Solution Manual with all cases for Contemporary Auditing, 7th Edition by Michael C. Knapp.

SOLUTION MANUAL WITH ALL CASES FOR
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Contemporary Auditing University Of Southern Indiano 7th Edition Michael C. Knap
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Case 1-8 with all section
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CASEv1.1vtovCasev1.11
CASEv2.1vtovCasev2.8
CASEv3.1vtovCasev3.6
CASEv4.1vtovCasev4.9
CASEv5.1vtovCasev5.6
CASEv6.1vtovCasev6.7
CASEv7.1vtovCasev7.9
CASEv8.1vtovCasev8.11




CASE 1.1 v




ENRON CORPORATION
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Synopsis

vArthurvEdwardvAndersenvbuiltvhisvfirm,vArthurvAndersenv&vCompany,vintovonevofvthevlargestv

andvmostvrespectedvaccountingvfirmsvinvthevworldvthroughvhisvreputationvforvhonestyvandvintegrity.
—
Thinkvstraight,vtalkvstraight‖vwasvhisvmottovandvhevinsistedvthatvhisvclientsvadoptvthatvsamevattitudevwh
envpreparingvandvissuingvtheirvperiodicvfinancialvstatements.v ArthurvAndersen‘svauditingvphilosop
hyvwasvnotvrule-
based,vthatvis,vhevdidvnotvstressvthevimportancevofvclientsvcomplyingvwithvspecificvaccountingvrulesvb
ecausevinvthevearlyvdaysvofvthevU.S.vaccountingvprofessionvtherevwerevfewvformalvrulesvandvguidelines
vforvaccountantsvandvauditorsvtovfollow.v Instead,vAndersenvinvokedvavsubstance-over-

formvapproachvtovauditingvandvaccountingvissues.v Hevpassionatelyvbelievedvthatvthevprimaryvrolevofvt
hevauditorvwasvtovensurevthatvclientsvreportedvfullyvandvhonestlyvtovthevpublic,vregardlessvofvthevcon
sequencesvforvthosevclients.
Ironically,vArthurvAndersenv&vCo.‘svdramaticvfallvfromvprominencevresultedvfromvitsvassoc
iationvwithvavclientvknownvforvaggressivevandvinnovativevusesvofv—
accountingvgimmicks‖vtovwindowvdressvitsvfinancialvstatements.v EnronvCorporation,vAndersen‘svse
condvlargestvclient,vwasvinvolvedvinvlarge,vcomplexvtransactionsvwithvhundredsvofvspecialvpurposevent
itiesv(SPEs)vthatvitvusedvtovobscurevitsvtruevfinancialvconditionvandvoperatingvresults.v Amongvothervuse
s,vthesevSPEsvallowedvEnronvtovdownloadvunderperformingvassetsvfromvitsvbalancevsheetvandvtovcon
cealvlargevoperatingvlosses.v Duringv2001,vavseriesvofvcircumstances,vincludingvavsharpvdeclinevinvth
evpricevofvEnron‘svstock,vforcedvthevcompanyvtovassumevcontrolvandvownershipvofvmanyvofvitsvtroub
ledvSPEs.v Asvavresult,vEnronvwasvforcedvtovreportvavlargevlossvinvOctoberv2001,vrestatevitsvearningsvfo
rvthevpreviousvfivevyears,vand,vultimately,vfilevforvbankruptcyvinvDecemberv2001.
Duringvthevearlyvmonthsvofv2002,vAndersenvbecamevthevfocalvpointvofvattentionvamongvlawve
nforcementv authoritiesv searchingv forv thev partiesv responsiblev forv Enron‘sv suddenv collapse.v The

,2v v Casev1.2v v JustvforvFeet,vInc.
accusationsvdirectedvatvAndersenvcenteredvonvthreevkeyvissues.v Thevfirstvissuevhadvtovdovwithvthevsc
opevofvprofessionalvservicesvthatvAndersenvprovidedvtovEnron.v Criticsvchargedvthatvthevenormousvco
nsultingvfeesvEnronvpaidvAndersenvimpairedvthevauditvfirm‘svindependence.v Thevsecondvissuevstem
medvfromvAndersen‘svallegedvrolevinvEnron‘svaggressivevaccountingvandvfinancialvreportingvtreatm
entsvforvitsvSPE-
relatedvtransactions.v Finally,vthevmostvembarrassingvissuevwasvthevmassiveveffortvofvAndersen‘svHo
ustonvofficevtovshredvEnronvauditvdocuments,vwhichveventuallyvledvtovthevdemisevofvthevfirm.

1


EnronvCorporation--KeyvFacts

1. ThroughoutvArthurvE.vAndersen‘svlife,v—
ThinkvStraight,vtalkvstraight‖vservedvasvavguidingvprinciplevforvhimselfvandvArthurvAndersenv&vCo.,v
thevaccountingvfirmvthatvhevfounded.

2. ArthurvAndersen‘svreputationvforvhonestyvandvintegrityvresultedvinvArthurvAndersenv&vCo.vgai
ningvstaturevinvthevbusinessvcommunityvandvgrowingvintovonevofvthevnation‘svleadingvaccountingvfirm
svbyvthevtimevofvhisvdeathvinv1947.

3. LeonardvSpacekvsucceededvArthurvAndersenvasvmanagingvpartnervofvArthurvAndersenv&vCo.vinv
1947vandvcontinuedvAndersen‘svlegacyvofvlobbyingvforvmorevrigorousvaccounting,vauditing,vandvet
hicalvstandardsvforvthevpublicvaccountingvprofession.

4. WhenvSpacekvretiredvinv1973,vArthurvAndersenv&vCo.vwasvonevofvthevlargestvand,varguably,vthev
mostvprominentvaccountingvfirmvworldwide

5. ThevpredecessorvofvEnronvCorporationvwasvanvOmaha-
basedvnaturalvgasvcompanyvcreatedvinv1930;vsteadyvgrowthvinvprofitsvandvsalesvandvnumerousvacqui
sitionsvallowedvEnronvtovbecomevthevlargestvnaturalvgasvcompanyvinvthevUnitedvStatesvbyvthevmid-
1980s.

6. Duringvthev1990s,vKennethvLay,vEnron‘svCEO,vandvhisvtopvsubordinate,vJeffreyvSkilling,vtrans
formedvthevcompanyvfromvavconventionalvnaturalvgasvsuppliervintovanvenergyvtradingvcompany.

7. LayvandvSkillingvplacedvavheavyvemphasisvonv—
strongvearningsvperformance‖vandvonvincreasingvEnron‘svstaturevinvthevbusinessvworld.

8. EnronvexecutivesvusedvhundredsvofvSPE‘sv(specialvpurposeventities)vtovarrangevlargevandvcomp
lexvrelatedvpartyvtransactionsvthatvservedvtovstrengthenvEnron‘svreportedvfinancialvconditionvandvoperat
ingvresults.

9. Duringv2001,vEnron‘svfinancialvconditionvdeterioratedvrapidlyvaftervmanyvofvthevcompany‘svSPEvt
ransactionsvunraveled;vinvDecemberv2001,vEnronvfiledvforvbankruptcy.

10. FollowingvEnron‘svcollapse,vthevbusinessvpressvandvothervcriticsvbeganvsearchingvforvpartiesvtovh
oldvresponsiblevforvwhat,vatvthevtime,vwasvthevnation‘svlargestvcorporatevbankruptcy.

, Casev1.2v v JustvforvFeet,vInc.v v 3


11. CriticismvofvAndersen‘svrolevinvthevEnronvdebaclevfocusedvonvthreevkeyvissues:v thevlargevamountvo
fvconsultingvrevenuevthevfirmvearnedvfromvEnron,vthevfirm‘svrolevinvmanyvofvEnron‘svSPEvtransacti
ons,vandvtheveffortsvofvAndersenvpersonnelvtovdestroyvEnronvauditvdocuments.

12. Andersen‘svfelonyvconvictionvinvJunev2002veffectivelyvendedvthevfirm‘svlongvandvproudvhistoryvinvt
hevpublicvaccountingvprofession.




InstructionalvObjectives

1. Tovprovidevstudentsvwithvavbriefvoverviewvofvthevhistoryvandvdevelopmentvofvthevpublicvaccou
ntingvprofessionvinvthevUnitedvStates.

2. Tovexaminevthev—
scopevofvservices‖vissue,vthatvis,vthevthreatsvtovauditorvindependencevposedvbyvauditvfirmsvprovidingvc
onsultingvservicesvtovtheirvauditvclients.

3. Tovexaminevthevextentvtovwhichvindependentvauditorsvshouldvbevinvolvedvinvtheirvclients‘vdecis
ionsvregardingvimportantvaccountingvandvfinancialvreportingvissues.

4. Tovreviewvrecentvrecommendationsvmadevtovstrengthenvthevindependentvauditvfunction.

5. Tovreviewvauditors‘vresponsibilitiesvregardingvthevpreparationvandvretentionvofvauditvworkpapers.


SuggestionsvforvUse

Ivtypicallyvbeginvanvauditingvcoursevbyvdiscussingvavmajorvandvwidelyvpublicizedvauditvcase.vCl
early,vthevEnronvcasevsatisfiesvthosevcriteria.v Thevpurposevofvpresentingvsuchvavcasevearlyvinvthevsem
estervisvnotvonlyvtovacquaintvstudentsvwithvthevnaturevofvauditingvbutvalsovtovmakevthemvawarevofvwhyv
thev independentv auditv functionv isv sov important.
Manyv accountingv studentsv arev notv wellv
acquaintedvwithvthevnaturevofvthevindependentvauditor'svworkvenvironment,vnorvarevtheyvgenerallyvf
amiliarv withv thev criticalv rolev thev independentv auditv functionv playsv inv ourv nationalv economy.vH
opefully,v casesv suchv asv thisv onev providev studentsv withv av"realityvjolt"vthatv willv stimulatev theirvinte
restvinvauditingvand,vpossibly,vmakevthemvmorevinclinedvtovpursuevavcareervinvthevauditingvfield.vThev
Enronvcasevalsovservesvasvavgoodvstartingvpointvforvanvauditingvcoursevsincevitvprovidesv studentsvwit
hvanvoverviewvofvhowvthevauditingvprofessionvdevelopedvandvevolvedvinvthevUnitedvStatesvovervthevpastv
century.vThevvehiclevusedvtovpresentvthisvoverviewvisvthevhistoryvofvArthurvAndersenv&vCo.vYouvwillvf
indvthatvthevcasevattemptsvtovcontrastvthev—
Thinkvstraight,vtalkvstraight‖vphilosophyvofvArthurvE.vAndersen,vthevfoundervofvthevAndersenvfirm,vwit
hvthevmorevbusiness-orientedvapproachvto
auditingvthatvhisvpredecessorsvadoptedvinvthevlattervdecadesvofvthevtwentiethvcentury.
ConsidervaskingvonevorvmorevofvyourvstudentsvtovinterviewvformervAndersenvpersonnelvwhovarevgrad
uatesvofvyourvschool.v IvhavevfoundvthatvmanyvformervAndersenvpartnersvandvemployeesvarevmore

, 4v v Casev1.2v v JustvforvFeet,vInc.
thanvwillingvtovdiscussvtheirvformervemployervandvthevseriesvofveventsvthatvledvtovthevfirm‘svsuddenvc
ollapse.v Thesevindividualsvtypicallyvsuggestvthatvfederalvprosecutors‘veffortsvtov—
bringvdown‖vtheventirevAndersenvfirmvasvavresultvofvthevdocument-
shreddingvincidentvwasvnotvonlyvunnecessaryvbutvalsovinequitable,vanvargumentvthatvmanyvmembers
vofvthevaccountingvprofession—includingvacademics—findvhardvtovrefute.




SuggestedvSolutionsvtovCasevQuestions

1. Avlargevnumbervofvpartiesvbearvsomevdegreevofvdirectvorvindirectvresponsibilityvforvthevproblemsvt
hatvthevEnronvfiascovultimatelyvposedvforvthevpublicvaccountingvprofessionvandvthevindependentvauditvf
unction.v Thevfollowingvbulletvitemsvidentifyvseveralvofvthesevpartiesv[seevbold-
facing]vandvthevrolevtheyvplayedvinvthevEnronvdrama.

 ThevleadershipvofvthevAndersenvfirmvthatvallegedlyvfocusedvtoovmuchvattentionvonvpracticevdeve
lopmentvactivitiesvatvthevexpensevofvthevpublicvservicevidealvembracedvbyvArthurvE.vAndersenvandvot
hervearlyvleadersvofvthevprofession.
 Impertinentvcorporatevexecutivesvwhovinsistedvonvaggressive,vifvnotvillegal,vaccountingvandvfinan
cialvreportingvtreatments.
 Individualvauditorsvwhovmadevshortsightedvand/orvunprofessionalvdecisionsvthatvtaintedvthevperc
eivedvintegrityvofvallvauditors.
 Regulatoryvauthoritiesvthatvfailedvtovtakevproactivevmeasuresvtovlimitvthevabilityvofvroguevcorporateve
xecutives,vaccountants,vandvauditorsvtovcircumventvtheirvprofessionalvresponsibilities.
 Academicsvwhovfailedvtovgoadvtheirvstudentsvintovinternalizingvthevaccountingvprofession‘svhighve
thicalvprinciples.

2. Onevapproachvtovansweringvthisvquestionvisvtovreviewvwithvyourvstudentsvtheveightvspecificvtypesvo
fvnon-auditvservicesvthatvthevSarbanes-
OxleyvActvofv2002vprohibitedvauditorsvofvpublicvcompaniesvfromvprovidingvtovtheirvclients.v Listedvn
extvarevthoseveightvnon-auditvservices.

 Bookkeepingvorvothervservicesvrelatedvtovthevaccountingvrecordsvorvfinancialvstatementsvofvtheva
uditvclient
 Financialvinformationvsystemsvdesignvandvimplementation
 Appraisalvorvvaluationvservices,vfairnessvopinions,vorvcontribution-in-kindvreports
 Actuarialvservices
 Internalvauditvoutsourcingvservices
 Managementvfunctionsvorvhumanvresourcesvfunctions
 Brokervorvdealer,vinvestmentvadviser,vorvinvestmentvbankingvservices
 Legalvservicesvandvexpertvservicesvunrelatedvtovthevaudit

Manyvofvthesevservicesvwouldveventuallyvplacevauditorsvinvsituationsvinvwhichvtheyvhadvtoveffe
ctivelyvauditvtheirvownvwork.v Forvexample,vauditorsvprovidingv—
financialvinformationvsystemsvdesignvservices‖vcouldvbevforcedvtovevaluatevthevintegrityvofvanvaccount
ingvsystemvtheyvhadvdesignedvforvanvauditvclient.