The events were eventually ensuing the filing for bankruptcy in December 2001, started manner much before fraud at Enron could be even suspected.A Andersen played a major function in the prostration of Enron.A Andersen failed two times sing audit issues merely a few old ages short clip before the prostration of Enron, at Waste Management in 1996 and at Sunbeam in 1997. The two audit failures mentioned supra should hold been immense warning marks for Andersen to protect itself against another client failure but what they had to confront sing Enron was worse than they of all time had.A Some internal memos at Andersen made it clear that several struggles existed between the hearers and the audit commission of Enron.A These memos contained several electronic mails as good which expressed concerns about accounting patterns used by Enron.A David B. Duncan as the taking spouse on the audit tipped over these concerns. Harmonizing to McNamee ( 2001 ) there is cogent evidence that Duncan ‘s squad wrote memos fraudulently saying that the professional criterions group approved of the accounting patterns of Enron that hid debts and pumped up net incomes. Andersen ‘s independency is besides extremely questionable due to the relationship between audit and non-audit fees. Harmonizing to McLean ( 2001 ) the individual who foremost spotted in 2001 that there was n’t even any opportunity for Enron to do net income was Jim Chanos, the caput of Kynikos Associates. He said that that parent company had technically become nil more than a hedging entity for all of its subordinates and affiliates.A In 2001 the runing border of Enron went down significantly to 2 % from the old twelvemonth ‘s figure of 5 % which is more than interesting because this sort of a lessening in one twelvemonth is unheard of in the public-service corporations industry. Chanos besides pointed out that Enron was still sharply selling stocks, despite there was barely any capital to endorse up the portions they were selling.Order now
To be professional and effectual, hearers must be independent of direction and measure the fiscal representations of direction for all users of fiscal statements. Less than 30 % of the fees that Andersen received from Enron came from scrutinizing, with the balance of fees coming from confer withing. Andersen acted as Enron ‘s external hearer and as its internal hearer. Andersen ‘s work as a adviser raises several inquiries. It appears that Andersen ‘s audit squad, when faced with accounting issues, chose to disregard them, acquiesced in silence to unsound accounting, or embraced accounting strategies as an advocator for its client.
Internal Control Weaknesses at Enron
Hearers assess the internal controls of a client to find the extent to which they can trust on a client ‘s accounting system. Enron had excessively many internal control weaknesses to be given here. Two serious failings were that the CFO was exempted from a struggles of involvement policy, and internal controls over SPEs were a fake, bing in signifier but non in substance. Many fiscal functionaries lacked the background for their occupations, and assets, notably foreign assets, were non physically secured. The trailing of day-to-day hard currency was slack, debt adulthoods were non scheduled, away balance sheet debt was ignored although the duty remained, and company-wide hazard was disregarded. Internal controls were unequal ; contingent liabilities were non disclosed ; and, Andersen ignored all of these failings.
Evaluation of Accounting — Materiality
Hearers focus on stuff deceits. A deceit is material if cognition of the deceit would alter the determinations of the user of fiscal statements. When Enron began to repeat its fiscal statements and investors began to hold on its deceits, the response of the market is incontestable as to materiality. Many mistakes were known, but were dismissed by Andersen as immaterial. Other mistakes may non hold been known, but should hold been known if sensible enquiry would hold revealed them.
Business Model, Experiences, and Organizational Culture
At Enron and at Andersen, the concern theoretical account and the organisational civilization were altering. Enron was traveling to a new concern theoretical account dominated by intangible assets, the rights to purchase and sell trade goods. This alteration in assets was driven by a new organisational civilization which so sharply cultivated its ain growing. As hearers moved to go portion of a confer withing industry, their concern theoretical account and organisational civilization were altering excessively. It is likely that both the alterations at Enron and at Andersen were increasing hazards for investors. Enron ‘s motion off from the laterality of fixed assets to the laterality of intangible assets was likely to increase volatility, and this chance was compounded by the usage of mark-to-market accounting. Besides, Andersen ‘s motion off from the professionalisation of scrutinizing to the commercialisation of consulting was likely to weaken hearers as proctors of direction. Into the mix of altering concern theoretical accounts and civilizations, add people who were non equipped for the alterations. The immature trading executives at Enron chased the trade for net incomes, while neglecting to hold on the hazards attached to the intangibles that were driving growing in net incomes. Likewise, immature hearers at Andersen embraced consulting, while neglecting to understand the hazard of audit failure.
Many accounting houses and independent CPAs reacted to these events and implemented alterations in process voluntarily.A The biggest alteration that accounting houses made was a move made by the four staying members of the large five, KPMG, Ernst and Young, Deloitte Touche Tohmatsu, and PricewaterhouseCoopers.A These four companies decided to interrupt all ties with Andersen in an effort to avoid being dragged down with the merchandising contention environing the Enron scandal.A This distancing was besides due to the major alterations mandated to Andersen as a manner to acquire back on their pess after the dirt broke, and the other houses were afraid that these alterations would be forced on them every bit good.
The authorities reacted sharply when they became cognizant of the Enron dirt, and a bustle of statute law and proposals emanated from Congress and the SEC about how best to cover with this situation.A President Bush even announced one post-Enron plan.A This program was to do revelations in fiscal statements more enlightening and in the direction ‘s missive of representation.A This program would besides include higher degrees of fiscal duty for CEOs and accountants.A Bush ‘s end was to be tough, but non to set an undue load upon the honest comptrollers in the industry.A
By far the biggest alteration brought approximately is the Sarbanes-Oxley Act.A The Sarbanes-Oxley Act requires companies to revaluate their internal audit processs and do certain that everything is running up to or transcending the outlooks of the auditors.A It besides requires higher degree employees, like the CEO and CFO to hold an apprehension of the workings of the companies that they head and to confirm the fact that they do n’t cognize of any fraud being committed by the company.A Sarbanes-Oxley besides brought with it new demands for disclosures.A These demands included coverage of minutess called reportable transactions.A These minutess are broken down into several classs, which impact every facet of a business.A One of these classs is listed transactions-which are by far the worst. They are minutess that are really written out in a list, each one pertaining to one specific state of affairs. Another is minutess with a book-to-tax difference of more than ten million dollars. A There are several others, nevertheless these two will hold the greatest effect.A Attach toing these demands are rigorous punishments if these minutess are non reported and discovered later.A This act will intend important extra work for comptrollers over the following several years.A
A For many old ages the SEC Chairman, so Arthur Levitt Jr. , had been naming for the separation of scrutinizing and confer withing services within one company.A However large houses like Andersen would use their proverbial weight to try to demo that confer withing did non interfere with an hearer ‘s independence.A Since the major concern of Andersen ‘s function in the contention Centres on their independency, and because of the big pecuniary consulting fees being paid to them by Enron, the push has been started afresh by Paul Volcker the former Federal Reserve Chairman.A Realistically, few think that the large houses will be able to deter the SEC from really implementing such a rule.A A A Many companies who use hearers believe that this is non the reply, because of the fact that it will do them to engage one house to make scrutinizing work, and another to make non-audit work like revenue enhancements and other filings. In an effort to non acquire damaged by any at hand authorities action, many business-including Disney and Apple Computer Inc. have already begun dividing their audit and non-audit work between different firms.A
Effectss on other Commercial Administrations
After the perplexing complexness of Enron ‘s SPEs and prepays, Worldcom ‘s fraud is simplicity itself. During the 1990s, WorldCom became a planetary telecommunication giant by geting companies such as MCI and constructing a big telecommunications web.
In add-on, WorldCom entered into long-run, fixed-rate line rentals to link its web with the webs of incumbent local exchange bearers.
Faced with the telecom downswing and intense force per unit areas on net incomes, WorldCom undertook a series of steps to blow up earnings37. The largest and simplest of these related to line costs. WorldCom merely recharacterized its ample line costs as “ Prepaid Capacity ” and transferred them from the Company ‘s income statements to its balance sheets. The consequence was that over $ 3.8 billion of line costs that should hold been shown as disbursal were capitalized as assets. WorldCom ‘s income was overstated by the same sum.
There were no SPEs and no complex accounting fast ones. There was merely a journal entry passed under the waies of the Chief Financial Officer, Scott Sullivan, that reclassified disbursals as assets without any back uping certification whatsoever. When this was eventually discovered by the internal audit section, Sullivan offered an every bit audacious explanation38 which is deserving citing at length:
At the clip of the cost recess, direction had determined that future economic benefit would be derived from these contractual committednesss as the grosss from these service offerings reached jutting degrees. At that clip, direction to the full believed that the jutting gross additions would more than countervail the future rental committednesss and deferred costs under the understandings. Therefore, the cost recesss for the unutilized part of the contract was considered to be an appropriate stock list of this capacity and would finally be to the full amortized prior to the expiration of the contractual committedness.
( FASB CON No. 6, par. 26 ) . ”
In a series of disclosures40 between March 2002 and June 2002, Adelphia Communications Corporation announced that it had concealed $ 2.6 billion of its liability. At the clip, Adelphia was the 6th largest overseas telegram telecasting operator in the United States. The Rigas household that owned a commanding interest in Adelphia besides owned several other companies ( “ Rigas entities ” ) that were besides in the overseas telegram telivision concern.
The Rigas entities were managed by Adelphia. Furthermore, Adelphia subordinates and the Rigas entities borrowed money under a co-borrowing understanding with that made all parties jointly and independently apt for the adoption regardless of who had drawn down the money. This meant that the debt had to be shown as a debt of the Adelphia subordinates ( and hence as portion of Adelphia ‘s amalgamate debt ) and non as a contingent liability. The undermentioned footer in Adelphia ‘s December 31, 2000 balance sheet would hold led everybody to believe that this liability was included in the amalgamate debt:
In fact, nevertheless, this sum was non included in Adelphia ‘s amalgamate debt. The footer was therefore calculated to hide this debt wholly. At least, if the note had disclosed a contingent liability, readers would hold known that that this debt was in add-on to the debt on the balance sheet. Of class, even that would hold been inaccurate from an accounting point of position as the co-borrowing needed to be disclosed as debt and non as a contingent liability. The SEC stated: “ The skip of these liabilities was a calculated strategy to under-report Adelphia ‘s overall debt, portray Adelphia as de-leveraging, and hide Adelphia ‘s inability to follow with debt ratios in loan compacts. ”
In March 2002, while showing the consequences for the last one-fourth of 2001, Adelphia for the first clip disclosed the being of $ 2.3 billion of concealed debt handling it as a contingent liability:
Subsequent revelation made it really clear that the sum of $ 2.3 billion was non merely a contingent liability but was really much a portion of Adelphia ‘s debt. It turned out that there was non in fact any clear limit between the drawdowns by Adelphia and the Rigas Entities. The allotment of the co-borrowing between them was an arbitrary reclassification carried out every one-fourth while fixing the fiscal statements. The SEC stated: “ Adelphia direction allocated and reallocated co-borrowing liabilities among Adelphia ‘s amalgamate subordinates and unconsolidated Rigas Entities at will and through a individual, quarterly hard currency direction rapprochement of the inter-company receivables and payables outstanding at one-fourth terminal between or among Adelphia ‘s subordinates and Rigas Entities ” In fact, Adelphia operated a Cash Management System ( CMS ) into which Adelphia, its subordinates and the Rigas Entities deposited their hard currency grosss ( generated from operations or obtained from adoptions ) and from which they withdrew hard currency for disbursals, capital outgo and debt refund. This resulted in the commingling of financess between Adelphia and the Rigas Entities.
Adelphia ‘s fraud was non restricted to privacy of debt. “ Between mid-1999 and the last one-fourth of 2001, Adelphia misrepresented its public presentation in three countries that are of import in the prosodies fiscal analysts use to measure overseas telegram companies: ( a ) the figure of its basic overseas telegram endorsers, ( B ) the per centum of its overseas telegram works ‘rebuild, ‘ or upgrade, and ( degree Celsius ) its net incomes, including its net income and quarterly EBITDA ” . Most of this was accomplished by straight-out disproof or by fabricated minutess with the Rigas Entities through the CMS.
Xerox restated its income for the old ages from 1997 to 2002 partially to reflect wrong accounting patterns associating to the timing and allotment of gross from bundled rentals. Xerox sells most of its merchandises and services under bundled contracts that contain multiple constituents – equipment, service, and funding constituents – for which the client pays a individual monthly-negotiated monetary value every bit good as a variable service constituent for page volumes in surplus of stated lower limits. The SEC claimed that Xerox ‘s revenue-allocation methodological analysis for these contracts did non follow with the accounting criterions and forced Xerox to alter its methodological analysis. Under the original methodological analysis, Xerox estimated the just value of the funding constituent ( utilizing a discounted hard currency flow method based on the company ‘s cost of equity and debt ) and of the service constituent ( by utilizing an estimation of service gross borders ) and attributed the balance to equipment. In the new methodological analysis, the just value of the service constituent and the just value of the equipment ( utilizing hard currency sale monetary values ) are deducted from the entire lease payment to get at the funding constituent as a reconciliation figure and the inexplicit funding rate is determined. Interestingly, the company ‘s old hearer, KPMG regards the original accounting as right and regards the new accounting adopted by the company and its new hearers, PricewaterhouseCoopers under force per unit area from the SEC as incorrect. KPMG stated that:
“ KPMG remains house in its strong belief that the fiscal statements reported on by us in May 2001, including Xerox ‘s fiscal statements for 2000 and the restated fiscal statements for 1997-1999, were reasonably presented in conformity with by and large accepted accounting rules.
KPMG, Xerox and PricewaterhouseCoopers had it right the first clip, when the company and three separate squads from PwC all agreed with us that Xerox ‘s rental accounting methodological analysis was GAAP compliant. By contrast, today ‘s intelligence studies lead us to believe that the restated fiscal statements withstand economic world. They seemingly give Xerox the benefit of acknowledging grosss in 2002 and in future old ages that it had already recognized in anterior old ages.
AOL Time Warner
AOL Time Warner Inc. admitted50 in October 2002 that it had improperly inflated gross by $ 190 million and profitableness ( EBITDA ) by $ 97 million by improperly accounting for some on-line ad gross revenues and other trades between July 2000 and June 2002. While AOL Time Warner did non place the minutess involved, it is likely that these were the 1s that the Washington Post had highlighted in two articles52 in July 2002. The Post had alleged that America Online ( AOL ) resorted to questionable accounting patterns in an effort to shore up advertisement gross at a clip when it was in the procedure of geting Time Warner in a stock barter trade. From late 2000 onwards, stock markets were highly worried about the sustainability of advertisement gross for cyberspace companies. A failing in advertisement grosss could conceivably hold led to a crisp autumn in the AOL stock monetary value that could hold endangered the amalgamation with Time Warner. The Washington Post alleged: “ AOL converted legal differences into ad trades. It negotiated a displacement in gross from one division to another, bolstering its online concern. It sold ads on behalf of on-line auction giant eBay Inc. , booking the sale of eBay ‘s ads as AOL ‘s ain gross. AOL bartered ads for computing machine equipment in a trade with Sun Microsystems Inc. AOL counted stock rights as ad and commercialism gross in a trade with a Las Vegas house called PurchasePro.com Inc ” . AOL ‘s accounting is under probe by the SEC and by the Justice Department. While the restatements are little comparative to AOL ‘s entire grosss and net incomes, it could hold had a disproportional impact on the portion monetary value at a critical point of clip when it was clinching the amalgamation trade with Time Warner.
Enron and Andersen-What Went Wrong and Why Similar Audited account Failures Could Happen Again by Matthew J. Barrett
Governance, Supervision and Market Discipline: Lessons from Enron by Jayanth R. Varma, Journal of the Indian School of Political Economy published ( October-December 2002 ) , Volume 14 Number 4, 559-632 ) .
Arthur Andersen and Enron: Positive Influence on the Accounting Industry byA Todd Stinson
hypertext transfer protocol: //faculty.mckendree.edu/scholars/2004/stinson.htm
McNamee, Mike and Harvy Pitt.A If You Violate the Law You Will Pay for it.A Business Week December 24, 2001: 33.
McLean, Bethany.A Why Enron Went Bust.A Fortune December 24, 2001: 59