The Internal Control Weaknesses At Enron Accounting Essay

The incidents were finally resulting the filing for personal bankruptcy in December 2001, started out way much before fraud at Enron could be even suspected. Andersen played out a major role in the collapse of Enron. Andersen failed two times regarding audit issues only a few years short time before the collapse of Enron, at Waste Management in 1996 with Sunbeam in 1997. The two audit failures mentioned above must have been huge warning signs for Andersen to safeguard itself against another consumer failure but what they had to face regarding Enron was worse than they ever had. Some inside memos at Andersen managed to get clear that several conflicts been around between the auditors and the audit committee of Enron. These memos included several e-mails as well which indicated concerns about accounting tactics employed by Enron. David B. Duncan as the leading partner on the audit tipped over these concerns. Corresponding to McNamee(2001) there is certainly evidence that Duncan's team wrote memos fraudulently stating that the professional requirements group approved of the accounting techniques of Enron that hid bills and pumped up income. Andersen's independence is also highly doubtful due to the relationship between audit and non-audit fees. According to McLean(2001) the individual who first spotted in 2001 that there wasn't even any chance for Enron to make revenue was Jim Chanos, the top of Kynikos Associates. He said that that mother or father company had officially become nothing more than a hedging entity for most of its subsidiaries and affiliate marketers. In 2001 the operating margin of Enron went down significantly to 2% from the previous year's amount of 5% which is more than interesting because this kind of a decrease in twelve months is unusual in the resources industry. Chanos also pointed out that Enron was still aggressively selling stocks, despite there is almost no capital to back up the stocks they were advertising.

To be professional and effective, auditors must be unbiased of management and measure the financial representations of management for any users of financial statements. Significantly less than 30% of the fees that Andersen received from Enron originated from auditing, with the balance of fees coming from consulting. Andersen acted as Enron's external auditor as its internal auditor. Andersen's are a consultant boosts several questions. It appears that Andersen's audit team, when confronted with accounting issues, chose to dismiss them, acquiesced in silence to unsound accounting, or embraced accounting plans as an advocate because of its client.

Internal Control Weaknesses at Enron

Auditors assess the internal controls of a client to determine the extent to that they can rely on a client's accounting system. Enron got too many internal control weaknesses to get here. Two serious weaknesses were that the CFO was exempted from a conflicts of interest policy, and inside settings over SPEs were a sham, existing in form however, not in substance. Many financial officials lacked the background for their jobs, and belongings, notably foreign possessions, were not in physical form anchored. The tracking of daily cash was lax, arrears maturities were not slated, off balance sheet debts was ignored even though obligation continued to be, and company-wide risk was disregarded. Internal control buttons were insufficient; contingent liabilities were not disclosed; and, Andersen dismissed all of these weaknesses.

Evaluation of Accounting -- Materiality

Auditors give attention to materials misrepresentations. A misrepresentation is material if understanding of the misrepresentation would change the decisions of an individual of financial statements. When Enron started out to restate its financial statements and traders began to understand its misrepresentations, the response of the market is indisputable concerning materiality. Many mistakes were known, but were dismissed by Andersen as immaterial. Other errors may well not have been known, but must have been known if sensible inquiry could have unveiled them.

Business Model, Experience, and Organizational Culture

At Enron with Andersen, the business model and the organizational culture were changing. Enron was moving to a fresh business model dominated by intangible possessions, the rights to trade goods. This change in belongings was driven by a fresh organizational culture which in turn aggressively cultivated its own progress. As auditors shifted to be part of an consulting industry, their business model and organizational culture were changing too. It is likely that both changes at Enron with Andersen were increasing risks for buyers. Enron's movement from the dominance of set property to the dominance of intangible possessions was more likely to increase volatility, and this prospect was compounded by the use of mark-to-market accounting. Also, Andersen's activity from the professionalization of auditing to the commercialization of consulting was likely to weaken auditors as monitors of management. In to the mixture of changing business models and cultures, add people who were not outfitted for the changes. The young trading executives at Enron chased the offer for income, while failing woefully to grasp the risks attached to the intangibles that were driving development in earnings. Also, young auditors at Andersen embraced consulting, while failing woefully to understand the chance of audit inability.

Many accounting businesses and independent CPAs reacted to these occasions and implemented changes in method voluntarily. The largest change that accounting organizations made was a move created by the four staying members of the big five, KPMG, Ernst and Young, Deloitte Touche Tohmatsu, and PricewaterhouseCoopers. These four companies decided to break all ties with Andersen in an attempt to don't be dragged down with the offering controversy encompassing the Enron scandal. This distancing was also due to the major changes mandated to Andersen in an effort to get back on the feet following the scandal broke, and the other firms were afraid these changes would have no choice but on them as well.

The federal reacted aggressively when they truly became aware of the Enron scandal, and a flurry of legislation and proposals emanated from Congress and the SEC about how exactly best to package with this example. Leader Bush even announced one post-Enron plan. This plan was to make disclosures in financial statements more beneficial and in the management's letter of representation. This plan would likewise incorporate higher levels of financial responsibility for CEOs and accountants. Bush's goal was to be hard, but not to put an undue burden upon the honest accountants on the market.

By far the biggest change brought about is the Sarbanes-Oxley Function. The Sarbanes-Oxley Take action requires companies to revaluate their interior audit techniques and make sure that everything is operating up to or exceeding the anticipations of the auditors. It also requires higher-level employees, like the CEO and CFO to have an understanding of the workings of the firms that they mind and affirm the fact that they don't really know of any fraud being dedicated by the company. Sarbanes-Oxley also brought with it new requirements for disclosures. These requirements included reporting of orders called reportable trades. These orders are divided into several categories, which impact every part of any business. Among these categories is shown transactions-which are probably the worst. They are simply transactions that are in fact written out in a list, each one regarding one specific situation. Another is transactions with a book-to-tax difference greater than ten million dollars. There are many others, however both of these will have the greatest effect. Associated these requirements are rigorous penalties if these transactions aren't reported and discovered later. This take action means significant additional improve accountants over the next many years.

For many years the SEC Chairman, then Arthur Levitt Jr. , have been calling for the separation of auditing and talking to services within one company. However big organizations like Andersen would apply their proverbial weight to try and show that consulting did not hinder an auditor's independence. Since the major concern of Andersen's role in the controversy centres on the independence, and because of the large economic consulting fees being paid to them by Enron, the push has been started anew by Paul Volcker the former Government Reserve Chairman. Realistically, few think that the big businesses will be able to dissuade the SEC from actually putting into action such a guideline. Many companies who use auditors assume that this is not the answer, because of the fact that it will lead them to hire one firm to do auditing work, and another to do non-audit work like fees and other filings. In an attempt to not get damaged by any imminent government action, many business-including Disney and Apple Computer Inc. have previously begun splitting their audit and non-audit work between different organizations.

Effects on other Commercial Organisations


After the bewildering complexity of Enron's SPEs and prepays, Worldcom's fraud is ease itself. Through the 1990s, WorldCom became a worldwide telecommunication giant by acquiring companies such as MCI and building a sizable telecommunications network.

In addition, WorldCom inserted into long-term, fixed-rate collection leases to hook up its network with the sites of incumbent local exchange carriers.

Faced with the telecom downturn and strong pressures on earnings, WorldCom undertook a string of procedures to inflate income37. The largest and simplest of the related to range costs. WorldCom simply recharacterized its sizeable range costs as "Prepaid Capacity" and transferred them from the Company's income claims to its balance sheets. The result was that over $3. 8 billion of series costs which should have been proven as expense were capitalized as belongings. WorldCom's income was overstated by the same amount.

There were no SPEs and no complex accounting stunts. There was just a journal entry approved under the guidelines of the Chief Financial Official, Scott Sullivan, that reclassified bills as assets without the supporting documentation whatsoever. When this is finally found out by the internal audit department, Sullivan offered an equally brazen justification38 which is worth quoting at duration:

At the time of the price deferral, management acquired motivated that future economic gain would be derived from these contractual commitments as the income from these service offerings reached projected levels. At that time, management fully believed that the projected earnings rises would more than offset the near future rent commitments and deferred costs under the agreements. Therefore, the price deferrals for the unutilized portion of the agreement was regarded as an appropriate inventory of the capacity and would eventually be totally amortized prior to the termination of the contractual determination.

(FASB CON No. 6, par. 26). "


In a series of disclosures40 between March 2002 and June 2002, Adelphia Communications Corporation announced that it got concealed $2. 6 billion of its indebtedness. At the time, Adelphia was the 6th largest cable television set operator in the United States. The Rigas family that managed a controlling stake in Adelphia also owned or operated other companies ("Rigas entities") that were also in the cable tv telivision business.

The Rigas entities were maintained by Adelphia. Additionally, Adelphia subsidiaries and the Rigas entities borrowed money under a co-borrowing contract your made all parties jointly and severally responsible for the borrowing irrespective of who had attracted down the amount of money. This intended that your debt had to be shown as a debt of the Adelphia subsidiaries (and for that reason as part of Adelphia's consolidated debts) and not as a contingent responsibility. The next footnote in Adelphia's December 31, 2000 balance sheet could have led every person to assume that this responsibility was included in the consolidated debts:

In simple fact, however, this amount was not contained in Adelphia's consolidated debt. The footnote was thus calculated to conceal this credit debt completely. At least, if the be aware had disclosed a contingent liability, readers could have known that that debt was in addition to the debt on the total amount sheet. Needless to say, even that would have been inaccurate from an accounting perspective as the co-borrowing needed to be disclosed as debt rather than as a contingent responsibility. The SEC explained: "The omission of these liabilities was a deliberate scheme to under-report Adelphia's overall credit debt, portray Adelphia as de-leveraging, and conceal Adelphia's inability to comply with credit debt ratios in loan covenants. "

In March 2002, while presenting the results going back quarter of 2001, Adelphia for the very first time disclosed the presence of $2. 3 billion of hidden personal debt treating it as a contingent liability:

Subsequent disclosure managed to get very clear that the amount of $2. 3 billion was not simply a contingent liability but was very much an integral part of Adelphia's personal debt. It turned out that there is not in reality any clear demarcation between your drawdowns by Adelphia and the Rigas Entities. The apportionment of the co-borrowing between them was an arbitrary reclassification carried out every quarter while planning the financial claims. The SEC stated: "Adelphia management allocated and reallocated co-borrowing liabilities among Adelphia's consolidated subsidiaries and unconsolidated Rigas Entities at will and through a single, quarterly cash management reconciliation of the inter-company receivables and payables exceptional at quarter end between or among Adelphia's subsidiaries and Rigas Entities" In fact, Adelphia managed a Cash Management System (CMS) into which Adelphia, its subsidiaries and the Rigas Entities deposited their cash receipts (produced from procedures or obtained from borrowings) and from which they withdrew cash for bills, capital expenditure and arrears repayment. This resulted in the commingling of money between Adelphia and the Rigas Entities.

Adelphia's fraud had not been limited to concealment of credit debt. "Between mid-1999 and the last quarter of 2001, Adelphia misrepresented its performance in three areas that are essential in the metrics financial analysts use to judge cable companies: (a) the amount of its basic cable television users, (b) the percentage of its wire vegetable 'rebuild, ' or upgrade, and (c) its revenue, including its net gain and quarterly EBITDA". Most of this was achieved by outright falsification or by fictitious transactions with the Rigas Entities through the CMS.


Xerox restated its income for the years from 1997 to 2002 partly to represent incorrect accounting routines associated with the timing and allocation of revenue from bundled leases. Xerox provides almost all of its products and services under bundled deals which contain multiple components - equipment, service, and funding components - that the customer gives a single monthly-negotiated price and a variable service element for page amounts in excess of mentioned minimums. The SEC claimed that Xerox's revenue-allocation methodology for these deals did not comply with the accounting expectations and compelled Xerox to improve its methodology. Under the original strategy, Xerox approximated the reasonable value of the funding component (using a discounted cashflow method based on the business's cost of equity and arrears) and of the service component (by using an estimate of service gross margins) and attributed the total amount to equipment. In the new technique, the good value of the service aspect and the reasonable value of the equipment (using cash deal prices) are deducted from the total lease payment to arrive at the financing component as a balancing physique and the implicit financing rate is set. Interestingly, the company's earlier auditor, KPMG regards the original accounting as accurate and regards the new accounting adopted by the business and its new auditors, PricewaterhouseCoopers under great pressure from the SEC as inappropriate. KPMG explained that:

"KPMG remains strong in its conviction that the financial claims reported on by us in-may 2001, including Xerox's financial assertions for 2000 and the restated financial assertions for 1997-1999, were pretty presented relative to generally accepted accounting ideas.

KPMG, Xerox and PricewaterhouseCoopers had it right the first time, when the business and three different teams from PwC all decided around that Xerox's lease accounting strategy was GAAP compliant. In comparison, today's news reviews lead us to think that the restated financial claims defy economic simple fact. They seemingly give Xerox the advantage of recognizing revenues in 2002 and in future years so it had already known in prior years.

AOL Time Warner

AOL Time Warner Inc. accepted50 in October 2002 which it had improperly inflated revenue by $190 million and success (EBITDA) by $97 million by incorrectly accounting for a few online ad sales and other bargains between July 2000 and June 2002. While AOL Time Warner didn't identify the trades involved, chances are that these were the ones that the Washington Post possessed highlighted in two articles52 in July 2002. The Post experienced alleged that America Online (AOL) resorted to doubtful accounting practices so that they can shore up advertising revenue at a time when it was along the way of acquiring Time Warner in a stock swap deal. From past due 2000 onwards, stock markets were extremely concerned about the sustainability of advertising income for internet companies. A weakness in advertising earnings could conceivably have resulted in a sharp land in the AOL stock price that could have endangered the merger with Time Warner. The Washington Post alleged: "AOL transformed legal disputes into advertisement deals. It negotiated a shift in revenue in one division to some other, bolstering its web business. It sold ads on behalf of online auction big eBay Inc. , reserving the sales of eBay's advertisings as AOL's own income. AOL bartered advertisements for computer equipment in a deal with Sun Microsystems Inc. AOL counted stock protection under the law as ad and commerce earnings in a offer with a Las Vegas company called PurchasePro. com Inc". AOL's accounting is under investigation by the SEC and by the Justice Department. As the restatements are small relative to AOL's total income and profits, it might have had a disproportionate effect on the talk about price at a crucial point of energy when it was clinching the merger offer as time passes Warner.


Enron and Andersen-What Went Wrong and just why Similar Audit Failures CAN HAPPEN Again by Matthew J. Barrett

Governance, Guidance and Market Discipline: Lessons from Enron by Jayanth R. Varma, Journal of the Indian College of Political Current economic climate printed (October-December 2002), Size 14 #4 4, 559-632).

Arthur Andersen and Enron: Positive Influence on the Accounting Industry by Todd Stinson

http://faculty. mckendree. edu/scholars/2004/stinson. htm

McNamee, Mike and Harvy Pitt. If You Violate the Law You Will Pay for it. Business Week December 24, 2001: 33.

McLean, Bethany. Why Enron Went Bust. Fortune December 24, 2001: 59

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