Casej1.3j j JustjforjFeet,jInc.j j 1
CASEj1.1
ENRONjCORPORATION
Synopsis
ArthurjEdwardjAndersenjbuiltjhisjfirm,jArthurjAndersenj&jCompany,jintojonejofjthejlargestjandjmo
stjrespectedjaccountingjfirmsjinjthejworldjthroughjhisjreputationjforjhonestyjandjintegrity.j “Thinkjstraight,jt
alkjstraight”jwasjhisjmottojandjhejinsistedjthatjhisjclientsjadoptjthatjsamejattitudejwhenjpreparingjandjissuin
gjtheirjperiodicjfinancialjstatements.j ArthurjAndersen’sjauditingjphilosophyjwasjnotjrule-
based,jthatjis,jhejdidjnotjstressjthejimportancejofjclientsjcomplyingjwithjspecificjaccountingjrulesjbecausejinj
thejearlyjdaysjofjthejU.S.jaccountingjprofessionjtherejwerejfewjformaljrulesjandjguidelinesjforjaccountantsja
ndjauditorsjtojfollow.j Instead,jAndersenjinvokedjajsubstance-over-
formjapproachjtojauditingjandjaccountingjissues.j Hejpassionatelyjbelievedjthatjthejprimaryjrolejofjthejaudit
orjwasjtojensurejthatjclientsjreportedjfullyjandjhonestlyjtojthejpublic,jregardlessjofjthejconsequencesjforjthos
ejclients.
Ironically,jArthurjAndersenj&jCo.’sjdramaticjfalljfromjprominencejresultedjfromjitsjassociationjwit
hjajclientjknownjforjaggressivejandjinnovativejusesjofj“accountingjgimmicks”jtojwindowjdressjitsjfinancialj
statements.j EnronjCorporation,jAndersen’sjsecondjlargestjclient,jwasjinvolvedjinjlarge,jcomplexjtransactio
nsjwithjhundredsjofjspecialjpurposejentitiesj(SPEs)jthatjitjusedjtojobscurejitsjtruejfinancialjconditionjandjope
ratingjresults.j Amongjotherjuses,jthesejSPEsjallowedjEnronjtojdownloadjunderperformingjassetsjfromjitsjba
lancejsheetjandjtojconcealjlargejoperatingjlosses.j Duringj2001,jaj seriesjofjcircumstances,jincludingjajsharpj
declinejinjthejpricejofjEnron’sjstock,jforcedjthejcompanyjtojassumej controlj andj ownershipj ofj manyj ofj itsj tr
oubledj SPEs.j Asj aj result,j Enronj wasj forcedj toj reportj a
, Casej1.3j j JustjforjFeet,jInc.j j 2
largej lossj inj Octoberj 2001,j restatej itsj earningsj forj thej previousj fivej years,j and,j ultimately,j filej forjban
kruptcyjinjDecemberj2001.
Duringjthejearlyjmonthsjofj2002,jAndersenjbecamejthejfocaljpointjofjattentionjamongjlawjenforcem
entjauthoritiesjsearchingjforjthejpartiesjresponsiblejforjEnron’sjsuddenjcollapse.jThejaccusationsjdirectedjatj
Andersenjcenteredjonjthreejkeyjissues.j Thejfirstjissuejhadjtojdojwithjthejscopejofjprofessionaljservicesjthatj
AndersenjprovidedjtojEnron.j CriticsjchargedjthatjthejenormousjconsultingjfeesjEnronjpaidjAndersenjimpair
edjthejauditjfirm’sjindependence.j ThejsecondjissuejstemmedjfromjAndersen’sjallegedjrolejinjEnron’sjaggre
ssivejaccountingjandjfinancialjreportingjtreatmentsjforjitsjSPE-
relatedjtransactions.jFinally,jthejmostjembarrassingjissuejwasjthejmassivejeffortjofjAndersen’sjHoustonjoffi
cejtojshredjEnronjauditjdocuments,jwhichjeventuallyjledjtojthejdemisejofjthejfirm.
EnronjCorporation--KeyjFacts
1. ThroughoutjArthurjE.jAndersen’sjlife,j“ThinkjStraight,jtalkjstraight”jservedjasjajguidingjprinciplej forjh
imselfjandjArthurjAndersenj&jCo.,jthejaccountingjfirmjthatjhejfounded.
2. ArthurjAndersen’sjreputationjforjhonestyjandjintegrityjresultedjinjArthurjAndersenj&jCo.jgainingjstatu
rejinjthejbusinessjcommunityjandjgrowingjintojonejofjthejnation’sjleadingjaccountingjfirmsjbyjthejtimej
ofjhisjdeathjinj1947.
3. LeonardjSpacekjsucceededjArthurjAndersenjasjmanagingjpartnerjofjArthurjAndersenj&jCo.jinj1947jan
djcontinuedjAndersen’sjlegacyjofjlobbyingjforjmorejrigorousjaccounting,jauditing,jandjethicaljstandard
sjforjthejpublicjaccountingjprofession.
4. WhenjSpacekjretiredjinj1973,jArthurjAndersenj&jCo.jwasjonejofjthejlargestjand,jarguably,jthejmostjpro
minentjaccountingjfirmjworldwide
5. ThejpredecessorjofjEnronjCorporationjwasjanjOmaha-
basedjnaturaljgasjcompanyjcreatedjinj1930;jsteadyjgrowthjinjprofitsjandjsalesjandjnumerousjacquisition
sjallowedjEnronjtojbecomejthejlargestjnaturaljgasjcompanyjinjthejUnitedjStatesjbyjthejmid-1980s.
6. Duringjthej1990s,jKennethjLay,jEnron’sjCEO,jandjhisjtopjsubordinate,jJeffreyjSkilling,j transformedjth
ejcompanyjfromjajconventionaljnaturaljgasjsupplierjintojanjenergyjtradingjcompany.
, Casej1.3j j JustjforjFeet,jInc.j j 3
7. LayjandjSkillingjplacedjajheavyjemphasisjonj“strongjearningsjperformance”jandjonjincreasingjEnron’sj
staturejinjthejbusinessjworld.
8. EnronjexecutivesjusedjhundredsjofjSPEsj(specialjpurposejentities)jtojarrangejlargejandjcomplex relatedjpartyjtra
9. Duringj2001,jEnron’sjfinancialjconditionjdeterioratedjrapidlyjafterjmanyjofjthejcompany’sjSPEjtransac
tionsjunraveled;jinjDecemberj2001,jEnronjfiledjforjbankruptcy.
10. FollowingjEnron’sjcollapse,jthejbusinessjpressjandjotherjcriticsjbeganjsearchingjforjpartiesjtojholdjresp
onsiblejforjwhat,jatjthejtime,jwasjthejnation’sjlargestjcorporatejbankruptcy.
11. CriticismjofjAndersen’sjrolejinjthejEnronjdebaclejfocusedjonjthreejkeyjissues:j thejlargejamountjofjcons
ultingjrevenuejthejfirmjearnedjfromjEnron,jthejfirm’sjrolejinjmanyjofjEnron’sjSPEjtransactions,jandjthej
effortsjofjAndersenjpersonneljtojdestroyjEnronjauditjdocuments.
12. Andersen’sjfelonyjconvictionjinjJunej2002jeffectivelyjendedjthejfirm’sjlongjandjproudjhistoryjinjthejpu
blicjaccountingjprofession.
InstructionaljObjectives
1. Tojprovidejstudentsjwithjajbriefjoverviewjofjthejhistoryjandjdevelopmentjofjthejpublicjaccountingjprofe
ssionjinjthejUnitedjStates.
2. Tojexaminejthej“scopejofjservices”jissue,jthatjis,jthejthreatsjtojauditorjindependencejposedjbyjauditjfir
msjprovidingjconsultingjservicesjtojtheirjauditjclients.
3. Tojexaminejthejextentjtojwhichjindependentjauditorsjshouldjbejinvolvedjinjtheirjclients’jdecisionsjregar
dingjimportantjaccountingjandjfinancialjreportingjissues.
4. Tojreviewjrecentjrecommendationsjmadejtojstrengthenjthejindependentjauditjfunction.
, Casej1.3j j JustjforjFeet,jInc.j j 4
5. Tojreviewjauditors’jresponsibilitiesjregardingjthejpreparationjandjretentionjofjauditjworkpapers.
SuggestionsjforjUse
Ijtypicallyjbeginjanjauditingjcoursejbyjdiscussingjajmajorjandjwidelyjpublicizedjauditjcase.jClearly,jthej
Enronjcasejsatisfiesjthosejcriteria.j Thejpurposejofjpresentingjsuchjajcasejearlyjinjthejsemesterjisjnotjonlyjtoja
cquaintjstudentsjwithjthejnaturejofjauditingjbutjalsojtojmakejthemjawarejofjwhyjthejindependentjauditjfuncti
onjisjsojimportant.j Manyjaccountingjstudentsjarejnotjwelljacquaintedjwithjthejnaturejofjthejindependentjaud
itor'sjworkjenvironment,jnorjarejtheyjgenerallyjfamiliarjwithjthejcriticaljrolejthejindependentjauditjfunctionj
playsjinjourjnationaljeconomy.j Hopefully,jcasesjsuchjasjthisjonejprovidejstudentsjwithjaj"realityjjolt"jthatjwi
lljstimulatejtheirjinterestjinjauditingjand,jpossibly,jmakejthemjmorejinclinedjtojpursuejajcareerjinjthejauditing
jfield.
ThejEnronjcasejalsojservesjasjajgoodjstartingjpointjforjanjauditingjcoursejsincejitjprovidesjstudentsjwith
janjoverviewjofjhowjthejauditingjprofessionjdevelopedjandjevolvedjinjthejUnitedjStatesjoverjthejpastjcentury
.j ThejvehiclejusedjtojpresentjthisjoverviewjisjthejhistoryjofjArthurjAndersenj&jCo.j Youjwilljfindjthatjthejcas
ejattemptsjtojcontrastjthej“Thinkjstraight,jtalkjstraight”jphilosophyjofjArthurjE.jAndersen,jthejfounderjofjthej
Andersenjfirm,jwithjthejmorejbusiness-
orientedjapproachjtojauditingjthatjhisjpredecessorsjadoptedjinjthejlatterjdecadesjofjthejtwentiethjcentury.
ConsiderjaskingjonejorjmorejofjyourjstudentsjtojinterviewjformerjAndersenjpersonneljwhojarejgraduate
sjofjyourjschool.j IjhavejfoundjthatjmanyjformerjAndersenjpartnersjandjemployeesjarejmorejthanjwillingjtojdi
scussjtheirjformerjemployerjandjthejseriesjofjeventsjthatjledjtojthejfirm’sjsuddenjcollapse.jThesejindividualsj
typicallyjsuggestjthatjfederaljprosecutors’jeffortsjtoj“bringjdown”jthejentirejAndersenjfirmjasjajresultjofjthej
document-
shreddingjincidentjwasjnotjonlyjunnecessaryjbutjalsojinequitable,janjargumentjthatjmanyjmembersjofjthejacc
ountingjprofession—includingjacademics—findjdifficultjtoj refute.
SuggestedjSolutionsjtojCasejQuestions
1. AjlargejnumberjofjpartiesjborejsomejdegreejofjresponsibilityjforjthejproblemsjthatjthejEnronjfiascojulti
matelyjposedjforjthejpublicjaccountingjprofessionjandjthejindependentjauditjfunction.j Thejfollowingjbulletji
temsjidentifyjseveraljofjthesejpartiesj[seejbold-facing]jandjthejrolejtheyjplayedjinjthejEnronjdrama.
• ThejleadershipjofjthejAndersenjfirmjthatjallegedlyjfocusedjtoojmuchjattentionjonjpractice developmentjact
• Impertinentjcorporatejexecutivesjwhojinsistedjonjaggressive,jifjnotjillegal,jaccountingjand financialjreporti
CASEj1.1
ENRONjCORPORATION
Synopsis
ArthurjEdwardjAndersenjbuiltjhisjfirm,jArthurjAndersenj&jCompany,jintojonejofjthejlargestjandjmo
stjrespectedjaccountingjfirmsjinjthejworldjthroughjhisjreputationjforjhonestyjandjintegrity.j “Thinkjstraight,jt
alkjstraight”jwasjhisjmottojandjhejinsistedjthatjhisjclientsjadoptjthatjsamejattitudejwhenjpreparingjandjissuin
gjtheirjperiodicjfinancialjstatements.j ArthurjAndersen’sjauditingjphilosophyjwasjnotjrule-
based,jthatjis,jhejdidjnotjstressjthejimportancejofjclientsjcomplyingjwithjspecificjaccountingjrulesjbecausejinj
thejearlyjdaysjofjthejU.S.jaccountingjprofessionjtherejwerejfewjformaljrulesjandjguidelinesjforjaccountantsja
ndjauditorsjtojfollow.j Instead,jAndersenjinvokedjajsubstance-over-
formjapproachjtojauditingjandjaccountingjissues.j Hejpassionatelyjbelievedjthatjthejprimaryjrolejofjthejaudit
orjwasjtojensurejthatjclientsjreportedjfullyjandjhonestlyjtojthejpublic,jregardlessjofjthejconsequencesjforjthos
ejclients.
Ironically,jArthurjAndersenj&jCo.’sjdramaticjfalljfromjprominencejresultedjfromjitsjassociationjwit
hjajclientjknownjforjaggressivejandjinnovativejusesjofj“accountingjgimmicks”jtojwindowjdressjitsjfinancialj
statements.j EnronjCorporation,jAndersen’sjsecondjlargestjclient,jwasjinvolvedjinjlarge,jcomplexjtransactio
nsjwithjhundredsjofjspecialjpurposejentitiesj(SPEs)jthatjitjusedjtojobscurejitsjtruejfinancialjconditionjandjope
ratingjresults.j Amongjotherjuses,jthesejSPEsjallowedjEnronjtojdownloadjunderperformingjassetsjfromjitsjba
lancejsheetjandjtojconcealjlargejoperatingjlosses.j Duringj2001,jaj seriesjofjcircumstances,jincludingjajsharpj
declinejinjthejpricejofjEnron’sjstock,jforcedjthejcompanyjtojassumej controlj andj ownershipj ofj manyj ofj itsj tr
oubledj SPEs.j Asj aj result,j Enronj wasj forcedj toj reportj a
, Casej1.3j j JustjforjFeet,jInc.j j 2
largej lossj inj Octoberj 2001,j restatej itsj earningsj forj thej previousj fivej years,j and,j ultimately,j filej forjban
kruptcyjinjDecemberj2001.
Duringjthejearlyjmonthsjofj2002,jAndersenjbecamejthejfocaljpointjofjattentionjamongjlawjenforcem
entjauthoritiesjsearchingjforjthejpartiesjresponsiblejforjEnron’sjsuddenjcollapse.jThejaccusationsjdirectedjatj
Andersenjcenteredjonjthreejkeyjissues.j Thejfirstjissuejhadjtojdojwithjthejscopejofjprofessionaljservicesjthatj
AndersenjprovidedjtojEnron.j CriticsjchargedjthatjthejenormousjconsultingjfeesjEnronjpaidjAndersenjimpair
edjthejauditjfirm’sjindependence.j ThejsecondjissuejstemmedjfromjAndersen’sjallegedjrolejinjEnron’sjaggre
ssivejaccountingjandjfinancialjreportingjtreatmentsjforjitsjSPE-
relatedjtransactions.jFinally,jthejmostjembarrassingjissuejwasjthejmassivejeffortjofjAndersen’sjHoustonjoffi
cejtojshredjEnronjauditjdocuments,jwhichjeventuallyjledjtojthejdemisejofjthejfirm.
EnronjCorporation--KeyjFacts
1. ThroughoutjArthurjE.jAndersen’sjlife,j“ThinkjStraight,jtalkjstraight”jservedjasjajguidingjprinciplej forjh
imselfjandjArthurjAndersenj&jCo.,jthejaccountingjfirmjthatjhejfounded.
2. ArthurjAndersen’sjreputationjforjhonestyjandjintegrityjresultedjinjArthurjAndersenj&jCo.jgainingjstatu
rejinjthejbusinessjcommunityjandjgrowingjintojonejofjthejnation’sjleadingjaccountingjfirmsjbyjthejtimej
ofjhisjdeathjinj1947.
3. LeonardjSpacekjsucceededjArthurjAndersenjasjmanagingjpartnerjofjArthurjAndersenj&jCo.jinj1947jan
djcontinuedjAndersen’sjlegacyjofjlobbyingjforjmorejrigorousjaccounting,jauditing,jandjethicaljstandard
sjforjthejpublicjaccountingjprofession.
4. WhenjSpacekjretiredjinj1973,jArthurjAndersenj&jCo.jwasjonejofjthejlargestjand,jarguably,jthejmostjpro
minentjaccountingjfirmjworldwide
5. ThejpredecessorjofjEnronjCorporationjwasjanjOmaha-
basedjnaturaljgasjcompanyjcreatedjinj1930;jsteadyjgrowthjinjprofitsjandjsalesjandjnumerousjacquisition
sjallowedjEnronjtojbecomejthejlargestjnaturaljgasjcompanyjinjthejUnitedjStatesjbyjthejmid-1980s.
6. Duringjthej1990s,jKennethjLay,jEnron’sjCEO,jandjhisjtopjsubordinate,jJeffreyjSkilling,j transformedjth
ejcompanyjfromjajconventionaljnaturaljgasjsupplierjintojanjenergyjtradingjcompany.
, Casej1.3j j JustjforjFeet,jInc.j j 3
7. LayjandjSkillingjplacedjajheavyjemphasisjonj“strongjearningsjperformance”jandjonjincreasingjEnron’sj
staturejinjthejbusinessjworld.
8. EnronjexecutivesjusedjhundredsjofjSPEsj(specialjpurposejentities)jtojarrangejlargejandjcomplex relatedjpartyjtra
9. Duringj2001,jEnron’sjfinancialjconditionjdeterioratedjrapidlyjafterjmanyjofjthejcompany’sjSPEjtransac
tionsjunraveled;jinjDecemberj2001,jEnronjfiledjforjbankruptcy.
10. FollowingjEnron’sjcollapse,jthejbusinessjpressjandjotherjcriticsjbeganjsearchingjforjpartiesjtojholdjresp
onsiblejforjwhat,jatjthejtime,jwasjthejnation’sjlargestjcorporatejbankruptcy.
11. CriticismjofjAndersen’sjrolejinjthejEnronjdebaclejfocusedjonjthreejkeyjissues:j thejlargejamountjofjcons
ultingjrevenuejthejfirmjearnedjfromjEnron,jthejfirm’sjrolejinjmanyjofjEnron’sjSPEjtransactions,jandjthej
effortsjofjAndersenjpersonneljtojdestroyjEnronjauditjdocuments.
12. Andersen’sjfelonyjconvictionjinjJunej2002jeffectivelyjendedjthejfirm’sjlongjandjproudjhistoryjinjthejpu
blicjaccountingjprofession.
InstructionaljObjectives
1. Tojprovidejstudentsjwithjajbriefjoverviewjofjthejhistoryjandjdevelopmentjofjthejpublicjaccountingjprofe
ssionjinjthejUnitedjStates.
2. Tojexaminejthej“scopejofjservices”jissue,jthatjis,jthejthreatsjtojauditorjindependencejposedjbyjauditjfir
msjprovidingjconsultingjservicesjtojtheirjauditjclients.
3. Tojexaminejthejextentjtojwhichjindependentjauditorsjshouldjbejinvolvedjinjtheirjclients’jdecisionsjregar
dingjimportantjaccountingjandjfinancialjreportingjissues.
4. Tojreviewjrecentjrecommendationsjmadejtojstrengthenjthejindependentjauditjfunction.
, Casej1.3j j JustjforjFeet,jInc.j j 4
5. Tojreviewjauditors’jresponsibilitiesjregardingjthejpreparationjandjretentionjofjauditjworkpapers.
SuggestionsjforjUse
Ijtypicallyjbeginjanjauditingjcoursejbyjdiscussingjajmajorjandjwidelyjpublicizedjauditjcase.jClearly,jthej
Enronjcasejsatisfiesjthosejcriteria.j Thejpurposejofjpresentingjsuchjajcasejearlyjinjthejsemesterjisjnotjonlyjtoja
cquaintjstudentsjwithjthejnaturejofjauditingjbutjalsojtojmakejthemjawarejofjwhyjthejindependentjauditjfuncti
onjisjsojimportant.j Manyjaccountingjstudentsjarejnotjwelljacquaintedjwithjthejnaturejofjthejindependentjaud
itor'sjworkjenvironment,jnorjarejtheyjgenerallyjfamiliarjwithjthejcriticaljrolejthejindependentjauditjfunctionj
playsjinjourjnationaljeconomy.j Hopefully,jcasesjsuchjasjthisjonejprovidejstudentsjwithjaj"realityjjolt"jthatjwi
lljstimulatejtheirjinterestjinjauditingjand,jpossibly,jmakejthemjmorejinclinedjtojpursuejajcareerjinjthejauditing
jfield.
ThejEnronjcasejalsojservesjasjajgoodjstartingjpointjforjanjauditingjcoursejsincejitjprovidesjstudentsjwith
janjoverviewjofjhowjthejauditingjprofessionjdevelopedjandjevolvedjinjthejUnitedjStatesjoverjthejpastjcentury
.j ThejvehiclejusedjtojpresentjthisjoverviewjisjthejhistoryjofjArthurjAndersenj&jCo.j Youjwilljfindjthatjthejcas
ejattemptsjtojcontrastjthej“Thinkjstraight,jtalkjstraight”jphilosophyjofjArthurjE.jAndersen,jthejfounderjofjthej
Andersenjfirm,jwithjthejmorejbusiness-
orientedjapproachjtojauditingjthatjhisjpredecessorsjadoptedjinjthejlatterjdecadesjofjthejtwentiethjcentury.
ConsiderjaskingjonejorjmorejofjyourjstudentsjtojinterviewjformerjAndersenjpersonneljwhojarejgraduate
sjofjyourjschool.j IjhavejfoundjthatjmanyjformerjAndersenjpartnersjandjemployeesjarejmorejthanjwillingjtojdi
scussjtheirjformerjemployerjandjthejseriesjofjeventsjthatjledjtojthejfirm’sjsuddenjcollapse.jThesejindividualsj
typicallyjsuggestjthatjfederaljprosecutors’jeffortsjtoj“bringjdown”jthejentirejAndersenjfirmjasjajresultjofjthej
document-
shreddingjincidentjwasjnotjonlyjunnecessaryjbutjalsojinequitable,janjargumentjthatjmanyjmembersjofjthejacc
ountingjprofession—includingjacademics—findjdifficultjtoj refute.
SuggestedjSolutionsjtojCasejQuestions
1. AjlargejnumberjofjpartiesjborejsomejdegreejofjresponsibilityjforjthejproblemsjthatjthejEnronjfiascojulti
matelyjposedjforjthejpublicjaccountingjprofessionjandjthejindependentjauditjfunction.j Thejfollowingjbulletji
temsjidentifyjseveraljofjthesejpartiesj[seejbold-facing]jandjthejrolejtheyjplayedjinjthejEnronjdrama.
• ThejleadershipjofjthejAndersenjfirmjthatjallegedlyjfocusedjtoojmuchjattentionjonjpractice developmentjact
• Impertinentjcorporatejexecutivesjwhojinsistedjonjaggressive,jifjnotjillegal,jaccountingjand financialjreporti
