The Enron Scandal: Impact on Audit Quality and Stakeholders' Trust

This report provides an in-depth analysis of the Enron scandal, examining its profound impact on audit quality, financial reporting, and stakeholder trust. It highlights the critical importance of auditor independence, ethical conduct, and the minimization of material misstatements. The report delves i...Read More

EXECUTIVE SUMMARY
This report highlights the importance of audit quality and fair reporting by looking at the case of
Enron Corp. Houston, Texas which is one of the biggest American companies and is engaged in
the paper, electricity, and communication and it has become bankrupt in 2001. This fraud
highlights the reformation in the audit function so as to maintain the audit quality and fairly
reporting. Enron scandal has highlighted that auditor should need to understand their
responsibility as they are performing on the trust of public and should fairly report on the
financial statement whether they are free from material misstatement or not. The auditor
should work more unbiasedly as the trust of public on the auditors have come down over the
years which should be regained by performing the auditor duties fairly and there is also need
for severe criminal punishment for the white collar crime so that they will think before
committing them and it helps to stop them in future.

CONTENT
1. Different Stakeholders interest in the company.
2. Independence of Auditors.
3. Major Scandal of Enron Corp.
4. Importance of Audit Quality in reference to APES 110 Code of Ethics for Professional
Accountants.

INTRODUCTION
The auditor should perform the reporting function fairly over the financial statements of the
company so as to minimize the material misstatement of the company. The auditor should
maintain audit Independence while performing the audit function so as to report fairly and stop
the Enron scandal in the future by enhancing the auditor role and its reporting function. APES
110 Code of Ethics for professional Accountants lay down the ethics such as Integrity,
Objectivity, and professional behavior which has to be followed strictly while performing the
reporting function. The reliability of the financial statements reporting should be increased so
as to save the public from economic exploitation and to regain the trust of the public over the
audit which has lost over the years. This highlights the need of reformation which is necessary
for the field of the audit so as to regain the trust of the public which has lost over the years and
to enhance the audit quality.

1.) Material misstatement refers to the misstatement in the financial statement which have not
identified and disclosed and which will ultimately affect the decision of the users of financial
statements and may provide economic loss to them. The persons that are interested in the
success or failure of the company are called stakeholders. The other stakeholders that are
called are key stakeholder who is essential for running of the business of the company or of a
particular project. The identification of misstatement primary responsibility is that of the
management who should maintain proper attitude to identify and disclose and with the
primary responsibility of management the auditor should also maintain the attitude of
professional skepticism while performing the audit. The auditor should report fairly on the
financial statements of the company whether the financial statements are not materially
misstated and should not provide economic loss to the company. The users of the financial
statements should be able to get fair representations of the financial position of the company
and should take economic decisions accordingly.
The stakeholders that are interested in the success or failure of the company are divided into
two external stakeholders and internal stakeholders where external stakeholders are those
which are not involved directly in the running of the business but its interest will be affected if
its operation is stopped and on another hand internal stakeholders refers to the persons who
are involved in the daily operation of the business and all decision for running the company are
taken after his approval and have both financial as well as personal interest in the company.
The numbers of stakeholders that are present in the company are creditors, executive
management, customers, employees, shareholders, and financial institution. The risk that is

faced by the different stakeholders are customers whose interest is that the price of the
product should be optimum and should not be economically exploited by the company, where
as financial institution face the risk of the amount which it has given to the company and has
the risk of both loan amount and interest, where as the employees faces the risk of its job
whether it is secure or not because it is the source of living for them where as the shareholder
faces the risk of successful running the operation of company so that the shareholder will get
fair return. There are also other stakeholders who face risk but the risk that each stakeholder
differs on the basis of their interest in the company. Stakeholders are related to the
organization in different ways and have the financial interest in the company.
2.) As per APES 110 Code of Ethics for Professional Accountants document public interest has
been defined as those entities which is formed through legislation or regulation or those
entities which are listed. The concept of ‘Independence’ and ‘Whistle blowing’ in relation to
public interest requirement refers to the situation that the auditor should not be related to
reporting entity either directly or indirectly which will affect the Independence of it and will
affect its functioning as the position of auditor. It should maintain the attitude of professional
skepticism as well as Integrity, Objectivity and professional behavior while performing the
audit. ‘Independence’ refers to the expression of opinion on the financial statements of the
entity on the basis of evidence obtained and should not be biased while reporting.
Independence of auditor is of utmost important because no auditor can report unbiased
without maintaining Independence and it has to be maintained throughout the audit process.
Independence has to be maintained throughout the audit and should report accordingly and

fairly and should maintain the audit quality so as to achieve the purpose of the audit. The
auditor should report fairly on the financial statements of the company and should draw the
conclusion on the basis of evidence obtained
‘Whistle blowing’ refers to establish of mechanism in the entity where the employees and other
persons of the entity can report fraud to the top management of the company so that proper
action can be taken. The entity while establishing whistle blowing should take care of
establishment of proper safeguard to the person who reports. It also involves obtaining of legal
advice in the extreme situation so that proper action can be taken. The reason for the
establishment of such mechanism so as to bring out fraud in the knowledge of management so
that proper action can be taken and should report proper authority in case of an extreme
situation so as to take proper action and report accordingly.
The auditor threat in relation to entity occurs when it along with functioning as auditor also
joins the entity as director or officer of the company and which will affect the functioning as
auditor of the company. The auditor should see that the entity has established the whistle
blowing system in the entity and has maintained proper safeguards to the reporting person.
The whistle blowing system helps in identification of fraud earlier and which helps in taking
proper steps timely so as to minimize them in future but in this, the safeguard of person who
reported has to be taken properly.
3.) The scandal of Enron Corp. which is the biggest American company and it is located in
Houston, Texas. This scandal highlights how the financial statements of the company are

manipulated over the past years and also the auditor has not performed its reporting function
correctly which ultimately leads to a major scandal and has provided major economic loss to
the users of the financial statements and the public has also lost faith over the audit due to
number of scandal over the years.
The crime has been committed by manipulating the accounts of the company by showing the
earning of the company greater than what it is earned. The company has manipulated the
accounts of the company by shifting its debt obligation and also reporting inaccurate revenue
during these years. After the Enron scandal comes out the company revise its financial
statement of its previous five years and has reported a loss of $586 million and after that it has
filed for bankruptcy.
This scandal highlights the involvement of many high level people in the scam and it leads to
imprisonment of them and also others who are involved in it. The result of this scandal has
greatly diminished the trust on the auditors and to maintain the quality of audit the firm
conducted peer review but has not provided a good result and to maintain the quality work
along with peer review other tools should also be used. The reason for maintaining audit
quality is so as to regain the trust of the public which has lost over the years due to a number of
scandals.
Greg Medcraft, Chairman of ASIC, has made a statement that ‘to stop the Enron scandal in
future the big four auditing firm should improve their auditing standards.’ Greg Medcraft has
also said that in order to regain the auditor faith the auditor should perform its duties fairly and
should maintain adequate procedure so that fraud can be identified and reported accordingly.

It has also highlighted the need for greater criminal liability for corporate criminals so as to stop
the fraud. According to a report the audit that is performed by major audit firms 23 percent has
not provided reasonable assurance and which comes out from the analysis of the sample of key
audits which has raised the level of concern over the audit function over which the public relied
on and take their economic decisions accordingly.
The major thing that the auditor should learn from the scandal is that Arthur Anderson which is
one of the big five auditing firms was not directly involved in the scandal but has not performed
its auditor role correctly and it leads to major scam and auditors are trusted persons whose
reporting will affect economic decision of the users of the financial statements. This scam has
made the government more active and it leads to enactment of Sarbanes Oxley Act which is a
public accounting reform and which is introduced by the U.S. Congress in July 2002. The reason
for this act is to stop the white collar crime and to restrict the consultancy service to the client.
This act highlights the creation of audit committee which performs the monitoring role on the
function of auditor and to keep a check on its function. The reason for this act is to make
auditor role more independently and fairly so that if any fraud is committed by the company
can be identified by the auditor and report accordingly. The auditor should also learn from this
scandal that they are functioning on behalf of the public and should perform their monitoring
role fairly and to regain the trust of the public over the auditors the government has enacted
Sarbanes Oxley Act which highlights the requirement of establishment of audit committee so as
to perform the monitoring function by proper analyzing the scope of audit, key audit areas and
discussing with the auditor the area which is of major concern and by keeping a proper check
on audit function so as to maintain the audit quality and conclusion reached is appropriate in

the circumstances and achieve the objective of audit by fairly reporting over the financial
statements of the entity.
Due to increase in the number of frauds in which auditor involvement is there and which leads
to a major scam the trust on auditor of its reporting function is decreasing and there is a need
for proper steps so as to maintain the trust which lost over the years. The auditor
independence should be checked correctly so that it will not affect its reporting function and
should report fairly whether the financial statements are free from material misstatement or
not and should report accordingly on the basis of evidence obtained and should not provide
economic loss to the users of the financial statements because they act on the trust of the
public and should accordingly report fairly.
4.) As per APES 110 Code of Ethics for professional Accountants states the ethics which should
be followed by auditor while performing the audit function. The ethics which auditor should
follow are Independence, Integrity, Confidentiality, and Objectivity which helps them to
maintain the audit quality which is expected of them and should report fairly. This should be
followed strictly when audit clients are Public Interest Entities and should report accordingly
because in these entities public are interested and has invested the amount in the company
and they take their economic decision accordingly.
The scandal known as Enron scandal which is a major white collar crime scandal has shocked
the entire world in which not only the company is involved in manipulating the accounts of the
company but the auditor of the company was also involved by not performing the reporting
role fairly. The audit firm which was involved in this major scam was Arthur Anderson &

Company which was one of the Big Five auditing firms and it has raised a matter of concern as
well as the question over the audit which is performed by other Big four audit firms. The
scandal came out by the Mr. Greg Medcraft , Chairman of ASIC, who states how the company
has manipulated the accounts of the company over the years and also the role of the auditor in
the same.
Mr. Greg Medcraft wants that the place should become hellhole for white collar crimes where
they think before they commit the crime and want greater and strict criminal liability over the
white collar crime. He also states that ‘He is concerned about the trust which the public placed
and which is to be assured by the auditor of the company.’ He states that there is a need for a
major step in the field of audit function otherwise it will lead to major corporate crime in
future. He mentions that the audit that is performed by major big four audit firms over 23
percent of sample key audits has not provided reasonable assurance over the financial
statements of the company.
The major part in the audit function is to maintain audit quality so as to ensure fair reporting so
that users of financial statements will not be economically exploited and to achieve this it has
to maintain integrity, objectivity and confidentiality. Mr. Greg Medcraft has raised the need of
reformation so as to maintain the audit quality and restore the faith of public which was lost
over the years. There is a need where the auditor should realize their responsibility of reporting
and perform their audit function fairly because they act on the trust of the public and if it is not
reported fairly it provides major economic loss to the users of the financial statements.

The main reason for audit of financial statements of the entity is to identify corporate frauds
and should report fairly on the basis of evidence obtained. ‘Audit Quality’ refers to the
performing the audit function fairly and independently and should not be biased while
reporting over the financial statements of the company. The auditor should perform its role by
maintaining integrity, objectivity and professional competence so as to maintain the audit
quality and reported fairly. The Enron scandal has raised the need for reformation in audit
function which has resulted in creation of Sarbanes Oxley Act which has put more focus on
putting a check on audit function and to form a audit committee which will perform the
monitoring role over the audit function so as to maintain the audit quality achieve the purpose
for which audit is performed. The act highlights the specific responsibility which the audit
committee has to perform like to check inter corporate advance, related party transaction,
discussing audit important area and perform monitoring role over the auditor. This committee
will keep proper check on the audit function so as to achieve the objective of the audit by fair
reporting on the basis of evidence obtained and the conclusion reached should be based on the
evidence collected and should not manipulate the reporting.
Enron scandal has shocked the entire world which involves manipulating the accounts and how
the auditors are involved by not performing the reporting function fairly and which leads to a
major scam. The result of scam over the years has resulted in loss of faith over the audit and
there is a need for reformation so as to regain the faith which is lost over the years. The result
for reformation is there so as to stop major corporate crimes in future by enhancing the
criminal liability so that white collar criminals will think before committing the crime and this
will help in stopping the major corporate crime. The audit should take proper steps so as to

maintain audit quality which is expected of them and should obtain sufficient evidence so as to
proper conclusion reached. The purpose of the audit committee is to maintain the quality of
audit function so as to reported fairly whether the financial statements are free from material
misstatement or not. There is a need for proper steps so as to regain the faith over the audit
which has lost over the years by taking proper steps and there is a need that the auditor should
realize their responsibility of reporting so as to stop major corporate crimes in future. The
conclusion reached by the auditor should be based on the evidence obtained and not be biased
while reporting and should maintain the audit quality so as to achieve the objective.
CONCLUSION
On the basis of the above analysis, it can be concluded that auditors have to perform their
duties honestly and should fairly report on the financial statement whether they are free from
material misstatement or not. Mr. Greg Medcraft has raised the concern that if proper action is
not taken then they will major another Enron scandal in future. The auditors have to work more
fairly so that they will correctly report by maintaining the integrity, Objectivity and professional
behavior so that they are able to keep the trust of the public which is expected of them. As per
APES 110 Code of Ethics for Professional Accountants the auditor have to work more rationally
and should maintain the ethical behavior while performing the duties of auditor so that they
are able to report fairly on the financial statement whether they are free from material
misstatement or not on the basis of evidence collected.
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