Auditing Cases

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Additional Cases
for the Course

The case readings have been developed solely as a basis for class discussion. The case readings are not intended to serve as a source of primary data or as an illustration of effective or ineffective auditing.

Reprinted by permission from Jay C. Thibodeau and Deborah Freier. Copyright © Jay C. Thibodeau and Deborah Freier; all rights reserved.

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Enron

Enrori’s First Few Years
hi~ 1985 Enron had assets along the three major stages of the supply chain of nat ural gas: production, transmission, and distribution. Natural gas was produced from deposits found underground. The natural gas was transmitted via pipe lines, or networks, of underground pipes, and sold directly either to industrial customers or to regional gas utilities, which then distributed the gas to smaller businesses and customers. Some companies in the industry had assets related to specific activities within the supply chain. For example, some companies owned pipelines but did not produce their own gas. These companies often entered into

Enron 2000 annual report, p. 7.
Joseph F. Berardino, remarks to U.S. House of Representatives Committee on Financial Services, December 12, 2001.
Bala G. Dharan and William It Bufkins, “Red Flags in Enron’s Reporting of Revenues and Key Financial Measures,” March 2003, prepublication draft (~.ruf.rice.edu/—bala/files/dharan-bufkins_ enronjed_flagsS4l 003.pdfl, p. 4.

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178 Section Six Comprehensive Company Cases

long-term “take or pay” contracts, whereby they paid for minimum volumes in the future at prearranged prices to protect against supply shortages. In early 1986 ]lnron reported a loss of $14 million for its first year. As a result, the company employed a series of cost-cutting measures, including layoffs and pay freezes for top executives. Enron also started selling off assets to reduce its debt. Nevertheless, Enron’s financial situation was still bleak in 1987. That year Moody’s downgraded its credit rating to junk bond status.4

Impact of Significant Industry Change on Enron
Enron faced significant change in its industry environment due to the government’s decision in the mid-1980s to deregulate the once highly regulated industry. The government, which had dictated the prices pipeline companies paid for gas and the prices they could charge their customers, decided to allow the market forces of supply and demand to dictate prices and volumes sold. As part of this pro cess, the government required that pipeline companies provide “open access” to their pipelines to other companies wanting to transport natural gas, so that pipeline companies would not have an unfair competitive advantage.5

Enron’s Natural Gas Pipeline Business
Enron adapted by providing open access to its pipelines—that is, charging other firms for the right to use them. It also took advantage of the ability to gain open access to pipelines owned by other companies. For example, in 1988 Enron signed a 15-year contract with Brooklyn Union to supply gas to a plant being built in New York. Because Brooklyn Union was not connected to Enron’s pipeline sys tem, Enron needed to contract with another pipeline company to transport the gas to Brooklyn Union. Enron was therefore assuming added risks related to the trans portation of the gas. The long-term nature of the contract was also risky because prices could rise to a level that would make the contract unprofitable.6

Enron Expands into Natural Gas Trading
and Financing
Enron capitalized on the introduction of market forces into the industry by becoming involved in natural gas trading and financing. Enron served as an intermediary among producers that contracted to sell their gas to Enron and gas customers that contracted to purchase gas from Enron. Enron collected as Bethany McLean and Peter Elkind, The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron (New York: Penguin Group,...
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