPEs) provide a valid and legal way for companies to sell assets that may effect the profits of the selling entity.

• Creating the SPE allows the selling company to remove the asset(s) and more important any related debt from their books, causing this practice to be controversial. The loophole this practice provides by allowing companies to avoid consolidated financial statements, and the removal of assets, and their debts from the books led to the demise of Enron

4.What are the auditor independence issues surrounding the

provision of external auditing

services, internal audit services, and management consulting

services for the same client?

Develop arguments for why auditor should be allowed to perform

these services for the

same client. Develop separate arguments for why auditor should

not be allowed to

perform non-audit services for their audit clients. What do you

believe?

• I strongly agree with the statement that auditors should not perform non-audit services to their clients.

• According Sarbanes-Oxley-Act, title II consists of nine sections and establishes standards for external auditor independence, to limit conflicts of interest. It also addresses new auditor approval requirements, audit partner rotation, and auditor reporting requirements.

• It restricts auditing companies from providing non-audit services (consulting) for the same clients. It is against the act if any auditor fails to obey these rules. It will be assumed that the auditor lack of independence in issuing the audit report if provide non-audit services for the same client.

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• Self-review threats arise when the auditor performs internal

audit services and external audit services and then provides

a management consulting service (which is prohibited

activities for auditors) for the same client.

• Doubts are sometimes expressed regarding the

independence of external auditors. Auditors may reach audit

opinions and judgments that are heavily influenced by the

wish to maintain good relations with the a client company.

• The issue of auditor supplying multiple services to their

clients is a controversial and there are both pros and cons as

stated in Sarbanes-Oxley-Act 2002 under section 101.

• Large audit firms can at least use separate

departments. I think that listed companies are not

allowed to obtain other services from their auditor. This

is to ensure that the auditor independence and

objectivity.

• An auditor must maintain their independence and be

aware of what type of activities they are giving to the

clients as when they give certain types of non-audit

services they immediately become not independent.

5.Explain how “rule-based” accounting standards differ from

“principle-based”

standards. How might fundamentally changing accounting standards

from“bright-line”

rules to principle-based standards help prevent another Enron-like

fiasco in the future?

Some argue that the trend toward adoption of international

accounting standards

represents a move toward “principles-based” standards. Are there

dangers in removing

“bright-line” rules? What difficulties might he associated with such a

change?

• Rule-based accounting standards provide very detailed rules in an attempt to contemplate every application of the standard.

• Encourages a check-the-box mentality to financial reporting that eliminates judgments from the application of the reporting. Difficult to evaluate whether the overall impact is consistent with the objectives of the standard.

• Principle-based accounting standards is based on applying the principles to accounting procedures which could be done differently from one company to another.

• It allows the users to evaluate the objective consistency of the overall impact.

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• “Bright-line” rules attempting to outline every accounting situation in detail and this will create entities and transaction that circumvent the intent of the rules.

• The accounting must be reported according to substance over form. Substance over form is an accounting concept which means that the economic substance of transactions and events must be recorded in the financial statements rather than just their legal form in order to present a true and fair view of the affairs of the entity.

• When the entity failed to follow the rules in this bright line rules standard, it in fact increases the risk of making fraud.

• Therefore, when we use principle based standards, we must record it in the true intention of the principle so that the benefit of the principle-based that is will be truly used.

• By removing the “bright-line” rules to principle-based standards, the preparers

will have the ability to consider and report a transaction. Each company able to

compare between the companies with similar transactions no matter the

industry and the ability to defend positions based on the principles followed.

• If we remove the bright line rules to principle based standards, it will cause the

conflict of interest arise in the company.

• In order to prevent the conflict of interest arise, Substance over form is an

accounting principle used to ensure that financial statements give a complete,

relevant, and accurate picture of transactions and events. Auditors will issue an

audit report that is in true and fair view when they are using principle-based

standards.

Enron and Andersen suffered severe consequences because of their perceived lack of integrity and damaged reputations. In fact, some people believe the fall of Enron occurred because of a form of “run on the bank”. Some argue that Andersen experienced a similar “run on the bank” as many top clients quickly dropped the firm in the wake of Enron’s collapse. Is the “run on the bank” analogy valid for both firms? Why or why not?

Question 6Question 6

“Run on the bank” analogy?“Run on the bank” analogy?

• Enron have build trust with Andersen, which lowered Andersen’s confidence on Enron’s finance

• Enron employed many former employees of Andersen

• Insufficient information about Enron failed to reassure the investors

• Investor’s confidence in Enron plummeted

• Enron to be a going concern

• Enron have build trust with Andersen, which lowered Andersen’s confidence on Enron’s finance

• Enron employed many former employees of Andersen

• Insufficient information about Enron failed to reassure the investors

• Investor’s confidence in Enron plummeted

• Enron to be a going concern

A liquidity crisis that generally occurs due to the lack of confidence in the companyA liquidity crisis that generally occurs due to the lack of confidence in the company

“Run on the bank” analogy proven to be valid

“Run on the bank” analogy proven to be valid

Run on the bank valid based on Enron view?Run on the bank valid based on Enron view?

Run on the bank analogy valid based on Arthur Anderson’s view?Run on the bank analogy valid based on Arthur Anderson’s view?

“Run on the bank” analogy proven to be valid

“Run on the bank” analogy proven to be valid

A perceived lack of integrity caused irreparable damage to both Andersen and Enron. How can you apply the principle learned in this case personally?

Question 7Question 7

Generate an example of how involvement in unethical or illegal activities, or even the appearance of such involvement, might adversely affect your career.

Involvement of Bribery- “Action of influencing the action of person in charge with their legal duties”

Involvement of Bribery- “Action of influencing the action of person in charge with their legal duties”

• A perceived lack of integrity is proven can cause damage to a career in many ways

• Anderson and Enron is a good example to conduct oneself with high standards

• We have to act independently in performing any duty given to us

• To maintain a good integrity as well as the trust relationship with everyone

• A perceived lack of integrity is proven can cause damage to a career in many ways

• Anderson and Enron is a good example to conduct oneself with high standards

• We have to act independently in performing any duty given to us

• To maintain a good integrity as well as the trust relationship with everyone

What are the possible consequences when others question your integrity?

Few people were involved with the scandal but thousands at the company lost their jobs

Few people were involved with the scandal but thousands at the company lost their jobs

What can you do to preserve your reputation throughout your career?

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.• 8. Why do audit partners struggle with making tough accounting decisions that may be contrary to their client’s position on the issue? What changes should the profession make to eliminate these obstacles?

Why do audit partners struggle with making tough accounting decisions that may be contrary to their client’s position on the issue?

To entertain client , service providers need to please their clients by providing value and excellent customer service. Prior to the Sarbanes-Oxley Act of 2002, partners looking forward to maximize services they could provide to clients, namely consulting services.

• they would fear losing the additional revenues generated by “add on” services such as consulting

An example:Andersen’s audit fee at Enron was about $50 million per year which literally

very high. In the year 2000 Andersen LLP earned $52 million as consulting fees which literally higher than what they received the previous years.

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when their client’s states that the transactions was honest; however something else also could be there (duplicate information)

• In this situation, the auditor is facing a tough dilemma where the auditor will be issuing an incorrect report or other unnecessary reports.

• If the auditor issued unqualified report, the auditor’s legal liability increases and the audit risk is very high.

Example:• Enron received borrowed funds that were recorded as a

revenue, but Enron didn’t record the borrowed funds as liabilities in the financial statements. In this situation, Enron tried to hide the true transactions that occurred. The auditor have to prove that Enron’s records didn’t follow the true procedures and substances over form requirements.

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when the auditor make a decision to issue the report, that will affect the audit firm image

• If the auditor issued unqualified report but there is fraud and material misstatement, the trust and confidence of stakeholders to the auditor will decrease.

• This situation will give bad effects to the audit partner and bad image to the audit firm.

• If the auditor issued a qualified report, then the auditor involved in a situation where a conflict of interest arises between the auditor and the client.

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• Auditors committed to put the public interest first

• Require national approval for local office partners to sign off for certain complex circumstances that reduces the pressures on local partners to please the client.

• The auditor cannot compromise with the fees clients offered for their reputation.

• The auditor must issue a clean report of audit.

• Sarbanes-Oxley Act of 2002 makes it illegal for external auditors to perform internal auditing and a variety of management consulting services for the same company

• A governmental regulatory agency - to monitor external auditing firms’ compliance with standards, including this issue of auditor independence.

• Public Company Accounting Oversight Board (PCAOB) • Securities and Exchange Commission (SEC)

What changes should the profession make to eliminate these obstacles?

9. What has been done, and what more can be done to restore the public trust in the auditing profession and in the nation’s financial reporting system?

• In America, the first action taken was the issuance of the “Sarbanes-Oxley Act of 2002”.

• Inside the Act:• the report does not contain any material misstatements or

omissions. • responsible for establishing and maintaining internal controls,

and have designed and reviewed the effectiveness of internal controls

• In Malaysia, the Audit Oversight Board (“AOB”) is established to promote and develop an effective audit oversight framework and to promote confidence in the quality and reliability of audited financial statements.

• The Revised By-Laws (On Professional Ethics, Conduct and Practice) strictly stated that the user is not allowed to translate, reprint or reproduce by any electronic, mechanical, including photocopying and recording without prior permission in writing from IFAC.

What has been done to restore the public trust in the auditing profession and in the nation’s financial reporting system?

• The government supposes to strictly control the relationship between auditor and audit form, company and audit firm.

• The government cannot let them become a community of interests.

• The financial statements and other financial information included in the report fairly present in all material respects the company’s financial condition and results of operations.

• They also should certify that they have disclosed to the audit committee any fraud and all significant deficiencies in the design or operation of the internal controls

What more can be done to restore the public trust in the auditing profession and in the nation’s financial reporting system?