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Enron Corporation and Anderson LLP, Analyzing the Fall of Two Giants

Requirements
1. What were the business risks Enron faced, and how did those risks increase the likelihood of material misstatements in Enron's financial statements?
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?
3. In your own words, summarize how Enron used SPE's to hide large amounts of company debt.
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.
5. Explain how "rules-based" accounting standards differ from "principles-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? Are there dangers in removing "bright- line" rules? What difficulties might be associated with such a change?
6. 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 "run on the bank." Some argue that Andersen experienced a similar "run on the bank" as many top clients quickly fired the firm in the wake of Enron's collapse. Is the "run on the bank" analogy valid for both firms? Why or why not?
7. A perceived lack of integrity caused irreparable damage to both Andersen and Enron. How can you apply the principles learned in this case personally? Generate an example of how involvement in unethical or illegal activities, or even the appearance of such involvement, might adversely affect your career. What are the possible consequences when others question your integrity? What can you do to preserve your reputation throughout your career?
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?
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?

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1. What were the business risks Enron faced, and how did those risks increase the likelihood of material misstatements in Enron's financial statements?
When Enron diversified beyond its pipeline business to become a trader in natural gas its business risks increased. It could make a loss. Further, it became a financial trader and a market maker in electric power, coal, steel, water and broadband fiber optic cable capacity, and paper and pulp. Each of these diversifications brought with it a risk that the business would not be successful. Most importantly, Enron undertook international projects relating to construction and management of energy capacity. This increased it business risk several fold. There was a strong possibility that Enron would not have cash to meet its operational needs. Consider this, Enron had to operate gas pipelines, pulp and paper plants, broadband facilities, international water plants and electricity generating plants. Moreover, it was trading on the international financial markets for these products/securities. The risks that it would not have the cash flow to finance these operations increased.

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?
Enron's Board had the responsibility to appointing a sub-committee that would oversee the work of the auditors. The Committee is also supposed to bring the working of the company to the notice of the Board. The Board and the Committee failed in this regard. The Audit committee was headed by Mr. R. Jaedicke, who had been an accounting professor at Stanford University Business School. Mr. Jaedicke simply did not use his expertise in carrying out his duties as the Chair of the Committee. He even recommended the suspension of the code of ethic so that an employee could set up a special partnership.
Instead of stopping all unethical practices, the Enron Chair of the Audit committee actually recommended the suspension of the code of ethics. The audit committee should actually oversee the implementation of the code of ethics. They should have disallowed any violation of the code of ethics. They knew about the risk and apparent lack of independence with the SPEs. They should have objected to the formation of and transactions with the SPEs but they instead suggested means of enabling this practice.

3. In your own words, summarize how Enron used SPE's to hide large amounts of company debt.
Enron used SPE's or special purpose entities. These are business entities formed for conducting and well specified activity like constructing a gas pipeline or collecting groups of accounts. Enron used SPE to get loans to finance a purchase from Enron. The purchase would just be a piece of plant or stock from Enron. The SPE paid the money to Enron. The result was that the loan belonged to the new company and did not show up on the balance sheet of Enron. Instead, when the SPE paid for ...

Solution Summary

This solution gives you a detailed discussion on the business risks and accounting decisions that lead to the loss of public trust in Enron Corporation and Anderson LLP. 1979 words total.

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