capitalizations following audit failures (Byrnes et al。, 2002)。

Enron’s business focused primarily on delivering and brokering energy domestically。 Its growth boomed with the US utility industry’s deregulation, which greatly increased the spot prices for electricity, natural gas and other commodities。 Using volatile, risky and expensive hedging transactions, Enron turned itself into essentially an unregulated derivative-trading entity。 To maintain its phenomenal growth, its management sought new, untapped busi- ness areas, taking huge, risky positions in international brokerage and movement of energy, water rights and broadband transmission of communications。 The investing community at first supported Enron’s new policies, helping to foster further rises in its stock value (e。g。, its stock price/earnings multiple exceeded 70) even though there was no proof that these practices would pay off。

Enron’s management “cooked the books” (both in form and in substance) to create the illusion that its business operations created real value for its shareholders and creditors。 Their questionable accounting practices included:

•Enron’s management establishing Special Purpose Entities (SPEs) in which outsiders were to hold 3% control, allowing Enron to shift its liabilities off the books。

•Recognizing profits and removing huge debt from Enron’s books, while violating the 3% minimum control test to set up SPEs。

•Basing the SPE partnerships in such tax havens as the Cayman Islands。

•Recognizing increased assets and equity when key Enron executives purchased Enron stock on credit (which they never repaid) to fund many “independent” partnerships。

•Not reporting many of the above and similar transactions in the financial statements。

•Paying millions of dollars in consulting fees over and above audit fees to its auditor, Andersen, which may well have impaired their independence。

•Making many restatements, corrections and new disclosures, which were associated with Enron’s financial collapse。

Enron’s management, Andersen and others should have reported financial information more fully, audited financial statements more carefully, and otherwise acted more respon- sibly regarding the entire financial reporting process。 As former SEC Chair Levitt stated, “Enron is the result of two decades of erosion of business ethics and a battle where pri- vate interests made significant gains over public interests” (Mayer, 2002, p。 65)。 The basic increasingly ignored principle is that generally accepted accounting principles (GAAP) represent minimum CPA requirements, and the AICPA Code of Ethics requires CPAs to go beyond GAAP if they conclude that doing otherwise would make the financial statements misleading (Berkowitz, 2000, p。 53)。 Demski (2002, p。 129) stresses that accounting’s use of a “bright line” to ascertain rules to account for transactions (rather than the use of general principles) inherently places form over substance and helped lead to the Enron debacle。 Substance must take precedence over form since GAAP’s primary goal is fairly presented financial statements。

We show in this paper how circumstances and actions taken in the Enron matter should not be considered a surprise, given the way the business environment and relationships have developed between public accountants and their clients during the past few decades。 First, we discuss how the practice of providing both consulting and auditing services by an accounting firm to the same client presents serious conflict of interest issues。 We also dis- cuss how the increased movement toward risk-based auditing approaches also introduced new difficulties into the auditing process。 Next we illustrate how a large body of litera- ture presents an abundance of guidance and information auditors can use to help prevent future Enrons from recurring。 Last, we point out how the behavior of parties besides Ander- sen and Enron (e。g。, financial analysts, banks, lawyers and journalists) also helped create the Enron debacle。 These parties have helped create business/accounting climates that are ideal for the development of similar financial failures fueled by distortions in financial statements。