1. Define the problem(s)
Enron failed to record some of its transactions. Arthur Andersen did not allow the LJM financial statement to stay unconsolidated.
2. Analyze the situation - again, take a "lessons learned" approach. You might use the following questions as guides:
A. What important internal controls were ignored when LJM1 was created? LJM1 ignored some of Enron’s entries in the books that were missing. Outsiders owned less than 3% of the Special Purpose Entities equities. There was an error made by Arthur Andersen to let LJM’s financial statement to remain unconsolidated. If the financial statements had been consolidated, some of the errors could have been found. They may have even had some time to correct these errors before
Enron’s recurrence of negative cash flows from their daily operations should have caused the Auditor to investigate to find out the origin of the problem that caused the negative numbers. Enron was growing quick and steady as the emerged from nothing. Fortune named Enron as "America's Most Innovative Company" for six consecutive years. Enron’s management would often have to justify their inappropriate account for their funding.
3. Present solutions - here are a couple of guideline questions:
A. How could the auditors, in this case, Arthur Andersen, have performed their audits and not caught the Enron fraud?
Arthur Andersen was able to perform Enron’s audit and not caught the audit fraud because he was connected to Enron. He was not independent enough. There were transactions that were not recorded in their books. These actions caused Enron to become vulnerable to fraud. The internal audit committee and the senior management should not have a personal relationship. It is hard for the Auditor to do any type of auditing if they have a relationship that is not independent because their advise to the senior management will be susceptible to biasness. Enron did not get a fair audit because of this close relationship with the Auditor.
Is it possible for a financial statement auditor to form a GAAS-compliant audit and not catch major financial statement fraud? Has GAAS auditing changed enough since Enron to guarantee that