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The Enron accounting scandal is one of the most shocking nightmares in the profession’s history. Enron rises to success quickly after its establishment in 1985. However, despite attracting huge share prices, the company files for bankruptcy in December 2001 and its share value plummets from $92 to $0.67 within a span of one month. The question that most stakeholders still have is how such a huge company, one of the most promising in the United States, comes crumbling down overnight. The underlying problem in Enron’s case is the lack of sufficient accounting oversight to ensure that the figures executives post reflect a true and fair view of the company’s position (McLean & Elkind, 2003). Massive deregulation and the lack of an independent accounting firm to audit Enron’s books helps to keep the con going for years. Though the company starts failing in the late 1990s, it is not until late 2001 that the world realizes what is going on behind the scenes. Main players in the scandal including CEO Jeffery Skilling, Enron former CEO Kenneth Bay and innovative CFO Andrew Fastow are all convicted of insider trading and fraud related charges. Arthur Andersen LLP, the accounting firm that fails report Enron’s misrepresentation is closed and convicted for obstructing justice, though this conviction is overturned.
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The SEC works with a tight regulatory framework looking to prevent companies from pulling stunts like the ones in Enron’s case. However, there are loopholes that allow Enron to thrive. Among them is a mechanism that allows companies to influence the progress of their share values on the stock market. Mark-to-market accounting allows Enron to peg its share value on the market price, rather than the value reflected on its books(Collins, 2006)On top of this, allowing companies to hedge their stock using SPV’s in the balance sheet represents a failure in preventing companies from unfairly influencing the progress of their stock value. These are only basic aspects that Enron’s exploits, but there is a bigger safeguard of them all, an independent audit firm. Arthur Andersen LLP fails in its obligation to provide a true and fair view of Enron’s operations. This allows the company to continue its fraud over an extended period of time. At this time, rather than report to the board of directors, the audit firm directly reports to the company executives, which limits its independence significantly, as well as introduce a loophole in the mechanism that allows executives to perpetuate their own interests at the expense of the shareholders (McLean & Elkind, 2003).
Changes to SAS 99
Communication of potential fraud: SAS 99 improves look to ensure that there is greater oversight against corporate fraud. As a result, the reporting framework has been expanded to include more than just management. The board of directors and other stakeholders are now more engaged in the communication of fraud process (Thomas, 2002). Furthermore, the obligation of the independent auditor has shifted and they now cover a wider stakeholder scope, which means that offering information to management alone is not enough. Failure to provide a thorough breakdown of the audit to other stakeholders now amounts to a failed engagement.
Fraud risk factors: auditors heavily rely on information that they gather in the course of an engagement to make a decision about the nature of a company’s financial statements. However, revisions to SAS 99 means that they can now establish ways to detect fraud by assessing the audit environment. That is, auditors can rely on more than just the financial information that a company presents to determine whether or not there is any misrepresentation in the information sent to the public or board of directors.
Greater auditor independence: SAS 99 reviews what is expected of an independent auditor in the course of an audit engagement. The greatest transformation that occurs to SAS in this regard is to distinguish the role of management from that of auditors. Initially, there is a small line between the auditor and management to the extent that the auditors are allowed to have other interests that are connected with management. What this change in the standard does is to eliminate the conflict of interest by drawing a line between these two key stakeholder groups when it comes to preventing accounting fraud. Greater independence not only comes because of regulations, but also a greater scope in the number of stakeholders that auditors report to (Thomas, 2002).
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Client’s illegal operations: SAS 99 does provide a new perspective when it comes to reporting illegal acts that the audit discovers are conducted by the client. Initially, failing to report these acts fell under the jurisdiction of criminal justice and was labelled as obstruction of justice. However, SAS 99 offers a fresher approach to the issue by outlining procedures and obligations of an auditor when it comes to reporting and handling perceived illegal operations by the client. Therefore, for the first time, the auditor does have a responsibility under accounting principles when it is suspected that there are illegal acts by the client.
Collins, D. (2006). Behaving Badly: Ethical Lessons from Enron. Dog Ear Publishing, LLC.
McLean, B. & Elkind, P. (2003). The Smartest Guys in the Room. New York: Portfolio Trade.
Thomas, W. (2002). The Rise and Fall of Enron. Journal of Accountancy. Retrieved from http://www.journalofaccountancy.com/issues/2002/apr/theriseandfallofenron.html
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