Case 6.1
Enron
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Enron Case
Relevant Technical Knowledge
PCAOB Ethics and Independence Rule 3520

“a registered public accounting firm and
its associated persons must be
independent of the firm's audit client
throughout the audit and professional
engagement period.”
2
Enron Case
Relevant Technical Knowledge
SARBOX Section 201

it shall be unlawful for a registered public accounting firm to
provide any non-audit service to an issuer contemporaneously
with the audit, including: (1) bookkeeping; (2) financial
information systems design and implementation; (3) appraisal or
valuation services, fairness opinions, or contribution-in-kind
reports; (4) actuarial services; (5) internal audit outsourcing
services; (6) management functions or human resources; (7)
broker or dealer, investment adviser, or investment banking
services; (8) legal services and expert services unrelated to the
audit; (9) any other service that the Board determines, by
regulation, is impermissible.
3
Enron Case
Relevant Technical Knowledge
SARBOX Section 203
 the lead audit or coordinating partner and
the reviewing partner must rotate off of
the audit every 5 years
SARBOX Section 206
 requires a “one year cooling off period”
before an audit firm employee accept a
position as CEO, CFO, Controller, or Chief
Accounting Officer of a former client
4
Enron Case
Relevant Technical Knowledge
SARBOX Section 301
 requires that the “audit committee of an
issuer shall be directly responsible for the
appointment, compensation, and
oversight of the work of any registered
public accounting firm employed by that
issuer.”
5
Enron Case
Relevant Technical Knowledge
Revenue Recognition Principle
 Revenue must be both earned and
realized before it is recognized. That is,
the product must have been delivered or
the services must have been provided to
the customer. In addition, the amount of
the sale needs to be fixed and
determinable. And, there must be a
belief that the cash will be collected from
the customer in a timely manner.
6
Enron Case
Relevant Technical Knowledge
PCAOB AS#12 – Paragraph #68
 “the auditor should presume that
there is a fraud risk involving
improper revenue recognition and
evaluate which types of revenue,
revenue transactions, or assertions
may give rise to such risks”
7
Enron Case
Relevant Technical Knowledge
PCAOB AS#15 – Paragraphs #4-8

describe the auditors’ responsibility regarding
evidential matter. In general, the auditor must
obtain evidence that is sufficient and appropriate
given the facts and circumstances. The
appropriateness of audit evidence refers to the
quality of the evidence gathered for a financial
statement assertion about a financial statement
account balance and/or an economic
transaction(s).
8
Enron Case
Relevant Technical Knowledge
PCAOB QC #20 - Paragraph #3
 “A firm has a responsibility to ensure that
its personnel comply with the professional
standards applicable to its accounting and
auditing practice. A system of quality
control is broadly defined as a process to
provide the firm with reasonable
assurance that its personnel comply with
applicable professional standards and the
firm's standards of quality.”
9
Enron Case
Relevant Technical Knowledge
SARBOX Section 103
 The PCAOB must require registered public
accounting firms to “prepare, and
maintain for a period of not less than 7
years, audit work papers, and other
information related to any audit report, in
sufficient detail to support the conclusions
reached in such report.”
10
Enron Case
Relevant Technical Knowledge
SARBOX Section 203
 the lead audit or coordinating partner and
the reviewing partner must rotate off of
the audit every 5 years
PCAOB
 As of the Summer 2013, the PCAOB is
contemplating the possibility of
mandatory firm rotation, although it is
not likely
11
Enron Case
Relevant Technical Knowledge
PCAOB AS #12 – Paragraph #7
 “The auditor should obtain an understanding of
the company and its environment to understand
the events, conditions, and company activities
that might reasonably be expected to have a
significant effect on the risks of material
misstatement.”
12
Enron Case
Relevant Technical Knowledge
PCAOB AS #13 – Paragraph #6

The auditor should determine whether it is necessary
to “make pervasive changes to the nature, timing, or
extent of audit procedures to adequately address the
assessed risks of material misstatement. Examples of
such pervasive changes include modifying the audit
strategy to: a) Increase the substantive testing of
the valuation of numerous significant accounts at
year end because of significantly deteriorating
market conditions, and b) Obtain more persuasive
audit evidence from substantive procedures due to
the identification of pervasive weaknesses in the
company's control environment.”
13
Enron Case
Relevant Technical Knowledge
PCAOB AS #5
 Paragraph # 28 – “relevant assertions are
those financial statement assertions that
have a reasonable possibility of
containing a misstatement that would
cause the financial statements to be
materially misstated.”
 Paragraph #30 – “what could go wrong?”
14
Enron Case
Relevant Technical Knowledge
PCAOB AS #12 – Paragraph #52
 “The discussion among the key engagement
team members about the potential for material
misstatement due to fraud should occur with an
attitude that includes a questioning mind, and
the key engagement team members should set
aside any prior beliefs they might have that
management is honest and has integrity.”
15
Enron Case
Relevant Technical Knowledge
PCAOB AS#12 – Paragraph #68
 “the auditor should presume that
there is a fraud risk involving
improper revenue recognition and
evaluate which types of revenue,
revenue transactions, or assertions
may give rise to such risks”
16
Enron Case
Relevant Technical Knowledge
PCAOB AS No. 5 – Paragraph #25
 “because of its importance to effective
internal control over financial reporting,
the auditor must evaluate the control
environment at the company.” The
control environment is influenced heavily
by a company’s management team and is
therefore often referred to as “the tone at
the top.”
17
Enron Case
Relevant Technical Knowledge
PCAOB AS No. 5 – Paragraph #21
 “A top-down approach begins at the
financial statement level and with the
auditor's understanding of the overall
risks to internal control over financial
reporting. The auditor then focuses on
entity-level controls and works down to
significant accounts and disclosures and
their relevant assertions.”
18
Enron Case
Relevant Technical Knowledge
SARBOX Section 301
 requires that the “audit committee of an
issuer shall be directly responsible for the
appointment, compensation, and
oversight of the work of any registered
public accounting firm employed by that
issuer.”
19
Enron Case
Relevant Technical Knowledge
SARBOX Section 302
 the CEO and CFO of each issuer must
now certify the “appropriateness of the
financial statements and disclosures
contained in the periodic report, and that
those financial statements and
disclosures fairly present, in all material
respects, the operations and financial
condition of the issuer.”
20
Enron Case
Relevant Technical Knowledge
PCAOB AS #15 – Paragraph 4
 “The auditor must plan and perform audit
procedures to obtain sufficient
appropriate audit evidence to provide a
reasonable basis for his or her opinion.”
PCAOB AS #15 – Paragraph 6
 “To be appropriate, audit evidence must
be both relevant and reliable in providing
support for the conclusions on which the
auditor's opinion is based.”
21
Enron Case
Relevant Technical Knowledge
PCAOB AS #15 – Paragraph 5
 “sufficiency is the measure of the
quantity of audit evidence.” All
things being equal, the greater the
risk of material misstatement
related to the financial statement
assertion, the more audit evidence
will be gathered by the auditor.
22
Enron Case
Relevant Technical Knowledge
SARBOX Section 401

explicitly requires that each set of financial
statements (and related disclosures) that is
required to be prepared in accordance with
GAAP, “shall disclose all material off-balance
sheet transactions" and "other relationships"
with "unconsolidated entities" that may have a
material current or future effect on the financial
condition of the issuer.”
23
Enron Case
Relevant Technical Knowledge
PCAOB AS #5
 Paragraph # 28 – “relevant assertions are
those financial statement assertions that
have a reasonable possibility of
containing a misstatement that would
cause the financial statements to be
materially misstated.”
 Paragraph #30 – “what could go wrong?”
24
Epilogue - Enron



Cliff Baxter, Vice Chairman, committed
suicide due to fraud
Arthur Andersen indicted for obstruction
of justice due to destroying evidence and
barred from auditing public companies for
five years
Former CEO Jeffrey Skilling sentenced to
24 years in prison
25
Epilogue - Enron



Founder Kenneth Lay dies from a heart
attack before his sentencing
Many top Enron executives were
sentenced to multi-year prison terms.
Eligible shareholders will receive $7.2
billion in settlements for their investment
losses
26