, Case 1.1 Enron Corporation
1
CASE 1.1
ENRON CORPORATION
Synopsis
Arthur Edward Andersen built his firm, Arthur Andersen & Company, into one of the largest
and 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 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.
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, 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 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 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.
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole or in part.
, Case 1.1 Enron Corporation
2
Enron Corporation--Key Facts
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.
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.
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 prominent accounting firm worldwide
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.
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.
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 transactions that served to strengthen Enron’s reported financial condition and
operating results.
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 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, 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.
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole or in part.
, Case 1.1 Enron Corporation
3
Instructional Objectives
1. To provide students with a brief overview of the history and development of the public
accounting profession in the United States.
2. To examine the “scope of services” issue, that is, the threats to auditor independence posed by
audit firms providing consulting services to their audit clients.
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.
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, 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 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 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. 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.
Suggested Solutions to Case Questions
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
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole or in part.
1
CASE 1.1
ENRON CORPORATION
Synopsis
Arthur Edward Andersen built his firm, Arthur Andersen & Company, into one of the largest
and 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 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.
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, 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 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 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.
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole or in part.
, Case 1.1 Enron Corporation
2
Enron Corporation--Key Facts
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.
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.
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 prominent accounting firm worldwide
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.
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.
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 transactions that served to strengthen Enron’s reported financial condition and
operating results.
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 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, 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.
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole or in part.
, Case 1.1 Enron Corporation
3
Instructional Objectives
1. To provide students with a brief overview of the history and development of the public
accounting profession in the United States.
2. To examine the “scope of services” issue, that is, the threats to auditor independence posed by
audit firms providing consulting services to their audit clients.
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.
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, 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 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 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. 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.
Suggested Solutions to Case Questions
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
© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole or in part.
