1.

What were the business risks Enron faced, and how did those risks increase
the likelihood of material misstatements in Enron’s financial statement?
Risks of Hardware & Data
Enron launching Enron Online, a Web-based commodity trading site. It was
handling more than $1 billion in transaction daily. The use of technology was good for
company. However if the systems fail, it will lead to business risk. Company will use of
unreliable information because of the business risk. This will lead to material
misstatement.
Risks arise when the price is instability
Enron acted as an intermediary and getting profit arbitraging price
differences. As an intermediary it not easy for Enron to predict the price. The price on
these types of market is fluctuated. This will increase the likelihood of material
misstatement in Enron’s financial statement.
High Degree of Leverage
Enron was involved in included guaranteeing borrowed funds with high stock prices and
reporting the borrowed funds as revenue, and never reporting the liabilities. Enron put
much pressure on itself to continue to look highly profitable and attempted to continue
to increase the stock valuation. So more investors to put more money into the company,
which greatly increase the likelihood of material misstatements.
2. In your own words, summarize how Enron used SPEs to hide large
amounts of company debt.
Enron was able to hide large amounts of debt by keeping the debt off the company’s
books using SPEs. Special purpose entities (SPEs) provide a valid and legal way for
companies to sell assets that may affect the profits of the selling entity. Creating the SPE
allows the selling company to remove the asset(s) and more important any related debt
from their books, causing this practice to be controversial. The loophole this practice
provides by allowing companies to avoid consolidated financial statements, and the
removal of assets, and their debts from the books led to the demise of Enron
3. a) What are the responsibilities of a company’s board of directors? (b) Could
the board of directors at Enron – especially the audit committee – have prevented the fail
of Enron? (c) Should they have known about the risks and apparent lack of independence
with Enron’s SPEs? What should they have done about it?
a) What are the responsibilities of a company’s board of directors?
The board of directors play a important roles to protect the shareholder's asset and provide
a return on investment.
Make a important decisions which may effect shareholder's benefit.
 In addition, directors also held liable by shareholder and others if they negligent in
their duties.
(b) Could the board of directors at Enron – especially the audit committee – have
prevented the fail of Enron?
Company‘s board of directors failed to prevent the fall of Enron. In fact, the board
could prevent the fall of Enron by taking several steps to improve corporate governance.
(c) Should they have known about the risks and apparent lack of independence with
Enron’s SPEs? What should they have done about it?

The audit committee should known about the risks and apparent lack of
independence with Enron's SPEs.
The audit committee have the opportunity to restrict the extent to which Enron used
the EPS. Slow the fall of Enron or even prevent it.
4. Explain how “rule-based” accounting standards differ from “principle-
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? Some argue that the trend toward adoption of international accounting standards
represents a move toward “principles-based” standards. Are there dangers in removing
“bright-line” rules? What difficulties might he associated with such a change?
Rule-based accounting standards provide very detailed rules in an attempt to
contemplate every application of the standard. Encourages a check-the-box mentality to
financial reporting that eliminates judgments from the application of the reporting.
Difficult to evaluate whether the overall impact is consistent with the objectives of the
standard. Principle-based accounting standards is based on applying the principles to
accounting procedures which could be done differently from one company to another. It
allows the users to evaluate the objective consistency of the overall impact
“Bright-line” rules attempting to outline every accounting situation in detail and
this will create entities and transaction that circumvent the intent of the rules. The
accounting must be reported according to substance over form. Substance over form is an
accounting concept which means that the economic substance of transactions and events
must be recorded in the financial statements rather than just their legal form in order to
present a true and fair view of the affairs of the entity. When the entity failed to follow the
rules in this bright line rules standard, it in fact increases the risk of making fraud.
Therefore, when we use principle based standards, we must record it in the true intention
of the principle so that the benefit of the principle-based that is will be truly used.
 By removing the “bright-line” rules to principle-based standards, the preparers will
have the ability to consider and report a transaction. Each company able to compare
between the companies with similar transactions no matter the industry and the ability to
defend positions based on the principles followed. If we remove the bright line rules to
principle based standards, it will cause the conflict of interest arise in the company. In
order to prevent the conflict of interest arise, Substance over form is an accounting
principle used to ensure that financial statements give a complete, relevant, and accurate
picture of transactions and events. Auditors will issue an audit report that is in true and
fair view when they are using principle-based standards.
5. What are the auditor independence issues surrounding the provision of
external auditing services, internal audit services, and management consulting services for
the same client? Develop arguments for why auditor should be allowed to perform these
services for the same client. Develop separate arguments for why auditor should not be
allowed to perform non-audit services for their audit clients. What do you believe?
I strongly agree with the statement that auditors should not perform non-audit
services to their clients. According Sarbanes-Oxley-Act, title II consists of nine sections
and establishes standards for external auditor independence, to limit conflicts of interest.
It also addresses new auditor approval requirements, audit partner rotation, and auditor
reporting requirements. It restricts auditing companies from providing non-audit services
(consulting) for the same clients. It is against the act if any auditor fails to obey these rules.
It will be assumed that the auditor lack of independence in issuing the audit report if
provide non-audit services for the same client.
Self-review threats arise when the auditor performs internal audit services and
external audit services and then provides a management consulting service (which is
prohibited activities for auditors) for the same client. Doubts are sometimes expressed
regarding the independence of external auditors. Auditors may reach audit opinions and
judgments that are heavily influenced by the wish to maintain good relations with the a
client company. The issue of auditor supplying multiple services to their clients is a
controversial and there are both pros and cons as stated in Sarbanes-Oxley-Act 2002 under
section 101.
Large audit firms can at least use separate departments
Large audit firms can at least use separate departments. I think that listed companies are
not allowed to obtain other services from their auditor. This is to ensure that the auditor
independence and objectivity. An auditor must maintain their independence and be aware
of what type of activities they are giving to the clients as when they give certain types of
non-audit services they immediately become not independent.
6. A perceived lack of integrity caused irreparable damage to both Andersen
and Enron. How can you apply the principle learned in this case personally? A perceived
lack of integrity is proven can cause damage to a career in many ways Anderson and Enron
is a good example to conduct oneself with high standards We have to act independently
in performing any duty given to us To maintain a good integrity as well as the trust
relationship with everyone Generate an example of how involvement in unethical or
illegal activities, or even the appearance of such involvement, might adversely affect your
career. Involvement of Bribery- “Action of influencing the action of person in charge with
their legal duties”
People lose confident and faith which decreases the self confidence
Unstable foundation that is unable to sustain a future growth to the company People lose
confident and faith which decreases the self confidence Slightest changes of opinions and
exchanging of loyalty What are the possible consequences when others question your
integrity? Few people were involved with the scandal but thousands at the company lost
their jobs
What can you do to preserve your reputation throughout your career?
Conduct themselves with ethical, moral standards and integrity Proactively build up a
network and work on your reputation when there is no crisis Integrity is a highly valued
trait, especially in leaders which will in turn, directly impacts success in life Integrity is a
hallmark of ethical leadership in organizations Being honest with the client, and always
keeping your word
7. 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 form of “run on the bank”. Some argue that Andersen experienced
a similar “run on the bank” as many top clients quickly dropped the firm in the wake of
Enron’s collapse. Is the “run on the bank” analogy valid for both firms? Why or why not?
“Run on the bank” analogy? A liquidity crisis that generally occurs due to the lack
of confidence in the company A lower level of trust1Higher level of independence2Enron
have build trust with Andersen, which lowered Andersen’s confidence on Enron’s finance
Enron employed many former employees of Andersen Insufficient information about
Enron failed to reassure the investors Investor’s confidence in Enron plummeted Enron to
be a going concern
“Run on the bank” analogy proven to be valid
Run on the bank valid based on Enron view? Enron’s employees who lost their jobs
Investor’s and creditor suffered large financial losses Enron could have avoided
bankruptcy If only the investors did not dump Enron’s shares Creditors did not refuse to
lend more money The company would not been forced into bankruptcy “Run on the bank”
analogy proven to be valid
 “Run on the bank” analogy proven to be valid
Run on the bank analogy valid based on Arthur Anderson’s view? Clients of Andersen
loss confidence in the firm’s credibility Many clients of Andersen fired the firm as an
external auditor Enron’s issue can be avoided if not being brought up by the press media
Andersen could have survived his large multinational firm “Run on the bank” analogy
proven to be valid
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?

Why do audit partners struggle with making tough accounting decisions that
may be contrary to their client’s position on the issue? 1To entertain client , service
providers need to please their clients by providing value and excellent customer service.
Prior to the Sarbanes-Oxley Act of 2002, partners looking forward to maximize services
they could provide to clients, namely consulting services. they would fear losing the
additional revenues generated by “add on” services such as consulting An example:
Andersen’s audit fee at Enron was about $50 million per year which literally very high.
In the year 2000 Andersen LLP earned $52 million as consulting fees which literally
higher than what they received the previous years.

28 2when their client’s states that the transactions was honest; however something
else also could be there (duplicate information)In this situation, the auditor is facing a
tough dilemma where the auditor will be issuing an incorrect report or other unnecessary
reports. If the auditor issued unqualified report, the auditor’s legal liability increases and
the audit risk is very high. Example: Enron received borrowed funds that were recorded
as a revenue, but Enron didn’t record the borrowed funds as liabilities in the financial
statements. In this situation, Enron tried to hide the true transactions that occurred. The
auditor have to prove that Enron’s records didn’t follow the true procedures and
substances over form requirements.

29 3when the auditor make a decision to issue the report, that will affect the audit
firm image If the auditor issued unqualified report but there is fraud and material
misstatement, the trust and confidence of stakeholders to the auditor will decrease. This
situation will give bad effects to the audit partner and bad image to the audit firm. If the
auditor issued a qualified report, then the auditor involved in a situation where a conflict
of interest arises between the auditor and the client.

30 What changes should the profession make to eliminate these obstacles?

Auditors committed to put the public interest first Require national approval for local
office partners to sign off for certain complex circumstances that reduces the pressures on
local partners to please the client. The auditor cannot compromise with the fees clients
offered for their reputation. The auditor must issue a clean report of audit. Sarbanes-Oxley
Act of 2002 makes it illegal for external auditors to perform internal auditing and a variety
of management consulting services for the same company A governmental regulatory
agency - to monitor external auditing firms’ compliance with standards, including this
issue of auditor independence. Public Company Accounting Oversight Board
(PCAOB)Securities and Exchange Commission (SEC)

31 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?

32 the report does not contain any material misstatements or omissions.

What has been done to restore the public trust in the auditing profession and in the nation’s
financial reporting system? In America, the first action taken was the issuance of the
“Sarbanes-Oxley Act of 2002”.Inside the Act: the report does not contain any material
misstatements or omissions. responsible for establishing and maintaining internal
controls, and have designed and reviewed the effectiveness of internal controls In
Malaysia, the Audit Oversight Board (“AOB”) is established to promote and develop an
effective audit oversight framework and to promote confidence in the quality and
reliability of audited financial statements. The Revised By-Laws (On Professional Ethics,
Conduct and Practice) strictly stated that the user is not allowed to translate, reprint or
reproduce by any electronic, mechanical, including photocopying and recording without
prior permission in writing from IFAC.

33 The government cannot let them become a community of interests.

What more can be done to restore the public trust in the auditing profession and in the
nation’s financial reporting system? The government supposes to strictly control the
relationship between auditor and audit form, company and audit firm. The government
cannot let them become a community of interests. The financial statements and other
financial information included in the report fairly present in all material respects the
company’s financial condition and results of operations. They also should certify that they
have disclosed to the audit committee any fraud and all significant deficiencies in the
design or operation of the internal controls