Acc4202 Acc3215 Auditing and Assurance Services 1 Enron Case Study

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ACC4202/ACC3215 AUDITING AND ASSURANCE SERVICES 1

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Question 1

        The business risks that Enron faced are price instability and foreign currency risks, where it is normally faced by any energy company. However, when Enron choose to diversifies its business into more and more markets like acted as broker of speculative energy in the future, and offered financial hedges, the complex business model brought them to extra risks. This significantly created pressure for Enron’s managers and executives to be fraudulent and aggressive performing in financial reports.

Interest rate risk and larger foreign exchange risk occurred when Enron providing financial hedges to their customers.  Since Enron was primarily in hedging and contracting for electricity, it is a highly competitive business which affected to environmental and price war. Since Enron acted as financial intermediary and brokers that earn income by arbitraging price differences, it is difficult for them to predict future price. The price instability in markets will increase the likelihood of material misstatement because risks come out when price fluctuate frequently. Besides, Enron launched a Web-based trading site where most of the business transactions are transacted through the trading site, exceeding $1 billion of transaction daily. This exposed Enron into technological risk if the system failed, when Enron used undependable information, eventually causing material misstatement in their financial statement.

The movement of Enron changing to mark-to-market accounting principle from historical cost accounting principle brings Enron into an inherent risk. It is a cause for aggressive accounting on foreseen profits of future sales. Valuation issues and undisclosed company’s liability is an inherent risk that might not see in a while, but impact extremely large in future. Special Purpose Entity (SPEs) is one of the inherent risks when liabilities were not recorded while there ware cash inflows through Enron. Beyond that, high level of leverage increases the likelihood of material misstatement as well. As Enron was totally depended on high and lifting stock price, they guaranteed to borrow funds with high stock prices, by the way recognize borrowed funds as revenue, but not the liabilities where practices in common accounting principles. Besides, SPEs were utilized by Enron to keep its debt off balance sheet, this method push business expansion risky and promptly.