Enron Scandal and the Importance of Reliable Financial Statements and Auditing

The Enron scandal is a symbol of corruption and a reminder of the importance of reliable financial statements and auditing. This article explores the relevance and reliability of financial statements, the role of auditors, and the need for professional skepticism. It also discusses the changes made by the accounting industry and government to prevent such scandals in the future.

COMPANY AUDITING

(a)
In the history of the US economy, Enron and its auditor, Arthur Andersen & Company is
considered as one of the most destructive accounting scandal. It is a symbol of corruption. The
Enron scandal is often considered as a White Collar Crime which is a criminal activity in the
eyes of law where the high level management retains the important information for the purpose
of earning financial gains. The executives of the company were involved in the unlawful
activities. They were fattening their bank accounts with the monies of the investors and used to
represent fruitful future earnings in the reports so as to attract more investments from the
potential investors (Fridson & Alvarez, 2012).
Such investors include almost thousands of Enron's employees who invested billions of dollars in
the company. However, the company later on showed a decline in the stock that fell to almost
nothing in terms of value. Thus, numerous doubts arose about the profession of auditing that
affected the trust and confidence of such stakeholders both in the financial statements and the
auditors (Mattessich, 2016). Some of the worst results that took place were:
 Loss of employment of almost 4500 employees
 70 billion dollars were lost which could have been someone's entire life monies, or
someone's old age security
 the pension fund of the company was liquidated
 Losses due to worst stock value loss resulting in the downfall of the financial market.
Such worst outcomes shook the citizen's trust in American economic system and the confidence
of the investors in the accounting management system and loss of faith in the auditing &
accounting profession (Paul, 2014) . The fact that in spite of having poor quality accounting
information by Enron, it's auditor Arthur Anderson signed the corporate reports and approved it
with its stamp which was enough for the investors and various employees to trust and make their
investment decisions. This scandal that affected the financial world largely shows us how much
it is important to make reliable financial statements as the effects of non reliable information can
shake the entire financial market & economic market and can affect the innocent investors in
terms of both monetary and emotional terms (Wahlen, 2012)s.

Though the Enron scandal took place in 2002, its effect remains. As stated in our case study, the
AISC chairman Greg Medcraft expressed his concern about recurrence of such Enron case. He
stated that the best way to not have another Enron scandal is to make sure that the auditors do
their jobs and that they express reasonable assurance about the true and fair presentation of
financial statements.
The Enron case shows how the trust can be played with and how it affects someone’s life. The
thousands of employees had trusted the reports of the company and invested billions of monies
in the company. Similarly the investors, with an expectation of earning high returns on their
investments, invested their monies into the company. Such trust brought massive destruction in
the lives of thousands of investors. Such losses question the ability and integrity of both the
accounting and auditing standards. The accounting & auditing industry definitely doesn’t aim
for such destructions. As such destructions not only results in losses but also affects the financial
markets and degrades the reputation of the auditing profession.
As a result of this, the accounting industry formulated a number of new rules and regulations that
aimed at detailed disclosures in the financial statements. The various tax laws were framed to
stop corruption. Such actions were taken to win back the trust of the community.
Financial statements are the most important documents as these statements are the reflection of a
company’s performance and position. Such financial statements are accompanied by Notes to
Accounts which are often considered as complex. A wide number of explanations are stated in
such notes explaining the financial policies used, accounting standards applied, management
discussions and such other factors having a bearing on the activities of the business. It is often
like the official financial statements are of 5-6 pages but the notes to accounts extend to 40
pages. In spite of being so complex, informative and detailed in nature, these notes to accounts
are considered as an integral part of every book of accounts (Girard, 2014).
The question usually arises about the relevance and reliability of such financial statements. The
users of such statements are managers, employers, employees, financial institutions, banks,
investors, other companies for comparison purposes, stock exchanges, media, directors,
government authorities, tax authorities, and general public (Taillard, 2013) . Every group of
users have their own requirements and expectations from the financial statements. Therefore, it is

important for the organization to prepare their financial statements in such a way that it can serve
the purposes of reliability and relevance to its different types of users (Ittelson, 2009).
Relevance and Reliability are two of the most important four qualitative characteristics of the
financial statements, the other two being understanding and comparability. According to
relevance, the accounting information should be such that it satisfies various users and helps
them in making decisions (Siciliano, 2015). Reliability refers to the accuracy and truthfulness of
the accounting information. Both of these factors are critical in nature, but both of them are
related in such a way that the defect in one will affect the other and vice versa. For example, the
accounting information is relevant but the information is not reliable as there is a lack of
information in the early stages of the business. However, if an investor waits for the information
to become reliable, the relevance of such information ends (Loughran, 2010).
The two reasons these financial statements are inaccurate is dishonesty and incompetence. To
eradicate such issues, the two best ways are:
 Strong Internal Controls: Internal controls are the most important weapon of any business
organization to establish control over the effectiveness & efficiency of the business
operations. A strong environment usually faces very few discrepancies and inaccuracy
and vice versa (Sargeant, 2010).
 Auditors are the people bestowed with the responsibility of carefully scrutinizing the
financial statements of a business organization and make an auditor opinion whether
such reports are true and fair or not (Strathern, 2010) Preparation of financial statements
is the management’s duty but auditing and examination of such statements is Auditor's
duty.
The profession of auditing is highly based on the trust and such trust represents the base of the
Auditor's existence in the market and measures the degree of confidence that different users have
in the services provided by such auditors. It is being noticed that such public trust is declining
due to unethical behavior (Bragg, 2016). The beneficiaries of the accounting information users
extend to a wide number of users apart from the stockholders or the investors. A certain and
genuine level of reliable performance is expected from such professions as various decisions to
be taken are based on such works. These expectations include the trust on the auditor report

which is the foremost direct report used by the public and affects the confidence of stakeholders
in the business and investments. The auditor is being obligated to pursue its moral and ethical
behavior so as to fulfill the expectations of the company as well as the accounting information
users. The audit services are related to the trust and are complementary to each other (Case,
2012) .
An investor, whether internal or external, makes investment on the basis of trust. The losses in
the financial market may not affect some, but it may destroy the lives of another investors. There
are investors whose business operations relates to the investment in the securities. Therefore, it
should be noted that there is a high level of trust a community places in the financial statements.
Even the smallest values in the financial statements can have large impacts. Foe example, the
assets once purchased cannot have the same value every year as its market value decreases with
use. Thus, an entity cannot show it on the cost in his books. Financial statements are a signal to
the investors that they are doing fine so that they can put their lifetime earnings in such
companies.
After such experiences of accounting scandals, it has become important for every profession to
improves its standards and bring in such tight regulations so that the companies as well as
auditors cannot even think of committing fraud and playing with the investors trust. Such strict
laws might have complicated the preparation of financial statements due to additional and
detailed requirement of disclosures, yet for the overall sustainability and prosperity of all the
citizens of the nation, it is important for every professional body to abide by such laws and rules.
(b)
Prior to such events of Enron and its Auditor Arthur Anderson, it was time for the accounting
and auditing industry to take steps to eliminate the recurrence of another Enron (Pratt, 2009) .
The AICPA made several standards where the three most prominent were SAS 96, SAS 98 and
SAS 99.
SAS 96 deals with the policies of retention of records of accounting firms. It contains a list of
points to be considered by the auditor while determining the timing, extent and nature of the
auditing process & planning. It requires auditor's to document their decisions and judgments and

observations that are significant enough to be disclosed for the stakeholder's knowledge (Piper,
2015).
SAS 98 made many amendments to the GAAS, quality standard controls, materiality concepts
and audit risks. All these amendments were in relation to the problems observed in the Enron
case.
SAS 99 deals with the concept of fraud that arose during Enron Case when Anderson didn't find
any fraud in Enron's financial statements, when the fraud actually existed. SAS 99 deals with the
auditor's responsibility of looking for fraud and shows the need for gathering all the relevant
information’s.
Many accounting firms applied changes on their own. One of the biggest change observed was
when the top big five companies during that time, KPMG, Deloitte, Ernest & Young, Touché
Tohmatsu, & PWC took a decision of breaking ties with Anderson so as to be not dragged in the
controversies related to Enron scandal because of the strict penalties imposed on Anderson and
these companies fear of being imposed by such penalties too (Rayman, 2009) .
The accounting industry after being satisfied with the enough changes it brought into effect, it
was the government's turn to react on the scandal. The government reacted aggressively to this
case and brought strict legislations and proposals. It announced Post Enron Plan. The plan was
all about making detailed disclosures about every significant event/events in the financial
statements (Scott, 2014) . The more informative the statements are, the higher the reliability is. It
increased the responsibility of all the persons in the top management such as CEOs and directors
and other Accountants and internal auditors. The government was aiming to be tough and not
creating an overburden or pressure upon the auditors (Siciliano, 2015).
Other observed change was the Sarbanes-Oxley Act (Ditman) that relates to the revaluation of
internal audit procedures and establishment of strong internal controls so as to make sure that
fraud doesn't exist and the operations are running effectively and efficiently. It also brought into
effect the new requirements of reporting including reporting of transactions called as reportable
transactions (Wahlen, 2012) .
The happening of such a scandal questions the auditor's ability. Although a wide number of
changes were made by the accounting industry & government, the implementation of it still

depends on the auditors. Where such a scandal brought complexities as in relation to detailed
scrutiny, it is the auditor that also has to work hard to implement such changes and adapt to such
environment. The stakeholder’s perception of reliably looking into the financial statements that
has been approved by an auditor is to be maintained and such a perception needs to be redressed
by the auditors (Warren, 2017).
The auditor is expected to strictly stick to its professional standards and ethics so as to provide
reasonable assurance about the company's financial statements. This calls for an appropriate
professional skepticism attitude. The ever-growing demand of trust in the financial statements
demands a serious improvement in the professional attitude. The reports often express the
concern about this concept of professional skepticism. To implement measures of improvement,
there must develop a better understanding of all the concepts and standards that has an influence
over the financial statements.
Professional skepticism means an attitude of questioning, observing the activities carefully, and
alert during the audit, suspicious about the facts and information’s so as to produce more
qualitative information. This attitude requires a standard of care and due dedication and
determination. When, we consider U. S. Or international auditing standards, we find same
meaning with different use of words. For example, these standards put a pressure on the facts of
having a questioning mind for critical evaluation of audit evidences. It is highly expected that the
auditors expand their expertise knowledge in the financial reporting and strengthen their
independence. However, it should be kept in mind that an auditor's duty is to express an opinion
and provide reasonable assurance. His opinion is not a guarantee of fair presentation of the
financial statements (McLaney & Adril, 2016).
The management is responsible to provide an auditor with such reasonable assistance that he
may require while executing his work. The management should provide reasonable and proper
explanations verbally or in form of written representations, when asked questions by the auditor.
The auditor is expected to challenge the management's abilities and functions. On the other hand,
the management is expected to answer all such challenges with due respect without being
questionable or restrictive. To assure strong audit quality, the auditors should be paid an
appropriate amount. A common understanding should be developed among all the roles and a
straightforward approach should be adopted where the sole purpose of every related person

should be approved financial statements for the sake of all the stakeholders, both internal &
external, connected with the company directly or indirectly.
Due to past experiences in audit failures and dishonesty on the part of auditors, observations says
that there is a deficiency in the auditing quality. To enhance such quality, more strict and tough
rules are being made, increasing the complexities while preparing financial statements of a
company. A demand of trust & reliability in the financial reports demands an enhancement in the
auditing practices and qualitative audit. One of the key practices to be enhanced is Professional
skepticism but what's theoretical cannot be always practical. There is a lack of practical support
to these theoretical demands. A shared understanding with a common purpose regarding the
audit work can help the professionals to exercise their responsibilities and duties in the most
efficient manner. It helps them to assess the risks involved and the proposed solutions. It also
allows the regulators to exercise their duties to determine the level of qualitative audit reports
produced.
We should understand that the Enron scandal was an eye opener for America. The lessons from
such a case instilled a fear among the American corporate and forced them to bring in such
reforms that improves their past mistakes. The reforms brought changes in the taxation laws to
stop corruption. It brought changes in the board of director’s regulations, composition of audit
committee, the scope of audit work, strict penalties imposition in case of default by anyone, etc.
Such steps are taken to ensure the protection of investors and the employees. A continuous
monitoring and analyzing of such changes is important. The America is aiming towards forming
a strong accounting & auditing industry with strict law and order in the nation (Lerner , 2009).

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