Acc 492 - Enron Corporation and Andersen, Llp

Case 4.1: Enron Corporation and Andersen, LLP

Team A:

University of Phoenix

ACC 492

Charlo Reynolds

March 24, 2008

Case 4.1 Enron Corporation and Andersen, LLP

1. What were the business risks Enron faced, and how did those risks increase the likelihood of material misstatement in Enron's financial statements?

Enron's business risks involved risks such as fraud; however, their ultimate failure was when they entered into aggressive transactions involving special purpose entities (SPE's). The problem was that the accounting practices were questionable when they treated loans to look like revenue and did not record them as liabilities, such as notes payable. This risk is that they did not show the liabilities on the financial statements and misled creditors, investors, and customers into believing that they were making more money then they actually were. Another business risk Enron faced was losing all their investors as they continued to cash in their shares of Enron stock. In the same year, the CEO at the time Jeffrey Skilling resigned from his short career at Enron. The company lost a great amount of their reputation and public trust due to all the bad publicity they received in the media, all of this created a weak future as they encountered a liquidity crisis later in 2001. Other business risks involved bad management decisions and practices.

2. What are the responsibilities of a company's board of directors? Could the board of directors at Enron - especially the audit committee -- have prevented the fall of Enron? Should they have known about the risks and apparent lack of independence with SPE's? What should they have done about it?

A company's board of directors is responsible for acting in favor of the shareholders benefit, such as making major company decisions that could affect the shareholders. The Board of Directors hires and fires the executives, decides on dividend policies, option policies and, how much to pay the executives. In my opinion, I think that the board of directors could have changed some policies, been more aware of the risk involving the SPE's instead of letting things unfold the way that they did. The Board of Directors could have researched SPE's and learned more about the way they work, not to mention finding out how to account for them on the financial statements. There should have been policies in place regarding employee stock options, putting a limit on how much they bought or even sold at the time.

3. In your own words, summarize how Enron used SPE’s to hide large amounts of company debt.

Enron used Chewco, LJM2, and Whitewing to hide a large portion of company debt. The SPE’s were carefully structured to eliminate the need to consolidate financial statements. Chewco was established in 1997 by Enron executives in connection with another Enron partnership with interest in natural gas pipelines. Enron’s CFO Andrew Fastow employed Michael Kopper to officially manage Chewco to prevent the disclosure of a conflict of interest for Fastow between Enron and Chewco. The LJM2 partnership was established in 1999 for the purpose of acquiring assets chiefly owned by Enron. LJM2 was also managed by Fastow and Kopper, LJM2 engaged with accounting firm PricewaterhouseCooper (PWC) and the law firm Kirkland & Ellis to help with the technicalities of the partnership. Enron used LJM2 to deconsolidate its less productive assets, which eventually generated a 30 percent average annual return for the limited-partner investors of LJM2. The Whitewing partnership established by Enron engaged in the purpose of purchasing power plants, pipelines, and water projects originally purchased by Enron. This partnership was crucial to Enron to evolve Enron from being an energy provider to becoming a trader of energy contract. Whitewing was the SPE through which Enron sold its energy production assets. Enron also guaranteed investors in Whitewing that if Whitewings assets were sold at a loss, Enron would compensate the investors with share of Enron common stock. Just in the three SPE’s listed here Enron was able to conceal a lot of debt and disguise the true financial stability of the company, which lead to false hope for the investors.

4. What are the auditor independence issues surrounding the provision of external auditing services, internal auditing services, and management consulting services for the same client? Develop arguments for why auditors should be allowed to perform these services for the same client. Develop separate arguments for why auditors should not be allowed to perform non-audit services for their audit clients.

There are auditor independence issues that surround the provision of external auditing services, internal auditing services, and management consulting services for the same client. Quite simply put the auditor of a given company must maintain independence meaning that the auditors cannot invest in their clients firms, cannot be related to or borrow money from their clients firms, and cannot be active in the management of their clients firms and further they cannot provide non-auditing services that would leave them auditing their own work. All of these reasons would indicate a conflict of interest that may leave the auditors work questionable. Going a bit further there are similar reasons as to why the auditor should be independent from providing external auditing services, internal auditing services and management consulting for the same client. On one hand on may argue that using the same auditor for external auditing, internal auditing and management consulting would make sense because it would be a one stop shop, the client would have one auditing firm that would perform all of the services. This would be beneficial in that the auditing firm that provided all of these services would be knowledgeable of their client. Their knowledge of the client from the perspective of the audit would give them knowledge that could be used to provide management consulting services. Rather than employ the services of three different firms for each of the different services, they could employ the services of just one firm and perhaps not just have the knowledge but save money in paying the one firm for all of the services. On the other hand, the arguments against such an arrangement are that familiarity breeds an environment where there may be a conflict of interest. Working too closely with management may create