Auditing and Accounting Cases: 3.1 - Eron

Chao Ren and Joseph Restuccia
AC  741
Case 3.1 – Enron

1.   Inherent risk is the risk that a class of transactions, account balances or disclosures is materially misstated without applying any related control. Paragraph 9 of PCAOB Auditing Standard NO.5 gives some instances where an auditor should pay attention to the effects on financial statements when planning the audit.
      In this case, Enron played an intermediary role between its gas suppliers and gas customers, allowing the contracts with gas suppliers to be traded. Enron applied this trading model to other markets using an “asset-light” strategy. In this model, Enron gave its producers cash up-front instead of payment over the life of the contract to diminish the risk brought by the long-term nature of the contracts. As for audit planning, this new payment method should be considered, thus raising Enron’s inherent risk. Also, Enron devised complex and variable contracts and traded them. This action brought those contracts into the trading market, bringing many uncertainties and risks for the company.
      Last but not least, Enron used the “asset-light” strategy to achieve its expansion to other markets. This strategy reduced the fixed capital expenditure by divesting its assets related to the beginning and ending activities. How they evaluated and recorded the proceeds from those divested assets also increased Enron’s inherent risk. Moreover, this strategy was applied to different markets and countries; the complexity of those markets also raised the inherent risk.

2.   The Planning section of AU Section 311 indicates that the nature, extent, and timing of planning vary with the size and complexity of the entity, experience with the entity, and knowledge of the entity's business. As in this case, Enron paid its producers cash up-front instead of payment over the life of the contract. Those transactions involved large amounts of cash and occurred frequently. This means there would be...