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The business risk faced by Enron are instability of price and risk of foreign currency. However Endron also face other risk that makes Endron to face many additional risk which pushes the company's executive to practice fraud in preparing the financial statement. Endron face the risk of interest rate and foreign exchange rate risk because of its involvement in offering financial hedges to customer. The action of Endron as a broker of speculative energy futures, exposed the company to face commodity price risk and greatly magnified energy. Another risk faced by Endron is technological failure as the transaction of Endron took place via Internet. Operating in different places in the world with different rules and regulatory also one of the risk faed by Endron.
Endron faced a big pressure to report financial statement that are free from material misstatement because of these risk faced by Endron. The high and rising of stock price influence most of the Endron's deals. This is because, Endron had guaranteed its obligation with stock. And, Endron agreed contractually that these obligation is payable s the price level f stock drops certain level. Apart from that, the business partners of the company have a high level of confidence that the company is able t meet its obligation and also provide electricity and other commodities effectively. So, reporting a poor r deteriorating financial statement may makes the company partners to question its ability to eet its future obligation and eventually they may refuse to invest or do business with the company.
The responsibilities of board of director are to ensure the company's management are acting for the best interest of the firm's owners.
It is uncertain that board of directors can prevent the fall of Enron. But the board and audit committee of the firm may take several steps to improve the corporate governance such as :
The publicly traded companies directors should take steps to :
Prohibits any arrangements that allow company transaction with company owned by senior personnel.
Prohibits the external auditor to do the internal auditing or giving any financial services to the company.
Prohibits any transaction that did not follows the generally accepted accounting principles that may result in fraudulent financial statement.
Prevent any activity used to make the financial condition of company appear better than it was and require the audit committee to disclose all activities that are materially affect the financial statement of the company.
The Securities and Exchange Commission and Auditor's Oversight Board should :
Prohibits the external auditor from giving any consulting services or involve with the internal auditing of the company to strengthen the requirements of auditors independence.
Strengthen the requirement of companies directors by requiring outside Directors free from the financial ties t the company
The risk and lack of independence with SPEs could be discovered by the board of directors if the followed the mentioned recommendation in the previous question. However, directors have inherent limitations where they meet only few times. So, they have to rely on management, internal and external audit reports for information. The directors also could not able to monitor the company on a full-time basis.
Enron hide large amounts of company debt by set up SPE as a separate legal entities. The purpose Enron create SPE is to sell off company assets to record a cash inflow and remove any related liabilities from the balance sheet. As Enron secured at least three percent of the value of the assets to be sold to the SPE, SPE was legal. Enron pledged company stock to the outside SPE investors to overcome the risk in the case where the assets sold for a loss. Enron also works with large bankers to take large loans which will appear like financial hedges rather than debt.
There are auditor independence issues that surround the provision of external auditing services, internal auditing services, and management consulting services for the same client. The auditor of a given company must maintain independence where the auditors cannot invest in their clients firms, cannot borrow money from their clients firms, and cannot be involve in the management of their clients firms and further they cannot provide non-auditing services. 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 relationships where ethical decisions become more difficult. Investors have to assure that the auditors opinion is truly independent and do not just give the appearance of independence. For an auditor to become involved in too many of the services with one client can decrease the objectivity due to either a mutual interest or a conflicting of interest. An auditor who is being paid by a client for various services can easily become partial. The auditor should be in a position to look at the financial statements from an outside perspective rather than from an inside perspective.
Rule based accounting standards differ from principle based standards in that rule based accounting standards provide very detailed rules in an attempt to contemplate every application of the standard, where as principles based standards is a more broader simpler approach based on applying the principles to accounting procedures which could be done differently from one company to another. The principle based standards would allow be broader, simpler statements of what accountants would have to look for. Changing from the bright-line rules to principle based standards is seen as a way to prevent another Enron-like fiasco in the future in that the bright-line rules lay down specific examples of how accounting standards. Companies like Enron were able to get around this by arguing that if there was not a specific rule that prohibiting what they were doing they would continue to do it, whether it made good business sense or not. If the principle-based standards had been in place rather than the bright-line rules it would have been easier for accountants to adhere to the standards of what made the best accounting sense. One of the dangers in removing the bright-line rules is that each company will be able to determine its own way of applying the GAAP and there will be no assurance of consistency. Comparing results between companies will be difficult because results may be arrived at by using different accounting methods.
The "run on the bank" analogy is valid for Enron and Andersen. Enron's crisis was spurred by a lack of confidence in the company. The same can be said for Andersen's crisis. Anytime there is a reason to believe that the credibility of a company is at stake, the first reaction from investors or clients is to get out and break ties before the situation worsens. Although there was a possibility that Enron could have recovered from impending financial disaster it was not possible without investors and creditors. A run on the bank causes a snow ball effect where the more investors leave, the more leave so to speak. It is virtually impossible to recover from a loss of reputation once the bail out begins. This was the case with both Enron and Andersen.
There are several ways to apply the principles learned in the Enron/Andersen case to personal aspects of life. For one, do unto others as you would want them to do unto you. Each individual must take responsibility for his/her actions and practice ethical decision-making in life. In addition, always be honest and set an example that others may want to follow. Last, be aware of those around you, and be alert of things that appear a little off, or out of the ordinary. The following is an example of how involvement or rather, the appearance of being involved in unethical or illegal activities may have an adverse affect on oneÐÂ²Ðâ€šââ€žÂ¢s career. Pamela worked in the accounting group of Enron, however, had no knowledge of and did not participate in the accounting shenanigans of Fastow and accomplices. After losing her job, pension, benefits, etc., Pamela goes to several companies to apply to work in the accounting group. Unfortunately, when employers see that PamelaÐÂ²Ðâ€šââ€žÂ¢s last employer was Enron and that she worked in the accounting group, it would appear to be the case that, most likely, Pamela does not get the accounting position for the sole reason that it may appear that Pamela may have been involved in the Enron collapse. There are several possible consequences when others question oneÐÂ²Ðâ€šââ€žÂ¢s integrity. One possible consequence may be the person explains their position, including skills and knowledge. Another consequence of oneÐÂ²Ðâ€šââ€žÂ¢s integrity being questioned is to explain the required independence of auditors and their findings. There are numerous steps one can take to preserve his/her reputation throughout his/her career. One step is, do not talk about people to other people. Another step is, always give everything 100% effort. A third step to take to preserve a reputation is to be a good communicator, and always do what you say you will do, and fulfill your obligations with a positive attitude. Be kind and respectful to everyone.
Audit partners struggle with making tough accounting decisions that may be contrary to their clientÐÂ²Ðâ€šââ€žÂ¢s position on the issue because the audit partners do not want to lose the clientÐÂ²Ðâ€šââ€žÂ¢s business. One change the auditing profession should make to eliminate such obstacles is to have the client sign an agreement, stating you will have their business for a five-year period, for example, at a 15% discount rate than if there were no agreement. Another change that would eliminate the obstacle of the struggle between audit partners and a clientÐÂ²Ðâ€šââ€žÂ¢s position, when they do not see eye to eye is for the audit partner to not have a choice regarding what goes in to the audited financial statements, when it is within a specified range of data or documentation. In addition the audit client must remember the auditorÐÂ²Ðâ€šââ€žÂ¢s responsibility of ethical standards, according to law.
Several things have been done and different steps taken to restore the public trust in the auditing profession and in the nationÐÂ²Ðâ€šââ€žÂ¢s financial reporting system. One example of something that has been done to restore the publicÐÂ²Ðâ€šââ€žÂ¢s trust in auditors is Congress passing the Sarbanes-Oxley Act of 2002. The Securities and Exchange Commission issued many new rules regarding standards governing publicly traded companies listed on the Nasdaq Stock Market and the New York Stock Exchange. The Act resulted in new corporate governance regime, which is now highly rule-driven rather than market-driven. One big factor about the Act is it puts the responsibility on the corporationÐÂ²Ðâ€šââ€žÂ¢s management, rather than on the auditing firm. ÐÂ²Ðâ€šÑÅ¡CEOs and CFOs are now required to certify that their companiesÐÂ²Ðâ€šââ€žÂ¢ annual and quarterly reports are accurate and not misleading and that they have met their responsibility for evaluating internal controlsÐÂ²Ðâ€šÑÅ“ (Lander, 2004, p. 2). Regarding what more can be done to restore the trust of the public towards the auditing profession is for the profession to continue to get national support regarding restrictions, guidelines, and expectations that may cause audit clients to put pressure on their auditors. Corporations should not be able to ÐÂ²Ðâ€š?dangle the carrotÐÂ²Ðâ€šââ€žÂ¢ in front of auditors, regarding the possibility the client dumps the auditing firm for ÐÂ²Ðâ€š?disagreeingÐÂ²Ðâ€šââ€žÂ¢ with the financial position of a client.