Case 1.3 Just for Feet, Inc. 1
TE
CASE 1.1
ENRON CORPORATION
ST
SO
Synopsis
Arthur Edward Andersen built his firm, Arthur Andersen & Company, into one of the largest and
LU
most respected accounting firms in the world through his reputation for honesty and integrity. “Think
straight, talk straight” was his motto and he insisted that his clients adopt that same attitude when
preparing and issuing their periodic financial statements. Arthur Andersen’s auditing philosophy was not
rule-based, that is, he did not stress the importance of clients complying with specific accounting rules
because in the early days of the U.S. accounting profession there were few formal rules and guidelines for
TI
accountants and auditors to follow. Instead, Andersen invoked a substance-over-form approach to
auditing and accounting issues. He passionately believed that the primary role of the auditor was to
ensure that clients reported fully and honestly to the public, regardless of the consequences for those
clients.
O
Ironically, Arthur Andersen & Co.’s dramatic fall from prominence resulted from its association
with a client known for aggressive and innovative uses of “accounting gimmicks” to window dress its
financial statements. Enron Corporation, Andersen’s second largest client, was involved in large,
N
complex transactions with hundreds of special purpose entities (SPEs) that it used to obscure its true
financial condition and operating results. Among other uses, these SPEs allowed Enron to download
underperforming assets from its balance sheet and to conceal large operating losses. During 2001, a
series of circumstances, including a sharp decline in the price of Enron’s stock, forced the company to
assume control and ownership of many of its troubled SPEs. As a result, Enron was forced to report a
, Case 1.3 Just for Feet, Inc. 2
large loss in October 2001, restate its earnings for the previous five years, and, ultimately, file for
bankruptcy in December 2001.
During the early months of 2002, Andersen became the focal point of attention among law
enforcement authorities searching for the parties responsible for Enron’s sudden collapse. The accusations
directed at Andersen centered on three key issues. The first issue had to do with the scope of professional
services that Andersen provided to Enron. Critics charged that the enormous consulting fees Enron paid
Andersen impaired the audit firm’s independence. The second issue stemmed from Andersen’s alleged
TE
role in Enron’s aggressive accounting and financial reporting treatments for its SPE-related transactions.
Finally, the most embarrassing issue was the massive effort of Andersen’s Houston office to shred Enron
audit documents, which eventually led to the demise of the firm.
Enron Corporation--Key Facts
ST
1. Throughout Arthur E. Andersen’s life, “Think Straight, talk straight” served as a guiding principle
for himself and Arthur Andersen & Co., the accounting firm that he founded.
SO
2. Arthur Andersen’s reputation for honesty and integrity resulted in Arthur Andersen & Co. gaining
stature in the business community and growing into one of the nation’s leading accounting firms by
the time of his death in 1947.
LU
3. Leonard Spacek succeeded Arthur Andersen as managing partner of Arthur Andersen & Co. in 1947
and continued Andersen’s legacy of lobbying for more rigorous accounting, auditing, and ethical
standards for the public accounting profession.
4. When Spacek retired in 1973, Arthur Andersen & Co. was one of the largest and, arguably, the most
TI
prominent accounting firm worldwide
O
5. The predecessor of Enron Corporation was an Omaha-based natural gas company created in 1930;
steady growth in profits and sales and numerous acquisitions allowed Enron to become the largest
natural gas company in the United States by the mid-1980s.
N
6. During the 1990s, Kenneth Lay, Enron’s CEO, and his top subordinate, Jeffrey Skilling, transformed
the company from a conventional natural gas supplier into an energy trading company.
, Case 1.3 Just for Feet, Inc. 3
7. Lay and Skilling placed a heavy emphasis on “strong earnings performance” and on increasing
Enron’s stature in the business world.
8. Enron executives used hundreds of SPEs (special purpose entities) to arrange large and complex related party
TE
9. During 2001, Enron’s financial condition deteriorated rapidly after many of the company’s SPE
transactions unraveled; in December 2001, Enron filed for bankruptcy.
10. Following Enron’s collapse, the business press and other critics began searching for parties to hold
ST
responsible for what, at the time, was the nation’s largest corporate bankruptcy.
11. Criticism of Andersen’s role in the Enron debacle focused on three key issues: the large amount of
consulting revenue the firm earned from Enron, the firm’s role in many of Enron’s SPE transactions,
SO
and the efforts of Andersen personnel to destroy Enron audit documents.
12. Andersen’s felony conviction in June 2002 effectively ended the firm’s long and proud history in the
public accounting profession.
LU
Instructional Objectives
1. To provide students with a brief overview of the history and development of the public accounting
TI
profession in the United States.
To examine the “scope of services” issue, that is, the threats to auditor independence posed by audit
O
2.
firms providing consulting services to their audit clients.
N
3. To examine the extent to which independent auditors should be involved in their clients’ decisions
regarding important accounting and financial reporting issues.
4. To review recent recommendations made to strengthen the independent audit function.
, Case 1.3 Just for Feet, Inc. 4
5. To review auditors’ responsibilities regarding the preparation and retention of audit workpapers.
Suggestions for Use
I typically begin an auditing course by discussing a major and widely publicized audit case. Clearly,
TE
the Enron case satisfies those criteria. The purpose of presenting such a case early in the semester is not
only to acquaint students with the nature of auditing but also to make them aware of why the independent
audit function is so important. Many accounting students are not well acquainted with the nature of the
independent auditor's work environment, nor are they generally familiar with the critical role the
independent audit function plays in our national economy. Hopefully, cases such as this one provide
ST
students with a "reality jolt" that will stimulate their interest in auditing and, possibly, make them more
inclined to pursue a career in the auditing field.
The Enron case also serves as a good starting point for an auditing course since it provides students
with an overview of how the auditing profession developed and evolved in the United States over the past
century. The vehicle used to present this overview is the history of Arthur Andersen & Co. You will find
SO
that the case attempts to contrast the “Think straight, talk straight” philosophy of Arthur E. Andersen, the
founder of the Andersen firm, with the more business-oriented approach to auditing that his predecessors
adopted in the latter decades of the twentieth century.
Consider asking one or more of your students to interview former Andersen personnel who are
graduates of your school. I have found that many former Andersen partners and employees are more than
willing to discuss their former employer and the series of events that led to the firm’s sudden collapse.
LU
These individuals typically suggest that federal prosecutors’ efforts to “bring down” the entire Andersen
firm as a result of the document-shredding incident was not only unnecessary but also inequitable, an
argument that many members of the accounting profession—including academics—find difficult to
refute.
TI
Suggested Solutions to Case Questions
O
1. A large number of parties bore some degree of responsibility for the problems that the Enron fiasco
ultimately posed for the public accounting profession and the independent audit function. The following
bullet items identify several of these parties [see bold-facing] and the role they played in the Enron drama.
N
The leadership of the Andersen firm that allegedly focused too much attention on practice development
Impertinent corporate executives who insisted on aggressive, if not illegal, accounting and financial rep
TE
CASE 1.1
ENRON CORPORATION
ST
SO
Synopsis
Arthur Edward Andersen built his firm, Arthur Andersen & Company, into one of the largest and
LU
most respected accounting firms in the world through his reputation for honesty and integrity. “Think
straight, talk straight” was his motto and he insisted that his clients adopt that same attitude when
preparing and issuing their periodic financial statements. Arthur Andersen’s auditing philosophy was not
rule-based, that is, he did not stress the importance of clients complying with specific accounting rules
because in the early days of the U.S. accounting profession there were few formal rules and guidelines for
TI
accountants and auditors to follow. Instead, Andersen invoked a substance-over-form approach to
auditing and accounting issues. He passionately believed that the primary role of the auditor was to
ensure that clients reported fully and honestly to the public, regardless of the consequences for those
clients.
O
Ironically, Arthur Andersen & Co.’s dramatic fall from prominence resulted from its association
with a client known for aggressive and innovative uses of “accounting gimmicks” to window dress its
financial statements. Enron Corporation, Andersen’s second largest client, was involved in large,
N
complex transactions with hundreds of special purpose entities (SPEs) that it used to obscure its true
financial condition and operating results. Among other uses, these SPEs allowed Enron to download
underperforming assets from its balance sheet and to conceal large operating losses. During 2001, a
series of circumstances, including a sharp decline in the price of Enron’s stock, forced the company to
assume control and ownership of many of its troubled SPEs. As a result, Enron was forced to report a
, Case 1.3 Just for Feet, Inc. 2
large loss in October 2001, restate its earnings for the previous five years, and, ultimately, file for
bankruptcy in December 2001.
During the early months of 2002, Andersen became the focal point of attention among law
enforcement authorities searching for the parties responsible for Enron’s sudden collapse. The accusations
directed at Andersen centered on three key issues. The first issue had to do with the scope of professional
services that Andersen provided to Enron. Critics charged that the enormous consulting fees Enron paid
Andersen impaired the audit firm’s independence. The second issue stemmed from Andersen’s alleged
TE
role in Enron’s aggressive accounting and financial reporting treatments for its SPE-related transactions.
Finally, the most embarrassing issue was the massive effort of Andersen’s Houston office to shred Enron
audit documents, which eventually led to the demise of the firm.
Enron Corporation--Key Facts
ST
1. Throughout Arthur E. Andersen’s life, “Think Straight, talk straight” served as a guiding principle
for himself and Arthur Andersen & Co., the accounting firm that he founded.
SO
2. Arthur Andersen’s reputation for honesty and integrity resulted in Arthur Andersen & Co. gaining
stature in the business community and growing into one of the nation’s leading accounting firms by
the time of his death in 1947.
LU
3. Leonard Spacek succeeded Arthur Andersen as managing partner of Arthur Andersen & Co. in 1947
and continued Andersen’s legacy of lobbying for more rigorous accounting, auditing, and ethical
standards for the public accounting profession.
4. When Spacek retired in 1973, Arthur Andersen & Co. was one of the largest and, arguably, the most
TI
prominent accounting firm worldwide
O
5. The predecessor of Enron Corporation was an Omaha-based natural gas company created in 1930;
steady growth in profits and sales and numerous acquisitions allowed Enron to become the largest
natural gas company in the United States by the mid-1980s.
N
6. During the 1990s, Kenneth Lay, Enron’s CEO, and his top subordinate, Jeffrey Skilling, transformed
the company from a conventional natural gas supplier into an energy trading company.
, Case 1.3 Just for Feet, Inc. 3
7. Lay and Skilling placed a heavy emphasis on “strong earnings performance” and on increasing
Enron’s stature in the business world.
8. Enron executives used hundreds of SPEs (special purpose entities) to arrange large and complex related party
TE
9. During 2001, Enron’s financial condition deteriorated rapidly after many of the company’s SPE
transactions unraveled; in December 2001, Enron filed for bankruptcy.
10. Following Enron’s collapse, the business press and other critics began searching for parties to hold
ST
responsible for what, at the time, was the nation’s largest corporate bankruptcy.
11. Criticism of Andersen’s role in the Enron debacle focused on three key issues: the large amount of
consulting revenue the firm earned from Enron, the firm’s role in many of Enron’s SPE transactions,
SO
and the efforts of Andersen personnel to destroy Enron audit documents.
12. Andersen’s felony conviction in June 2002 effectively ended the firm’s long and proud history in the
public accounting profession.
LU
Instructional Objectives
1. To provide students with a brief overview of the history and development of the public accounting
TI
profession in the United States.
To examine the “scope of services” issue, that is, the threats to auditor independence posed by audit
O
2.
firms providing consulting services to their audit clients.
N
3. To examine the extent to which independent auditors should be involved in their clients’ decisions
regarding important accounting and financial reporting issues.
4. To review recent recommendations made to strengthen the independent audit function.
, Case 1.3 Just for Feet, Inc. 4
5. To review auditors’ responsibilities regarding the preparation and retention of audit workpapers.
Suggestions for Use
I typically begin an auditing course by discussing a major and widely publicized audit case. Clearly,
TE
the Enron case satisfies those criteria. The purpose of presenting such a case early in the semester is not
only to acquaint students with the nature of auditing but also to make them aware of why the independent
audit function is so important. Many accounting students are not well acquainted with the nature of the
independent auditor's work environment, nor are they generally familiar with the critical role the
independent audit function plays in our national economy. Hopefully, cases such as this one provide
ST
students with a "reality jolt" that will stimulate their interest in auditing and, possibly, make them more
inclined to pursue a career in the auditing field.
The Enron case also serves as a good starting point for an auditing course since it provides students
with an overview of how the auditing profession developed and evolved in the United States over the past
century. The vehicle used to present this overview is the history of Arthur Andersen & Co. You will find
SO
that the case attempts to contrast the “Think straight, talk straight” philosophy of Arthur E. Andersen, the
founder of the Andersen firm, with the more business-oriented approach to auditing that his predecessors
adopted in the latter decades of the twentieth century.
Consider asking one or more of your students to interview former Andersen personnel who are
graduates of your school. I have found that many former Andersen partners and employees are more than
willing to discuss their former employer and the series of events that led to the firm’s sudden collapse.
LU
These individuals typically suggest that federal prosecutors’ efforts to “bring down” the entire Andersen
firm as a result of the document-shredding incident was not only unnecessary but also inequitable, an
argument that many members of the accounting profession—including academics—find difficult to
refute.
TI
Suggested Solutions to Case Questions
O
1. A large number of parties bore some degree of responsibility for the problems that the Enron fiasco
ultimately posed for the public accounting profession and the independent audit function. The following
bullet items identify several of these parties [see bold-facing] and the role they played in the Enron drama.
N
The leadership of the Andersen firm that allegedly focused too much attention on practice development
Impertinent corporate executives who insisted on aggressive, if not illegal, accounting and financial rep
