Case 3
Case 3.1 Enron: Understanding the Client’s Business and Industry
Price, Ria; Walters, Jessica 1. Inherent risk, a component of the audit risk model, refers to the susceptibility of the accounts to material misstatement, without regard to the systems internal controls.
Inherent risk is a function of the nature of the client’s business, the major types of transactions, and the effectiveness and integrity of its managers and accountants. A clear understanding of the audit client’s business model is essential in assessing inherent risk. Paragraph 9 of PCAOB Auditing Standard No. 5 entails the planning of the audit of internal control over financial reporting. The paragraph states that the auditor should properly plan the audit of internal control over financial reporting and properly supervise the engagement team members and lists factors that could impact the auditor’s procedures. Upon evaluation of the case, our understanding of inherent risk and Paragraph 9 of PCAOB Auditing Standard No. 5, we found the following factors that would result in elevated inherent risk: ● Enron’s industry was significantly impacted following the government’s decision to deregulate the once highly regulated natural gas industry. As part of the deregulation process, the government required that pipeline companies provide open access to other companies wanting to transport natural gas. Enron adapted to this change by charging other firms for the right to use their pipelines. Additionally, Enron entered into long term contracts with their clients to transport gas, in some instances contracting with other companies to use their pipelines, in order to fulfill their contractual agreements. By doing so,
Enron assumed additional risk related to gas transportation. The long term
contracts Enron entered into held the risk of prices rising to high enough levels that would cause the contract to be unprofitable. The significant change in the industry, assumption of
Price, Ria; Walters, Jessica 1. Inherent risk, a component of the audit risk model, refers to the susceptibility of the accounts to material misstatement, without regard to the systems internal controls.
Inherent risk is a function of the nature of the client’s business, the major types of transactions, and the effectiveness and integrity of its managers and accountants. A clear understanding of the audit client’s business model is essential in assessing inherent risk. Paragraph 9 of PCAOB Auditing Standard No. 5 entails the planning of the audit of internal control over financial reporting. The paragraph states that the auditor should properly plan the audit of internal control over financial reporting and properly supervise the engagement team members and lists factors that could impact the auditor’s procedures. Upon evaluation of the case, our understanding of inherent risk and Paragraph 9 of PCAOB Auditing Standard No. 5, we found the following factors that would result in elevated inherent risk: ● Enron’s industry was significantly impacted following the government’s decision to deregulate the once highly regulated natural gas industry. As part of the deregulation process, the government required that pipeline companies provide open access to other companies wanting to transport natural gas. Enron adapted to this change by charging other firms for the right to use their pipelines. Additionally, Enron entered into long term contracts with their clients to transport gas, in some instances contracting with other companies to use their pipelines, in order to fulfill their contractual agreements. By doing so,
Enron assumed additional risk related to gas transportation. The long term
contracts Enron entered into held the risk of prices rising to high enough levels that would cause the contract to be unprofitable. The significant change in the industry, assumption of