Accounting Chapter 1 Homework Enron Stock Holdings And Lost Their Jobs

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internal controls or hiring/firing client employees. Independence is threatened because the

auditor is acting as management, and so would in essence be reviewing his or her own work.

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Safeguards include:

1. Safeguards created by the profession or regulation. Examples include:

• Education, continuing education, and training requirements

• Professional standards and disciplinary punishments

2. Safeguards created by the audit client. Examples include:

• Client personnel with expertise to adequately complete necessary management and

3. Safeguards created by the audit firm. Examples include:

• Audit firm leadership that stresses the importance of independence

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Individual audit clients are like individual stocks in an investment portfolio in that they can be

added to a portfolio or eliminated from it, and they each represent variable risk profiles.

Individual audit clients are different from individual stocks because an audit client poses

litigation risk for the audit firm, whereas the only risk from an individual stock is a decline in its

value.

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The following are some of the key types of risk that audit firms consider when they make client

acceptance and client continuance decisions, along with relevant examples.

• Client entity characteristics. For example, a history of earnings management or of making

unrealistic promises to analysts; failing to meet market expectations or consistently just

prior histories of financial fraud or other types of legal difficulties.

• Quantitative risk factors. For example, the client is in significant financial stress, is having

difficulty raising capital or paying its existing debts, or is experiencing significant cash flow

problems.

• Qualitative risk factors. For example, the industry in which the client operates is in either the

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Fraud Focus: Contemporary and Historical Cases

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The following are the main reasons that Deloitte resigned from the Longtop engagement:

• Top management interfered with the confirmation process

• The company had recorded fictitious revenue and fictitious cash

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a. The objective of external auditing is to provide opinions on the appropriateness of the

financial statements and, as part of an integrated audit, provide opinions on internal control

effectiveness. The capital markets depend on accurate, reliable, and objective (neutral) data that

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b. Alloy Steel requires an independent audit on its financial statements because it is a

publicly traded stock in the U.S., and therefore is required to comply with SEC requirements to

provide shareholders reliable, independent assurance on those financial statements.

c. Likely users of Alloy Steel’s financial statements include:

• Current and future shareholders and lenders – they were likely adversely affected by

Forbes’ actions because they received an audit report that was signed by an audit firm

that did not actually do the audit work on the engagement. As such, audit quality was

d. The auditors required knowledge of international financial accounting standards and U.S.

auditing standards as adopted by the PCAOB. The auditors that actually completed the audit

work on this engagement were not trained to conduct such an audit, so while they performed

audit procedures those procedures were not necessarily appropriate in providing reasonable

assurance on the financial statements of Alloy. Further, auditors should conduct an audit with an

appropriate level of professional skepticism, which did seem to be the case for this audit.

e. The key drivers of audit quality are as follows:

did not conduct the engagement, Forbes did not review or obtain evidence necessary to

issue an audit opinion, and the auditors from the other audit firm that actually conducted

the audit tests were not trained to do so in accordance with U.S. auditing standards.

• Factors outside the control of the external auditor – case facts do not speak to this driver

of audit quality.

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f. No, Bentleys and Forbes should not have agreed to conduct this audit in the first place.

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a. While managers are the individuals actually responsible for the financial statements and

they are the ones actually committing the fraud, auditors are responsible for providing assurance

that those financial statements are not materially misstated. In the case of Enron, the auditors

failed to stand up to management’s aggressive and fraudulent financial reporting, and failed to

alert users about the company’s true financial condition.

b. Independence is important in terms of both fact and in terms of appearance. Duncan did

not violate any independence standards that existed at the time. Andersen had every right to

provide both consulting and audit services to Enron, because professional standards at the time

c. There were many user groups adversely affected by the fraud:

• Management and other Enron employees. Those not involved in the fraud lost the value

of their Enron stock holdings, and lost their jobs. Their resumes will be forever tainted by

their association with Enron.

d. The SEC and federal regulators were likely suspicious of the overall audit quality of

Andersen as an entire firm because of the sequential number of high-profile frauds that revealed

audit failures by Andersen. That, coupled with the document shredding, likely led to the

conclusion that this audit firm needed to be stopped before it continued to act in a low quality

manner.

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Application Activities

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Answers to this question will vary depending on the date of access to the web site.

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Answers to this question will vary depending on the date of access to the web site.

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a. The purpose of this exercise is to exhibit the numerous cases brought by the SEC, as well

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a. The web site notes the following:

“The PCAOB is a private sector, nonprofit corporation, created by the Sarbanes-Oxley Act of

2002, to oversee the auditors of companies in order to protect the interests of investors and

further the public interest in the preparation of informative, fair and independent audit reports.”

With respect to its authority to discipline auditors, the Web Site notes:

b. The web site indicates:

“The PCAOB enforcement staff conducts informal inquiries as well as formal investigations

c. There are many instances that the students can point to, all of which relate to the

respondents’ audits of American Fiber Green Products, Inc. Some examples include: the audit

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was not properly planned, only a few auditing procedures were performed and significant

account balances and transactions were not tested, and documentation was incomplete.

Academic Research Cases

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a. The issue relates to public accounting career paths that extend beyond the senior manager

level. Specifically, the historically expected partner position is compared to the relatively new

rise of post senior manager (PSM) positions. PSM is used to refer to all salaried titles higher than

senior manager that exclude any equity stake. In practice, titles such as director and principal are

generally used to refer to PSMs.

b. The paper finds that most firms responding to the survey (57%) do have PSM positions,

and they were generally created over the last decade as an alternative to the partner track. Firm

leadership tends to highly influence which path a rising auditor takes. The same PSM title’s

hierarchy varies across separate firms, though even the highest PSM title tends to be viewed as

inferior to partner level.

Even within a specific firm, the same PSM title does not have homogeneous duties. However,

usually the PSMs focus on daily engagement management and staff development, while the

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c. An understanding of the different career paths’ duties and hierarchy from a source

outside of the firm helps practicing auditors who reach senior manager level better understand

which career path is more personally appealing. This outsider examination helps eliminate the

bias of information that may come from within the firm when a partner or PSM tries to influence

the senior manager in a certain direction through coaching.

For current PSMs, it enhances their understanding of the perceptions of their role from the

viewpoints of outsiders and partners, including any possible inferiority that is implied.

d. A two stage method was used whereby the authors first conducted a survey that solicited

responses from HR Directors employed at the top 100 public accounting firms, as well as the Big

4 firms. The survey results presented are based on 52 respondents. Secondly, structured

interviews were conducted with two senior partners, one with a Big 4 firm and the other with a

large regional firm. The purpose of the interviews was to explore further some of the issues

raised by the survey data.

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a. The authors examine whether workload pressures (consisting of two factors) affect audit

quality of a client. The first factor is whether the client’s audit is completed during busy season

(clients with December fiscal year-end dates); the second factor is the relative concentration of

clients with the same fiscal year end date in the auditor’s client portfolio (referred to as auditor

workload compression). These workload pressures are thought to result in a less rigorous or

b. The authors find that both factors are associated with reductions in audit quality. Clients

who have a December fiscal year-end (busy season clients) have greater magnitudes of abnormal

accruals and are more likely to beat or meet certain earnings expectations. Further, if the auditor

c. Prior research suggests that busy season pressures can result in reduced audit quality.

Pressures during busy season can occur because of limited audit resources during that time and

the need to complete many audit engagements in a limited time period. These pressures can

d. The authors consider public company audits completed during 2006-2009. Their sample

includes 8,384 individual audits completed during this time period. These audits represent 2,627

different companies and 262 local audit offices. Companies in highly regulated industries were

not included in the sample because of differences in their reporting requirements.

e. The authors’ analysis only includes public companies. Thus, the authors are not able to

consider non-public companies and their impact on workload compression. Therefore, the