Solution Manual for Contemporary Auditing 11th Edition Michael Knapp – Complete Case Solutions (All Chapters 1-12)

CaseV1.3V V JustVforVFeet,VInc.
VV1




CASEV1.1


ENRONVCORPORATION




Synopsis



ArthurVEdwardVAndersenVbuiltVhisVfirm,VArthurVAndersenV&VCompany,VintoVoneVofVtheVla
rgestVandVmostVrespectedVaccountingVfirmsVinVtheVworldVthroughVhisVreputationVforVhonestyVandVi
ntegrity.V “ThinkVstraight,VtalkVstraight”VwasVhisVmottoVandVheVinsistedVthatVhisVclientsVadoptVthatV
sameVattitudeVwhenVpreparingVandVissuingVtheirVperiodicVfinancialVstatements.V ArthurVAndersen’sVa
uditingVphilosophyVwasVnotVrule-
based,VthatVis,VheVdidVnotVstressVtheVimportanceVofVclientsVcomplyingVwithVspecificVaccountingVrul
esVbecauseVinVtheVearlyVdaysVofVtheVU.S.VaccountingVprofessionVthereVwereVfewVformalVrulesVand
VguidelinesVforVaccountantsVandVauditorsVtoVfollow.V Instead,VAndersenVinvokedVaVsubstance-over-
formVapproachVtoVauditingVandVaccountingVissues.V HeVpassionatelyVbelievedVthatVtheVprimaryVrole
VofVtheVauditorVwasVtoVensureVthatVclientsVreportedVfullyVandVhonestlyVtoVtheVpublic,VregardlessVof
VtheVconsequencesVforVthoseVclients.


Ironically,VArthurVAndersenV&VCo.’sVdramaticVfallVfromVprominenceVresultedVfromVitsVasso
ciationVwithVaVclientVknownVforVaggressiveVandVinnovativeVusesVofV“accountingVgimmicks”VtoVwin
dowVdressVitsVfinancialVstatements.V EnronVCorporation,VAndersen’sVsecondVlargestVclient,VwasVinv
olvedVinVlarge,VcomplexVtransactionsVwithVhundredsVofVspecialVpurposeVentitiesV(SPEs)VthatVitVuse
dVtoVobscureVitsVtrueVfinancialVconditionVandVoperatingVresults.V AmongVotherVuses,VtheseVSPEsVall
owedVEnronVtoVdownloadVunderperformingVassetsVfromVitsVbalanceVsheetVandVtoVconcealVlargeVope
ratingVlosses.V DuringV2001,VaV seriesVofVcircumstances,VincludingVaVsharpVdeclineVinVtheVpriceVof
VEnron’sVstock,VforcedVtheVcompanyVtoVassumeV controlV andV ownershipV ofV manyV ofV itsV troubledV
SPEs.V AsV aV result,V EnronV wasV forcedV toV reportV a

, CaseV1.3V V JustVforVFeet,VInc.
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largeV lossV inV OctoberV 2001,V restateV itsV earningsV forV theV previousV fiveV years,V and,V ultimately,
V fileV forVbankruptcyVinVDecemberV2001.


DuringVtheVearlyVmonthsVofV2002,VAndersenVbecameVtheVfocalVpointVofVattentionVamongVl
awVenforcementVauthoritiesVsearchingVforVtheVpartiesVresponsibleVforVEnron’sVsuddenVcollapse.VThe
VaccusationsVdirectedVatVAndersenVcenteredVonVthreeVkeyVissues.V TheVfirstVissueVhadVtoVdoVwithVt
heVscopeVofVprofessionalVservicesVthatVAndersenVprovidedVtoVEnron.V CriticsVchargedVthatVtheVenor
mousVconsultingVfeesVEnronVpaidVAndersenVimpairedVtheVauditVfirm’sVindependence.V TheVsecondVi
ssueVstemmedVfromVAndersen’sVallegedVroleVinVEnron’sVaggressiveVaccountingVandVfinancialVreport
ingVtreatmentsVforVitsVSPE-
relatedVtransactions.VFinally,VtheVmostVembarrassingVissueVwasVtheVmassiveVeffortVofVAndersen’sVH
oustonVofficeVtoVshredVEnronVauditVdocuments,VwhichVeventuallyVledVtoVtheVdemiseVofVtheVfirm.

EnronVCorporation--KeyVFacts



1. ThroughoutVArthurVE.VAndersen’sVlife,V“ThinkVStraight,VtalkVstraight”VservedVasVaVguidingVpri
ncipleV forVhimselfVandVArthurVAndersenV&VCo.,VtheVaccountingVfirmVthatVheVfounded.



2. ArthurVAndersen’sVreputationVforVhonestyVandVintegrityVresultedVinVArthurVAndersenV&VCo.Vg
ainingVstatureVinVtheVbusinessVcommunityVandVgrowingVintoVoneVofVtheVnation’sVleadingVacco
untingVfirmsVbyVtheVtimeVofVhisVdeathVinV1947.



3. LeonardVSpacekVsucceededVArthurVAndersenVasVmanagingVpartnerVofVArthurVAndersenV&VCo.
VinV1947VandVcontinuedVAndersen’sVlegacyVofVlobbyingVforVmoreVrigorousVaccounting,Vauditin
g,VandVethicalVstandardsVforVtheVpublicVaccountingVprofession.



4. WhenVSpacekVretiredVinV1973,VArthurVAndersenV&VCo.VwasVoneVofVtheVlargestVand,Varguably
,VtheVmostVprominentVaccountingVfirmVworldwide



5. TheVpredecessorVofVEnronVCorporationVwasVanVOmaha-
basedVnaturalVgasVcompanyVcreatedVinV1930;VsteadyVgrowthVinVprofitsVandVsalesVandVnumerou
sVacquisitionsVallowedVEnronVtoVbecomeVtheVlargestVnaturalVgasVcompanyVinVtheVUnitedVState
sVbyVtheVmid-1980s.



6. DuringVtheV1990s,VKennethVLay,VEnron’sVCEO,VandVhisVtopVsubordinate,VJeffreyVSkilling,V tra
nsformedVtheVcompanyVfromVaVconventionalVnaturalVgasVsupplierVintoVanVenergyVtradingVcom
pany.

, CaseV1.3V V JustVforVFeet,VInc.
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7. LayVandVSkillingVplacedVaVheavyVemphasisVonV“strongVearningsVperformance”VandVonVincreasi
ngVEnron’sVstatureVinVtheVbusinessVworld.



8. EnronVexecutivesVusedVhundredsVofVSPEsV(specialVpurposeVentities)VtoVarrangeVlargeVandVcomplex
relatedVpartyVtr
a



9. DuringV2001,VEnron’sVfinancialVconditionVdeterioratedVrapidlyVafterVmanyVofVtheVcompany’sVS
PEVtransactionsVunraveled;VinVDecemberV2001,VEnronVfiledVforVbankruptcy.



10. FollowingVEnron’sVcollapse,VtheVbusinessVpressVandVotherVcriticsVbeganVsearchingVforVpartiesVt
oVholdVresponsibleVforVwhat,VatVtheVtime,VwasVtheVnation’sVlargestVcorporateVbankruptcy.



11. CriticismVofVAndersen’sVroleVinVtheVEnronVdebacleVfocusedVonVthreeVkeyVissues:V theVlargeVa
mountVofVconsultingVrevenueVtheVfirmVearnedVfromVEnron,VtheVfirm’sVroleVinVmanyVofVEnron
’sVSPEVtransactions,VandVtheVeffortsVofVAndersenVpersonnelVtoVdestroyVEnronVauditVdocuments
.



12. Andersen’sVfelonyVconvictionVinVJuneV2002VeffectivelyVendedVtheVfirm’sVlongVandVproudVhisto
ryVinVtheVpublicVaccountingVprofession.



InstructionalVObjectives



1. ToVprovideVstudentsVwithVaVbriefVoverviewVofVtheVhistoryVandVdevelopmentVofVtheVpublicVacc
ountingVprofessionVinVtheVUnitedVStates.



2. ToVexamineVtheV“scopeVofVservices”Vissue,VthatVis,VtheVthreatsVtoVauditorVindependenceVposed
VbyVauditVfirmsVprovidingVconsultingVservicesVtoVtheirVauditVclients.




3. ToVexamineVtheVextentVtoVwhichVindependentVauditorsVshouldVbeVinvolvedVinVtheirVclients’Vde
cisionsVregardingVimportantVaccountingVandVfinancialVreportingVissues.



4. ToVreviewVrecentVrecommendationsVmadeVtoVstrengthenVtheVindependentVauditVfunction.

, CaseV1.3V V JustVforVFeet,VInc.
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5. ToVreviewVauditors’VresponsibilitiesVregardingVtheVpreparationVandVretentionVofVauditVworkpapers.

SuggestionsVforVUse



IVtypicallyVbeginVanVauditingVcourseVbyVdiscussingVaVmajorVandVwidelyVpublicizedVauditVcase.
VClearly,VtheVEnronVcaseVsatisfiesVthoseVcriteria.V TheVpurposeVofVpresentingVsuchVaVcaseVearlyVin
VtheVsemesterVisVnotVonlyVtoVacquaintVstudentsVwithVtheVnatureVofVauditingVbutValsoVtoVmakeVthe
mVawareVofVwhyVtheVindependentVauditVfunctionVisVsoVimportant.V ManyVaccountingVstudentsVareV
notVwellVacquaintedVwithVtheVnatureVofVtheVindependentVauditor'sVworkVenvironment,VnorVareVthey
VgenerallyVfamiliarVwithVtheVcriticalVroleVtheVindependentVauditVfunctionVplaysVinVourVnationalVeco
nomy.V Hopefully,VcasesVsuchVasVthisVoneVprovideVstudentsVwithVaV"realityVjolt"VthatVwillVstimulate
VtheirVinterestVinVauditingVand,Vpossibly,VmakeVthemVmoreVinclinedVtoVpursueVaVcareerVinVtheVaudi
tingVfield.

TheVEnronVcaseValsoVservesVasVaVgoodVstartingVpointVforVanVauditingVcourseVsinceVitVprovides
VstudentsVwithVanVoverviewVofVhowVtheVauditingVprofessionVdevelopedVandVevolvedVinVtheVUnited
VStatesVoverVtheVpastVcentury.V TheVvehicleVusedVtoVpresentVthisVoverviewVisVtheVhistoryVofVArthu
rVAndersenV&VCo.V YouVwillVfindVthatVtheVcaseVattemptsVtoVcontrastVtheV“ThinkVstraight,VtalkVstra
ight”VphilosophyVofVArthurVE.VAndersen,VtheVfounderVofVtheVAndersenVfirm,VwithVtheVmoreVbusin
ess-
orientedVapproachVtoVauditingVthatVhisVpredecessorsVadoptedVinVtheVlatterVdecadesVofVtheVtwentieth
Vcentury.


ConsiderVaskingVoneVorVmoreVofVyourVstudentsVtoVinterviewVformerVAndersenVpersonnelVwhoV
areVgraduatesVofVyourVschool.V IVhaveVfoundVthatVmanyVformerVAndersenVpartnersVandVemployeesV
areVmoreVthanVwillingVtoVdiscussVtheirVformerVemployerVandVtheVseriesVofVeventsVthatVledVtoVtheV
firm’sVsuddenVcollapse.VTheseVindividualsVtypicallyVsuggestVthatVfederalVprosecutors’VeffortsVtoV“br
ingVdown”VtheVentireVAndersenVfirmVasVaVresultVofVtheVdocument-
shreddingVincidentVwasVnotVonlyVunnecessaryVbutValsoVinequitable,VanVargumentVthatVmanyVmembe
rsVofVtheVaccountingVprofession—includingVacademics—findVdifficultVtoV refute.



SuggestedVSolutionsVtoVCaseVQuestions



1. AVlargeVnumberVofVpartiesVboreVsomeVdegreeVofVresponsibilityVforVtheVproblemsVthatVtheVEnr
onVfiascoVultimatelyVposedVforVtheVpublicVaccountingVprofessionVandVtheVindependentVauditVfunctio
n.V TheVfollowingVbulletVitemsVidentifyVseveralVofVtheseVpartiesV[seeVbold-
facing]VandVtheVroleVtheyVplayedVinVtheVEnronVdrama.



• TheVleadershipVofVtheVAndersenVfirmVthatVallegedlyVfocusedVtooVmuchVattentionVonVpractice
developmentVac
t