Background of the Enron Scandal

The definition of auditing can be given as the on-site verification activities, such as to inspect, examine or verify, of certain processes or quality system related to accouts and finance, with the aim to ensure the needed compliance (Eilifsen et al. 2013). For this reason, it is needed for the auditors to perform the needed audit procedures for gaining the needed audit evidences. While performing the audit operations, the auditors of the companies must consider their compliance with certain principles and standards like audit independence, professional scepticism and others (Christensen, Glover and Wood 2013). At the same time, the auditors are needed to provide utmost attention to the public interest requirements of audit profession (Chou 2015). First objective of this report is the analysis of the impact of material misstatements on the decision-making process of the key stakeholders. The next objective of the report is to discuss about the public interest requirements of the auditors. The report also provides the discussion on the collapse of Enron for deriving its teachings for the auditors. The last part discusses about the procedures to improve the audit quality.  

The aim of this part is to measure the impact and risk of material misstatements on the key stakeholders of Woolworths Limited (Woolworths). There are certain key stakeholders who will be impacted with the presence of material misstatements in the financial statements; they are Shareholders, Deb Funders, Employees and Suppliers.

Shareholders: It can be seen from the appendix that Woolworths has numerous number of shareholders and the range of these shareholders start from different institutions to individual (woolworthsholdings.co.za 2019). As they have stake in the company, they largely depends in the financial statements to obtain the needed information for making the correct investment decision. The risk of inappropriate investment decision is created when the auditors of the company fail to identify, disclose and adjust the material misstatements in the financial reports (Backof, Bowlin and Goodson 2017).

Debt Funders: It can be seen from the appendix that debt funders are a major source of capital for the company as this group provides the company with the required capital as loan or borrowings (woolworthsholdings.co.za 2019). For this reason, they must ensure the company’s ability of repaying the borrowed money. For this purpose, they extract information from financial reports. In case the auditors fail in identifying, disclosing and adjusting the material misstatements, the risk is created where these stakeholders will not be able to assess the company’ ability to pay off all the debts (Keune and Johnstone 2015).

Impact of Material Misstatements on Key Stakeholders

Suppliers: As per the appendix, Woolworths deals with many direct as well as indirect suppliers and the company wants to provide them with favourable terms as well as support (woolworthsholdings.co.za 2019). In case, the suppliers of this firm have the knowledge about the liquidity position of the firm, they can make effective decision on whether to provide credit to the firm or not. In this position, in case the auditors of the company fail in effectively identifying, disclosing and adjusting the material misstatements, the risk of ineffective judgment of the company’s liquidity position is created (Ruhnke and Schmidt 2014).

Employees: As per the appendix, Woolworths has an employee base of 46000 people and it is needed for the company to ensure their wellbeing (woolworthsholdings.co.za 2019). In this situation, the auditors’ inability to effectively recognize, disclose and adjustment of the material misstatements can affect the company’s ability to continue as a going concern. This aspect creates the risk of losing the jobs of these employees in future (Suseno 2013).

Auditor independence can be considered as the independence of the external auditors. The auditor independence can be characterized by the aspects of integrity as well as an objective approach to the whole audit process (Daugherty et al. 2013). The main requirement of the concept of auditor independence is to ensure the fact that the auditors perform their work freely and in an objective manner. As per the concept of auditor independence, the auditors must be independent from the parties that have interest in the audit client (Sultana, Singh and Van der Zahn 2015).

It needs to be mentioned that the auditors are needed to consider the concept of audit whistleblowing. In case the auditor concludes that there has been occurrence of fraudulent or unethical behaviour within the organization, he/she needs to consider the fact that whether there is a necessity of whistleblow on the lawbreaker and to whom it needs to be reported (Ismail 2013). As per the definition of whistle-blower, it can be considered as a person who reveals information he/she rationally believes evidence a breach of any law, regulation or rule, or mismanagement, or gross waste of public funds, authority misuse and others. As the example of whistle-blower, the name of Sherron Watkings can be mentioned as he became concerned about Enron’s off balance sheet accounting treatments and reported this matter to the Chairman of Enron, Key Lane in August 2001 (Yee et al. 2017).

Audit Quality Improvement Procedures

In order to maintain independence and to whistleblowing, it is needed for the auditors to follow the regulations mentioned in APES 110 Code of Ethics for Professional Accountants. APES 110 has mentioned the requirements for the auditors for audit nomination (apesb.org.au 2019). It is given under Section AUST210.11.1 of APES 110 that the present auditor of a firm can help the new auditor by providing certain crucial information on audit proposal and to obtain this particular information from the present auditors, the new auditor must replace the audit nomination and obtain the permission of the client to demand the information from the current auditor (apesb.org.au 2019). The auditors must reject the audit nomination if the client declines the permission. The potential auditor is needed to follow certain procedures where the obligation is on them to collect the information from the current auditor on nomination by lettering when the permission comes from the audit client (apesb.org.au 2019). The presence of this regulation is needed as it provides the required safeguard to the whistle-blowers. It is also written under Section 100.1 of APES 110 that there is a restriction on the auditors to perform audit for only fulfilling the needs of the client, but the ruling states that the auditor should audit in the best interest of the public (apesb.org.au 2019).

Accounting Fraud: The information of Enron collapse helps to know the fact that the management of the company was involved in major accounting frauds in the forms of off-balance sheet financing, creation of false value of the assets and the generation of false financial gains; and the appointment of Arthur Andersen was done so that the management can get assistance from them to continue these accounting frauds. The main lesson that can be obtained from this is that the responsibilities and authorities for auditing the company’s financial statements must stay in the hands of the government agencies instead of the private audit firms. Moreover, the audit regulatory bodies need to ensure imposing a ban on the auditors to provide non-audit services and consultancy services to the audit client as it can lead to self-interest threat of audit independence (Lennox, Lisowsky and Pittman 2013).  

Statutory Audit and Accounting Standards: The auditor of Enron along with the management of the company did not consider this necessary to comply with the accounting and auditing standards; and this aspect contributed towards the development of disputes in the accounting books and audit statements. Hence, the lesson that the auditors can get from this aspect is that it is needed to have certain statutory regulations in both the accounting and auditing profession that will prevent the auditors in involving in any kind of unethical actions (Hosseini and Mahesh 2016).

Auditor Independence and Whistleblowing

Auditor Incentives: The collapse of Enron has been able in conveying the specific fact that the presence of immense penalties affects the motivation of the auditors as this motivation can be retained by introducing certain incentives for the auditors due to the fact that majority portion of the auditors have compliance with the principles of objectivity and professional competence and due care (Merkel 2017). For this reason, auditor independent oversight can be used as a major promoter of the audit quality due to the fact that the strengths and weaknesses of the audit operations can be identified with this. Sarbanes-Oxley Act can be considered as an example in this aspect as it has put a ban on the companies’ practice to publish the audit inspection report that criticises the audit works.

Auditor Independent Oversight: The particular insight that can be gained from the Enron scandal is that one major way to improve the audit quality is the introduction of auditor independent oversight (Haswell and Evans 2018). However, for the application of the auditor independent oversight, it is needed for the auditors to acquire the needed skills, knowledge and experience. Another way to improve the auditor independent oversight is the introduction of the audit inspection program where the main aim will be the inspection of the used audit judgements that the auditors have used for the development of audit opinion.

Connection between External Auditors and Audit Committee: Another major insight that can be gained from the collapse of Enron is the maintenance of the true and fair disclosure of the financial information by the companies as only then auditor independent oversight will be useful for enhancing the audit quality (Peng and Talib 2017).

Internal Control: Internal control is essential for the companies and the Enron scandal has conveyed this particular lesson. Shareholders want to assess the strength of the company’s internal control for financial reporting as string internal control prevents frauds and errors in accounting.  For this reason, the companies must ensure the true and fair disclosure of the financial information that the shareholders obtain from the financial statements with the aim to make proper investment decisions. It also requires the compliance with the necessary financial reporting regulations and rules (Ewelt-Knauer, Gold and Pott 2013).

Behaviour of Arthur Andersen: It needs to mention the fact that Arthur Andersen has the responsibility of auditing the financial accounts and financial statements of Enron. Providing the necessary assurance on the true and fair view of the financial statements of Enron was the one major part of the job responsibilities of Arthur Andersen (Springate 2013). The shareholders of Enron considered the audit report of Arthur Andersen correct and they invested money in the company. However, it was later disclosed that Arthur Andersen was majorly involved in the business relationship with Enron. In addition, some audit executives of Arthur Andersen received job from Enron. This aspect created severe self-interest threat of audit independence. In the presence of major personal interest and business relationship, Arthur Andersen did not obtain the needed information on the audit nomination before being appointed as the audit partner of Enron. In addition, certain auditors of the company were held accountable for destroying some of the crucial audit documents before the investigation of the federal government agency. All these aspects indicate towards the aspect that Arthur Andersen did not comply with the needed audit standards and were majorly unethical in the profession (Springate 2013).  

It is not easy to define the audit quality as certain aspects need to be considered for this. As per the definition of ASIC, audit quality can be considered as certain substances or matter that help the auditors to accomplish the audit objectives in the objective manner and this objective is the recognition of the material misstaments in the financial reports by acquiring the needed audit evidence and information (asic.gov.au 2019). As per ASIC, to maintain the audit quality, the auditors are needed to convey the disputes in the financial statement through audit report (asic.gov.au 2019). In the recent time, the outgoing Chairman of ASIC, Greg Medcraft, expressed his opinion on the collapse of Enron and the overall quality of audit. As per him, possibility is there where Australia could face an Enron-style corporate collapse except the big four audit companies radically increase their standards of audit (abc.net.au 2019). For this reason, the auditors from these firms must develop as well as implement strategies for the improvement in audit quality.

He has also mentioned the fact that it is needed for the auditors in Australia to perform the audit operations of the large Australian corporations in the most responsible as well as accountable manner with the aim to find major accounting manipulation in their accounts. Thus, with the aim to address the warning note of Greg Medcraft, the auditors of Australia need to ensure the fact that they have proper compliance with all the required fundamental, ethical as well as statutory auditing principle and standards. It is written in APES 110, Section 2 that it is the responsibility of the auditors to include any materially false statement, false information and other omission of information in the auditor’s report (apesb.org.au 2019). In Enron, due to the close association of the auditor with the management of the company, they did not put the materiality related information in the auditor report and it pushed the company one step towards the collapse.

It can be seen from the statement of Greg Medcraft in ABC News that ASIC investigated the key audit samples of the big four audit companies in Australia for certain period of the year so that they can check the overall audit quality of these companies (abc.net.au 2019). It can be seen from the result that the auditors of the big four audit firms fails in providing the necessary assurance on the true and fair view of the financial statements in 23 percent of cases and this aspect indicates towards the failure of the auditors of these companies to face the critical audit situations. At the same time, the lack of professional scepticism can be considered as the reason for this audit failure. It needs to be mentioned that lack of scepticism was a vital part in the collapse of Enron. This aspect demands the commitment of the auditors to maintain the needed professional scepticism in audit.

Over the period of six years, ASIC conducted numerous amount of surveillance along with huge number of investigations. The outcome of these surveillances and investigations contributed towards the imprisonment of more than 80 people along with the restriction of more than 600 people (abc.net.au 2019). At the same time, ASIC was able to return more than $1.3 billion to the investors.

As per Section 290.155 of APES 110, the requirement for the companies is to have certain specific number of professionals and these professionals must have the needed skills, knowledge and experience to perform the audit processes; otherwise, the is no scope for the application of the safeguard of the rotation of the audit partners (apesb.org.au 2019). However, there are some situations where the audit authority does not put any obligation on the companies to rotate the audit partners; for this reason, the audit partners can serve the audit client for longer period of time. It is needed for the auditors to consider this aspect effectively (apesb.org.au 2019). Apart from this, it is written in Section 100.1 of APES 110 that the standards and regulations of the auditing profession states that the auditors must put focus on the interest of the common public (apesb.org.au 2019). Due to this, exclusive consideration of the demands and interest of the clients and employers is not the appropriate responsibility of the auditors. It needs to be mentioned that it is needed for the Australian auditors to maintain this regulation of APES 110 while considering the public interest requirements of the profession. This aspect helps in reducing the self-interest threat of audit independence.

For addressing the concerns or the warning note of Greg Medcraft, the auditors of Australia must ensure the fact that they adhere to the fundamental, ethical and statutory principles of the audit profession (abc.net.au 2019). It puts the obligation on the auditors to ensure adherence with the principles related to ethics of APES 110; these principles are integrity, objectivity, professional competence and due care, confidentiality and professional behaviour (apesb.org.au 2019). Apart from this, with the aim to avoid the reoccurrence of the scandals like Enron in Australia, the requirement for the auditors of the big four audit firms is to enhance the audit quality by being more responsible as well as accountable in the audit procedures of the large Australian companies as it will help them in gaining effective insight about the presence of any kind of accounting and financial frauds in the financial statements of these large companies. All these aspects need to be ensures to avoid the Enron like scandal in Australia (Gul,  Wu and Yang 2013).

Conclusion

It can be seen from the above discussion that the failure of the auditors in effectively identifying, disclosing and adjusting the material misstatements can create severe risk for the key stakeholders of Woolworths due to the fact that it can provide them with materially affected financial information about the company. After that, it can be seen that both the auditor independence and whistleblowing has large role to play in the audit profession. The process of whistleblowing helps in reporting any illegal business activities within the companies where the requirement of audit independence put the obligation on the auditors to carry out the audit procedures in the most objective manner. It can be seen from the report that the collapse of Enron has provided the auditors with major lessons like the need for statutory audit regulations, audit responsibilities to the government agencies, Importance of internal control and others. As per the above discussion, the auditors of the big four audit firms need to ensure the increase in the audit quality by maintain their compliance with the required audit standards, codes of APES 110 and others. All these aspects can avoid the occurrence of another Enron in Australia.  

References

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