Audit and Party Transactions

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April 21, 2003
The Enron Collapse

Was Enron’s collapse due to a failure in the standard setting process? Why or why not?

The Enron collapse was by no means due to a failure in the standard setting process instead, the collapse resulted from Enron’s fast growing rate and its highly “creative” management team who at one point just lost control of the business. The company stopped doing what it was known for doing best, energy generations, and began exploring and operating in a new and unknown business segment and a new industry. The standard setting process was indeed effective; however management kept finding ways to go around the system. Finally, the collapse can also be attributed to management integrity and Andersen’s failure to detect accounting irregularities. Auditors should have looked closer at the complex and complicated SPEs transactions in whish the company was venturing.

What is the Emerging Issues Task Force (EITF)? Is it the same as FASB? Does a Consensus of the EIFT have the same power of GAAP as an FASB Statement?

No they are not the same. The EITF was formed in 1984 in response to the recommendations of the FASB’s task force on timely financial reporting guidance and an FASB invitation to Comment on those recommendations. Task Force members are selected from public accounting firms but also include representatives of industry nominated by the Financial Executives, the Institute of Management Accountants, and the Business Roundtable. The chief accountant of the Security Exchange Commission attends Task Force Meeting regularly as an observer with the privilege of the floor. EITE tries to develop a procedure for something new before it is embedded in FASB. In regards to the EIFT Consensus, they don’t have the same power of GAAP as per FASB Statement. Although they are usually accepted by FASB and become rulings in some instances they have been declined and veto.

Should the FASB revise the “3 percent rule” that now governs the consolidation of SPEs? If so, then what level of outside ownership should be required for non-consolidation?

As it was illustrated throughout the case, the 3% percentage rule did not create Enron’s problems. Indeed, if Enron’s management had complied said rule, the company would have been required to consolidate from the beginning. As it stands, the 3 percent rule provides adequate standards for consolidation. Enron’s problem was lack of integrity and a strong desired to find alternative ways structure complex transaction for the sole purpose of avoiding consolidation. Even if the rule were to change to 50 percent, some individuals would still be motivated to find alterative ways to structure transactions in order to avoid consolidation. Management integrity would be the best solution.

Should a company be required to provide information in its annual report regarding all SPEs in which it is invested? What type of information should be disclosed?

According to FASB, if a business enterprise has a controlling financial interest in an SPEs, the assets, liabilities and results of the activities of the SPE should be included in consolidated financial statements with those of the business enterprise, which is referred to as the primary beneficiary of the SPE. In other words, a company should consolidate if it is subject to a majority of the risk of loss from the SPEs’ activities.

However, even if the company is not required to consolidate it should mention and disclose material investments in SPEs on its annual report. The disclosure should be brief but include purpose of entity, amount invested as well as terms of the agreement.

How does a company ascertain that related party transactions were on terms that were reasonable compared to terms that would be obtained from unrelated third parties?

Companies must disclose certain details about material related party transactions, and other information necessary to understand the transaction’s effects on the financial...
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