Consult Paragraphs 52–53 of PCAOB Auditing Standard No. 12. How might a revenue

Question

Consult Paragraphs 52–53 of PCAOB Auditing Standard No. 12. How might a revenue recognition fraud occur under Enron’s strategy in the late 1990s? Identify an internal control procedure that would prevent, detect, or deter such a fraudulent scheme.

Consult Paragraphs 65–69 of PCAOB Auditing Standard No. 12. Based on your understanding of fraud risk assessment, what three conditions are likely to be present when fraud occurs (the fraud triangle)? Based on the information provided in the case, which of these three conditions appears to have been the most prevalent at Enron, and why?

Explanation / Answer

Part A)

One possible scenario where a fraud could occur is with respect to the treatment of related party (international subsidiaries/special performance entities) revenue transactions. It may not have been possible for Enron to ensure that all these transactions meet the arm's length standards resulting in improper revenue recognition. In such a case, the company can adopt preventive controls such as prior approvals complemented with proper documentation for all related party transactions. This control can help in reducing the possibility of revenue fraud that may occur as a result of side agreements within related party transactions affecting the provisions relating to revenue recognition.

________

Part B)

The fraud triangle comprises of three components:

1) Incentive or Pressure-(where an employee/manager has an incentive to conduct fraud and provide misleading information or is under pressure to attain specific targets, goals or estimates)

2) Opportunity-(where an employee has an opportunity to conduct fraud. Such an opportunity is generally available in the absence of proper internal controls)

3) Rationalization (Attitude)-(where an employee is able to justify his/her wrongful/fraudulent)

In case of Enron, the condition that could have existed the most is "Incentive or Pressure". It is so because, the salary and bonuses of executives were linked to their performances (revenue) which in turn could have forced them to inflate their revenue figures/focus on short term profitability. Grant of stock options based on the performance of company's stock price also aggravated the problem.

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