CASE 1.1
ENRON CORPORATION
Synopsis
Arthur Edward Andersen built his firm, Arthur Andersen & Company, into one of the largest
and most respected accounting firms in the world through his reputation for honesty and integrity.
window dress its financial statements. Enron Corporation, Andersen’s second largest client, was
involved in large, complex transactions with hundreds of special purpose entities (SPEs) that it used
to obscure its true financial condition and operating results. Among other uses, these SPEs allowed
Enron to download underperforming assets from its balance sheet and to conceal large operating
losses. During 2001, a series of circumstances, including a sharp decline in the price of Enron’s
2 Case 1.1 Enron Corporation
1. Throughout Arthur E. Andersen’s life, “Think Straight, talk straight” served as a guiding
principle for himself and Arthur Andersen & Co., the accounting firm that he founded.
2. Arthur Andersen’s reputation for honesty and integrity resulted in Arthur Andersen & Co.
3. Leonard Spacek succeeded Arthur Andersen as managing partner of Arthur Andersen & Co. in
5. The predecessor of Enron Corporation was an Omaha-based natural gas company created in
6. During the 1990s, Kenneth Lay, Enron’s CEO, and his top subordinate, Jeffrey Skilling,
transformed the company from a conventional natural gas supplier into an energy trading company.
7. Lay and Skilling placed a heavy emphasis on “strong earnings performance” and on increasing
Enron’s stature in the business world.
8. Enron executives used hundreds of SPEs (special purpose entities) to arrange large and complex
9. During 2001, Enron’s financial condition deteriorated rapidly after many of the company’s SPE
transactions unraveled; in December 2001, Enron filed for bankruptcy.
11. Criticism of Andersen’s role in the Enron debacle focused on three key issues: the large amount
12. Andersen’s felony conviction in June 2002 effectively ended the firm’s long and proud history
Case 1.1 Enron Corporation 3
2. To examine the “scope of services” issue, that is, the threats to auditor independence posed by
audit firms providing consulting services to their audit clients.
4. To review recent recommendations made to strengthen the independent audit function.
5. To review auditors’ responsibilities regarding the preparation and retention of audit workpapers.
Suggestions for Use
I typically begin an auditing course by discussing a major and widely publicized audit case.
Clearly, the Enron case satisfies those criteria. The purpose of presenting such a case early in the
semester is not only to acquaint students with the nature of auditing but also to make them aware of
why the independent audit function is so important. Many accounting students are not well
acquainted with the nature of the independent auditor’s work environment, nor are they generally
familiar with the critical role the independent audit function plays in our national economy.
Hopefully, cases such as this one provide students with a “reality jolt” that will stimulate their
interest in auditing and, possibly, make them more inclined to pursue a career in the auditing field.
Suggested Solutions to Case Questions
1. A large number of parties bore some degree of responsibility for the problems that the Enron
fiasco ultimately posed for the public accounting profession and the independent audit function. The
following bullet items identify several of these parties [see bold-facing] and the role they played in
the Enron drama.
•The leadership of the Andersen firm that allegedly focused too much attention on practice
4 Case 1.1 Enron Corporation
2. One approach to answering this question is to review with your students the eight specific types
of non-audit services that the Sarbanes-Oxley Act of 2002 prohibited auditors of public companies
from providing to their clients. Listed next are those eight non-audit services.
•Bookkeeping or other services related to the accounting records or financial statements of the
audit client
3. Given the assumption that the Powers Report excerpts included in Exhibit 3 are accurate, one
could plausibly argue that Arthur Andersen violated several of the ten generally accepted auditing
standards included in AU Section 150 of the PCAOB’s Interim Standards, including the following:
[Note: The AICPA Professional Standards (the “clarified” auditing standards) do not explicitly
include the ten “generally accepted auditing standards” found in the PCAOB’s Interim Standards—
of course, those ten “generally accepted auditing standards” were explicitly included in the previous
Case 1.1 Enron Corporation 5
4. Note: The PCAOB has established the documentation requirements for the audits of publicly
owned companies in PCAOB Auditing Standard No. 3, “Audit Documentation.” The documentation
requirements that pertain to audits of other organizations can be found in AU–C Section 230, “Audit
Documentation,” of the AICPA Professional Standards.
AU-C Section 230:
Paragraph .08 of AU-C Section 230 provides the following general guidance to independent
auditors regarding audit workpapers or “audit documentation.”
PCAOB Auditing Standard No. 3:
This standard defines audit documentation as “the written record of the basis for the auditor’s
conclusions that provides the support for the auditor’s representations, whether those representations
6 Case 1.1 Enron Corporation
representation. Audit documentation may be in the form of paper, electronic files, or other media”
(para. .04).
PCAOB No. 3 notes that there are three key objectives of audit documentation: “demonstrate
that the engagement complied with the standards of the PCAOB, support the basis for the auditor’s
conclusions concerning every major relevant financial statement assertion, and demonstrate that the
underlying accounting records agreed or reconciled with the financial statements” (para. .05).
5. During and following the Enron debacle, wide-ranging recommendations were made by many
parties to strengthen the independent audit function. Listed next are several of these
recommendations, including certain measures that were incorporated in the Sarbanes-Oxley Act of
2002.
•Establish an independent audit agency. Some critics have suggested that to “cure” the
paradoxical nature of the auditor-client relationship (that is, to eliminate the economic leverage
that clients have on their auditors), the independent audit function should be performed by a
government agency comparable to the Internal Revenue Service.
Case 1.1 Enron Corporation 7
6. Many critics of our profession suggest that beginning in the latter part of the twentieth century
certain accounting firms gradually turned away from the public service ideal embraced by Arthur E.
Andersen and other early pioneers within the profession and, instead, adopted a somewhat
mercenary attitude toward the independent audit function. A key factor that certainly accelerated
7. In the spring of 2000, the SEC began requiring public companies to have their quarterly
financial reports (typically included in Form 10-Q filings) reviewed by their independent auditors.
(Note: AU-C Section 930, “Interim Financial Information,” of the AICPA Professional Standards
provides guidance to auditors on the “nature, timing, and extent of procedures to be applied” to a
client’s interim financial information. The comparable section of the PCAOB’s Interim Standards is
AU Section 722, “Interim Financial Information.”)
Should quarterly reports be audited? In fact, many parties have advocated an even more