Chapter 8 United States Auditing Classes Often Spend Considerable

CASE 8.8

OAO GAZPROM

Synopsis

In 2001, PricewaterhouseCoopers (PwC) became entangled in what business journalists referred

to as fiRussia’s Enron.” One of PwC’s largest audit clients at the time was OAO Gazprom, the

largest publicly owned company in Russia and the company that had long dominated that country’s

natural gas industry. Over the past several years, critics had charged top Gazprom officials with

engaging in a wide range of fiasset–stripping” practices. Allegedly, these executives funneled

billions of dollars of Gazprom’s assets into a network of privately owned companies that they and

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OAO Gazprom—Key Facts

Case 8.8 OAO Gazprom 343

1. Gazprom is a huge Russian company that dominates that nation’s important natural gas industry.

2. Similar to most major Russian companies, Gazprom was a product of Russia’s fiprivatization

programme” of the early 1990s that was intended to convert the country from a communistic to a

capitalistic economic system.

6. A reform movement begun by new Russian president Vladimir Putin shortly after he took office

in 2000 forced large numbers of so-called fired directors” to resign their positions with large Russian

companies, including Chernomyrdin and Vyakhirev.

7. To improve the credibility of Russian corporate financial statements, Putin and other reformers

took measures to strengthen Russia’s financial reporting system, including the adoption of Western–

style accounting principles and auditing practices.

11. Gazprom’s minority stockholders filed several lawsuits against PwC that charged the firm with

defective audits of the company; these were the first such lawsuits filed against a major accounting

firm in Russia.

Instructional Objectives

344 Case 8.8 OAO Gazprom

1. To illustrate the central importance of a reliable accounting and financial reporting infrastructure

and rigorous independent audit function for a free market economy.

Suggestions for Use

This case provides an opportunity for instructors to discuss several key auditing issues as well as

lend an assist to any of their students concurrently enrolled in Russian History 101. In fact, the

recent history of Russia is very relevant to this case. This case tracks the history of Russia’s largest

and most important company, OAO Gazprom, through the turbulent 1990s and beyond when that

nation effectively converted from a controlled to a free market economy. More than any other case,

Probably most importantly, this case provides students with an opportunity to discuss the

overarching ethical responsibilities of independent auditors and independent audit firms. The key

events in the Gazprom case occurred in an environment in which there were very few formal rules,

regulations, or legal constraints on auditors and accountants. It is in such an environment that the

Suggested Solutions to Case Questions

Case 8.8 OAO Gazprom 345

1. Listed next are examples of key challenges that an accounting firm may face when it decides to

establish its first practice office in a foreign country.

•Need to become familiar with the laws and other regulations that govern business operations in that

country.

For most firms, fieconomics” dictate whether a practice office should be established in a new

market. After considering the items just listed and a slew of other relevant variables, an accounting

firm’s management must decide whether it makes economic fisense” to open the new office, that is,

will the new office contribute to the economic well-being of the firm? Among the fiother relevant

2. In my view, this is a difficult but important question for students to address. Practically every

multinational company or organization struggles with this issue at some point in time. I believe that

one important point that instructors and students alike should realize is that no one country,

including ours, has cornered the market on business ethics. That is, there is room for improvement

346 Case 8.8 OAO Gazprom

in Russia.

In my view, the best strategy for coping with situations similar to the one posed by this question

is to simply rely on the bedrock ethical principles that have been embraced by the public accounting

profession in the United States. In auditing classes, we often spend considerable time studying and

Integrity is measured in terms of what is just. In the absence of specific rules, standards, or

guidance, or in the face of conflicting opinions, a member should test decisions and deeds by

asking: fiAm I doing what a person of integrity would do? Have I retained my integrity?”

Integrity requires a member to observe both the form and the spirit of technical and ethical

standards, circumvention of those standards constitutes subordination of judgment. (ET 54.03)

3. Recognize that we do not have access to the engagement letter that PwC signed for the Gazprom

engagement—which is an important caveat to raise for your students in addressing this question. So,

we do not know what specific commitments that PwC made to Gazprom officials. Likewise,

recognize that Russian laws and common law precedents relevant to independent auditors are, as

indicated in the case, fiscanty” at best, which means that it is difficult, if not impossible, to pinpoint

PwC’s specific legal responsibilities to the various parties relying on the firm’s Gazprom audits.

With those disclaimers out of the way, I would suggest that PwC certainly had multiple

responsibilities to Gazprom’s minority investors. For example, since the minority investors were

Case 8.8 OAO Gazprom 347

following simple questions: fiAm I doing what a person of integrity would do? Have I retained my

integrity?”

4. This is a good discussion question for an auditing class but another question that does not have a

clear-cut answer. In the final analysis, the PwC personnel making the decision of whether or not to

perform the Itera special audit had to consider a number of variables, including their perception of

whether or not they could objectively complete that engagement. A key variable those personnel

•Could the PwC auditors be objective in reviewing major transactions that they likely had already

considered in arriving at ficlean” opinions on Gazprom’s previous financial statements?

•How would the PwC auditors react to any explicit or implicit pressure imposed on them by

Gazprom management during the course of the special audit? (Clearly, Gazprom officials had a

vested interest in a ficlean” report from that audit. The large audit fee that PwC received for the

5. The relevant section of the professional standards in this context is AU 334.07, fiDetermining

the Existence of Related Parties.” This section points out that certain related parties are ficlearly

evident.” For example, each subsidiary of a conglomerate or holding company qualifies as a related

party. Auditors have an affirmative responsibility to search for related parties that may not be

348 Case 8.8 OAO Gazprom

6. You can find numerous articles in recent years that have documented, described, and debated

the differences between the audit philosophy applied in the United States versus that applied in the

United Kingdom. Although a little fidated” at this point, the following article provides a

comprehensive and insightful analysis of those differences: C.A. Frost and K.P. Ramin,

fiInternational Auditing Differences: The Implications for Investors and Other Financial Statement

Users,” Journal of Accountancy, April 1996. [Note: This article actually compares and contrasts

auditing practices in the United States, the United Kingdom, and Germany.] Here is the opening

Frost and Ramin suggest that the audit philosophies applied in the United Kingdom and the

United States are more similar than they are different, which is to be expected since the independent

audit function in this country was effectively imported from the United Kingdom during the late 19th

and early 20th centuries. Nevertheless, there is one readily apparent philosophical difference

between U.K. and U.S. auditing standards. Frost and Ramin report that U.S. auditing standards tend

to be fihighly specific and comprehensive,” while U.K. auditing standards are more principle-based.

Because of this difference, U.K. auditors tend to have more flexibility or leeway in designing audit

plans for their clients than U.S. auditors. This difference in U.S. and U.K. auditing standards has