Enron and Anderson Questions: ● In your own words, summarize how Enron used SPEs to hide large amounts of company debt. ○ The company would hide their assets using SPE's. SPE's require that you transfer at least 3% of the asset towards SPE which then gets paid for using new debt or equity issuance. Enron's accounting indicates they transferred an asset to the SPE to get sold for cash when all they did was issue debt to maintain an appropriate level of cash to satisfy investors. They used their stocks as an incentive for the investor to put money into the SPEs as the stock was to be used as collateral. However, when the stock went below par, Enron was unable to pay back their financial obligations. In reality what they were doing in accounting terms was not technically illegal, but highly misleading. ● What were the business risks Enron faced, and how did those risks increase the likelihood of material misstatements in Enron's financial statements? ○ Competition, foreign currency fluctuations, price instability, industry regulation, and foreign regulation ○ Online marketplace doing electrical contracting online opened them up to potential inherent risk ○ Pledged their stock as collateral for the SPEs ■Risk that the stock would not be able to pay back the financial obligations ■Pressure to pay back leading to fraud ● (a) What are the responsibilities of a company's board of directors? ○ Acting in an advisory and oversight role ○ Act as a fiduciary on behalf of the shareholders ○ Identify risk areas and oversee risk management and ensure the integrity of their published financial statements ○ Ensure independence while auditing ● (b) Do you think the board of directors at Enron—especially the audit committee—could have prevented the fall of Enron? (c) Should they have known about the risks and apparent lack of independence with Enron's SPEs? What do you think they should have done about it? ○ It is a possibility that the audit committee could have prevented the fall if they had paid close attention and understood the risks with the SPEs ○ If investigated sufficiently, they should have known about the risks and apparent lack of independence
■Fastow ran the partnerships as the CFO and benefited personally the audit committee should have known. ○ The BOD and audit committee could have created new policies to stop the creation of the SPEs or help with the proper accounting and disclosures ● Explain how "rules-based" accounting standards differ from "principles-based" standards. ○ Rules-based: explain in detail the requirements companies should follow in the process of preparing financial statements ○ Principle-based: set of objectives, which cover all accounting situations ● How might fundamentally changing accounting standards from "bright-line" rules to principles-based standards help prevent another Enron-like fiasco in the future? ○ Bright-line rules are standards that are usually recognized by courts in legal instances or by legislatures in statutory provisions ○ If bright-line rules were changed to principle-based standards, it would prevent companies from finding an escape in their practices and would require them to follow set standards ○ Switching to principle based → strict rules that need to be followed, possibility of lawsuits diminished ■Set of rules can increase accuracy and reduce ambiguity in legal aspects to ensure judgment is fair ○ Some argue that the trend toward convergence with or even adoption of international accounting standards represents a move toward more "principles-based" standards. Are there dangers in removing "bright-line" rules? What difficulties might be associated with such a change? ■Dangers in removing bright-line rules in some situations will involve human judgment and discretion ●Auditors may rationalize aggressive financial decisions ○They will defend themselves when questioned that the accounting standard did not prohibit their action ● What are the current 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. What is your view of the arguments on both sides, which side do you take, and why? ○ Current auditor independence issues of external auditing services, internal auditing services, and management consulting services for the same client are about independence of the auditors ■Auditors should remain independent in order to perform professional skepticism during services
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