15+ million members; + million publications; k+ research projects . Andersen's relationship with Enron and it's involve- matters that were the subject of recent press reports. Arthur Andersen LLP was Enron's auditor from the. Lesson 1. Theme. A Case Study: Enron. Duration. 40 minutes. Expected Learning Outcomes: . Enron's auditor, Arthur Andersen, suggested to change the accounting . guilty of deliberately destroying evidence relating to its relationship with. Arthur Andersen, a twenty-eight-year-old Northwestern University accounting the professional ethics education and research in accounting that is going on today. question, and who was most likely to be subject to the influence of the client. AA did not advise Enron's audit committee that Andrew Fastow, Enron's CFO.
Over 1, accounting firms are registered with the Board, including over non-U.
Thirteen Japanese firms have registered. The Sarbanes-Oxley Act requires us to annually inspect the nine accounting firms that audit more than public companies. Other firms must be inspected once every three years, if they are actually engaged in auditing public companies. We have conducted nearly inspections and issued over inspection reports, representing reviews of over 1, public company audits. We have brought five enforcement actions. We have issued four auditing standards, plus rules on auditor independence and rules governing auditor tax services for audit clients.
However, some lessons are already clear. Also, some major challenges still face us. I would like to outline five areas in which there are both lessons and challenges. Independent Oversight Strengthens Auditing First, I think it is clear that independent oversight strengthens the auditing profession. It also encourages better documentation.
Even more importantly, the fact that the PCAOB may be reviewing how tough auditing and accounting issues were resolved empowers auditors to resist management pressure to go along with questionable accounting calls or to ignore warning signs that should be pursued. But, along with this power to strengthen auditing comes a challenge. It is critical that we administer our inspection program in a way that respects the role of judgment.
Auditing is based heavily on the exercise of professional judgment in response to the circumstances of the audit. We do not want to encourage over-auditing or a mechanical, checklist approach. Similarly, it is critical that our auditing standards not become overly detailed. Supervisory Approach -- Incentives to Improve Second, we have already learned that audit quality can usually best be improved by providing incentives, rather than threatening punishment.
The vast majority of auditors and accounting firms are deeply committed to professionalism and integrity. Oversight should be a catalyst in helping firms to identify weaknesses and strengthen their practices. The Sarbanes-Oxley Act contains an example of this kind of incentive to improve. This seems to be working well. Each firm made a detailed written submission describing its efforts in areas such as audit performance, evaluation and compensation of partners, independence, acceptance and continuance of clients, and supervision of foreign affiliates.
The Board calls this philosophy the supervisory approach. The challenge here is to know when to exercise restraint and when to be aggressive. Some violations of the auditing standards are too serious to rely solely on promises to improve in the future.
We have brought enforcement actions in cases where we did not think more limited steps would work. In those kinds of situations, the Board must take the harsher enforcement approach. But deciding when to use inspections reports to encourage improvement and when to use enforcement to punish violations requires careful judgment.
Internal Control Auditing The third area of lessons and challenges is internal control auditing. This topic is one that may be of special interest, in light of the internal control reporting requirements that J-SOX would create in Japan.Enron Scandal Presentation
I mentioned earlier that one of the things that Congress did to restore investor confidence was to require management and auditor reporting on the effectiveness of company internal control over financial reporting. One of the lessons we have learned is how difficult it is to balance costs and the benefits in this area. The good news is that internal control seems to be improving. Innearly one in 12 public companies filed restatements and almost 16 percent of the companies subject to internal control reporting concluded that their controls were not effective.
Inthrough May 15, that percentage had fallen to about 8 percent.
A recent study suggests that the securities markets place a premium on effective controls. It finds increases in capital costs of about one percent for companies that report material weaknesses and comparable decreases in those costs when reported weaknesses are corrected. However, internal control reporting has come at a high cost. While costs fell substantially in the second year, they are still significant and may be unsustainable for smaller companies.
We do not want internal control reporting costs to drive small companies out of the securities markets. Making sure that the benefits of internal control auditing can be achieved on a cost-effective basis is one of the greatest challenges the PCAOB faces.
We intend to take several steps. The Board has announced that it will amend its internal control auditing standard. We also want the financial statement audit and the internal control audit to be integrated -- that is, performed as a single process. We are also looking for other ways to make sure that internal control audits are as efficient as possible.
The Board has also announced that the inspections of large firms will focus on how firms are conducting internal control audits. We know the inspection program is a powerful tool. We want to make sure that we are using it to encourage auditors to do this new job effectively and efficiently.
We recognize that small audit firms may need training to help with the process. The Board plans to develop guidance for auditors of small companies. The Auditor-Audit Committee Relationship The fourth lesson we have learned is that external accounting oversight cannot be fully effective if the company itself is not committed to fair and accurate financial disclosure.
However, the Board wants to strengthen the auditor-audit committee relationship. We periodically hold educational forums for small company audit committee members, and we interview audit committee heads as part of our inspections in order to understand how the committee and the auditor are working together. The inspection program also looks at the information that auditors provide to audit committees. Auditing as a Global Profession The final lesson I would like to mention is one that was, of course, clear from the beginning.
Auditing is a global profession. Therefore, it is critical for the Board to work with other auditor oversight bodies. The Board recognizes that the oversight of the roughly non-U. To address those issues, the Board will rely, to an appropriate degree, on the work of non-U. This was debated already in the middle s, but the debate escalated following the Enron scandal.
Arthur Andersen Arthur Andersen was founded in by the man who came to give his name to the company, Arthur Edward Andersen Skaalmo, ; Dagens Nyheter - ekonomi, The company grew and became a major actor in auditing and consultancy. In the consultancy part of the company was separated from the audit firm, creating Andersen Consulting Dagens Nyheter - ekonomi, In Arthur Andersen Consulting broke off the relationship with Arthur Andersen after a long dispute Computer Sweden,and changed its name to Accenture Skaalmo, ; Dagens Reklamnyheter, Whereas Accenture entailed management consulting, consulting on accounting and taxes remained a part of Arthur Andersen.
The Enron scandal and its consequences Enron was one of the largest companies in the US, positioned as a trading house in the energy sector. In October,the first signs of a company scandal were brought to light as the company presented its interim report. The company was deeply in dept, something that had previously been hidden via a construct of subsidiaries Dagens Industri, Attempts to save the company failed, and Enron went bankrupt in the late fall of As the scandal was largely a result of bogus accounting, the audit firm Arthur Andersen was one of the suspects.
The approval of illegal transactions and the destruction of documents came to be the end for Arthur Andersen.
Arthur Andersen attempted at finding a new partner, but these attempts failed. Instead, various audit companies acquired parts of Arthur Andersen on a national level.
The setting The Enron scandal and its consequences can be seen as a chain of connected events. First, the scandal broke off the relationship between Enron and Arthur Andersen and the activities between these two companies strongly affected the reputation of Arthur Andersen. The bad reputation of Arthur Andersen could both be seen as an effect of the unmasking of the affairs related to Enron, but also as a new event, which in turn made the company losing its credibility towards other companies.
The events are connected in a cause-and-effect like pattern and via relationship connectivity with Arthur Andersen as a common node the events came to involve other companies.
The focus of this paper is on the relationships between previous Swedish Arthur Andersen and its customers. This paper focuses on relationship changes between previous Arthur Andersen in Sweden and its customers see Figure 1.
In terms of customer relationship change, four options apply: Business relationship change Whereas business relationships are commonly characterised as stable Gadde and Mattsson, ; Johansson, built on longevity, interdependence and adaptation e.
These changes may either be incremental changes in on-going relationships, or radical meaning that relationships are created or dissolved Halinen, Salmi and Havila, The trigger to change may originate from either of the involved parties, their relationship or be external to the relationship, that is, a connected change Dwyer, Schurr and Oh, ; Giller and Matear, ; Halinen, Salmi and Havila, Inspired by Flanaganideas developed primarily in the field of service marketing Edvardsson and Strandvik, ; Giller and Matear, ; Hoffman, Kelley and Rotalsky, ; Holmlund and Strandvik, ; Keaveney, describing triggers of change in terms of critical incidents.
Critical incidents were initially a technique to identify events that were perceived, or referred to, as especially positive or negative, and in service marketing the technique was developed as a tool to reflect, for instance, quality, dis satisfaction and their consequences on relationships Edvardsson and Roos, Early research focused on single critical incidents in order to explain, for instance, dissolution.
More recent research refers to how a critical incident constitutes one parameter, but that the present state of the relationship affects whether, for example, dissolution will be the result.
Dissolution of business relationships has recently been given increased attention in the literature e. Dissolutions modify the business network in that they cause a definite disruption of ongoing business relationships. Research on dissolution of business relationships largely targets why relationships end, or the dissolution process. Much research on dissolutions is built on case studies focusing on single relationships, whereas this paper illustrates possible dissolutions of several relationships.
Personal level of relationships The importance of social ties in the creation of long-term business relationships was early recognised e. In the field of dissolution, social ties have come to play a significantly important role to stabilise, or trigger, change of business relationships.
Perrien, Paradis and Banting showed that the most common reason for a business relationship to dissolve was that the manager of the supplying party changed jobs cf. Seabright, Levinthal and Fichman use the approach of personal relationships as stabilising company-to-company relationships through pointing at how social ties may decrease the likelihood of shifting suppliers.
Changes in relationships between Swedish Arthur Andersen and its customers are connected via the dissolved relationship between Arthur Andersen and Enron. Critical incidents driving these changes are bankruptcy, acquisition and reputation cf. The four options presented previously in the Setting section could be classified the following way see Figure 2: Given the connectivity of change, the following questions are formulated: Auditors could both be seen as carriers of the customer relationship, but also carriers of badwill from the Enron scandal, meaning that shifting auditor would be a way to further disconnect from Arthur Andersen.
Method Data collection — Background data For the background data about Enron and Arthur Andersen, a newspaper search was performed capturing newspaper items referring to Enron and Arthur Andersen simultaneously. The search resulted in news items covering a time period from to Data collection — Data on auditors and audit firms from customer companies The results are built on data collected from annual reports. Annual reports were collected from companies that had once had Arthur Andersen as audit firm.
As different audit firms acquired Arthur Andersen following the Enron scandal, the search was delimited to Swedish companies. These search methods could be expected to cover large companies to a higher extent than small businesses, something which might affect the results. The initial search resulted in 54 companies of interest. Through the web sites of each of these customer companies, annual reports were collected for as many years as possible.
Lessons from Enron: The Importance of Proper Accounting Oversight
In certain cases, annual reports comprising the time from to could be found, but often only the past five years were available. In case no annual reports could be reached via the company website, the company was contacted and asked to send its annual reports. In total, observations data per year and company were found. As the annual reports also present facts about the preceding year, the search of annual reports published by Waymaker also included Out of the initial 54 companies, relevant data data comprising at least from was found for 50 companies.
The search in annual reports was performed in Octobermeaning that the last year of observations was The data was in a first step analysed to see whether the company had used Arthur Andersen as audit firm. For the further analysis, only data from these 35 companies were used. If the auditor continued to another firm, this was referred to as a shift in audit firm, but not in auditor, a semi-radical change. If both the auditor and the audit firm were changed, this was stated as a radical change.
The 7 dissolutions on an audit company-to-customer company level were thus numerous. However, as the data captures customer companies that at any time had had Arthur Andersen as audit firm, five companies shifted away from Arthur Andersen during tothat is, before or during the year of the Enron scandal since the scandal was unmasked during latechanges during are not taken into account; the annual general meeting electing auditors is commonly held early during the financial year.
Number of companies changing audit firm per year. With customer company-to- audit firm relationships commonly being referred to as long-term, in certain instances comprising fifty to sixty years Dagens Industri,the disruption of as much as twelve relationships ought to be regarded as a clear indicator that the scandal, or the acquisition, was a critical incident. As all customers were exposed to the same incidents, customer companies responded in various ways, which indicates that there is more than a critical event or chain of events that decides who stays and who leaves.
As seen from Table 1, the year of the dissolution differ between the customer companies. Changes on an auditor-to-customer company level Relationships on a personal level could be expected to stabilise company-to-company relationships. They further construct a bridge between relationships Havila,meaning that if a company-to-company relationship is dissolved, it might be carried forward to a new company-to-company relationship via social bonds.
At the same time, it could be expected that if personal relationships are broken off, this is a trigger to also dissolve the company-to- company relationship.
On the other hand, if the auditor is coloured by, for instance, badwill of the company it represents, this may trigger a change of auditor. Six of the customer companies had shifted auditor already during the years prior to, or of, the Enron scandal, leaving fourteen customer companies that shifted auditor following the scandal and the acquisition. As in the case of shifting audit firms, was the year entailing most of these dissolutions.
Table 2 summarises the number of dissolutions on an auditor-to-customer company level. Number of companies changing auditor per year. Table 3 indicates that there is a strong relationship between those shifting audit firm and auditor. Five of these shifted auditor and audit firm prior to these incidents, leaving twelve customer companies that changed auditor and audit firm during the years following the scandal and the acquisition.