Enron as a symptom of audit process breakdown: can the Sarbanes-Oxley Act cure the disease?

Abstract

Andersen’s deficiency in the Enron case mainly involved an unwillingness to stand up to Enron management regarding accounting issues. This is a critical phase of the audit; however, it is only one phase of an audit. This paper presents a model of the auditor’s misstatement detection and reporting process, which consists of three steps: (1) awareness of the transaction, (2) recognition that the transaction’s accounting treatment results in a misstatement, and (3) a willingness to modify the audit opinion to disclose the nature of misstatement if management does not correct the misstatements. For an auditor to best serve the public interest, he or she would need to carry through all three steps of the model. Five recent financial statement misstatements are then addressed: Sunbeam, Cendant, Waste Management, Enron and Worldcom. What emerges from a review of these recent cases is that the failure point in the misstatement detection and reporting process varies among these cases and there are often multiple points of failure, suggesting the need for multiple approaches to improving the process. The Sarbanes-Oxley Act, passed largely as a result of the Enron failure, attempts to improve the audit process for public companies in the US. The relationship of the act’s provisions to the misstatement detection and reporting process, and their potential efficacy in preventing cases similar to the recent frauds are addressed. From this analysis, the paper concludes that most of the audit-related provisions of the Sarbanes-Oxley Act are concerned with strengthening auditor independence. Because other aspects of the audit model have been responsible for some recent frauds, the Act may be treating the symptoms of the audit breakdown which appear to have caused the Enron failure, while missing an opportunity for more meaningful legislative reform of other aspects of the audit process which are associated with other recent frauds.