Enron debacle forces audit rethink

Enron's accounts were an unclear picture of its health

By BBC News Online's James Arnold

At the end of February this year, accounting giant Arthur Andersen gave its official seal of approval to Enron's annual report.

Although hedged about with much legal jargon, the auditors' statement was clear: the energy firm's accounts presented "fairly, in all material aspects, the financial position of Enron Corp and subidiaries."

The current financial reporting system was created in the 1930s... when assets were tangible and investors were sophisticated and few

Joe Berardino, Arthur Andersen

Nine months later, Enron admitted that its accounts for that year, and for the three previous years, had been more or less fictional - an admission that culminated in the firm's messy bankruptcy last Sunday.

Now, the accounting industry is taking a long hard look at itself.

The biggest auditing firms, together with the regulators that oversee their work, are hoping that the Enron debacle could result in new, more realistic standards to measure more accurately company performance.

Big Five remorse

The accountants' soul-searching began within days of Enron's bankruptcy filing.

On Tuesday, the "Big Five" accountancy firms - Arthur Andersen, KPMG, Deloitte & Touche, PricewaterhouseCoopers and Ernst & Young - issued a joint statement.

Enron's dealings made accounting rules out of date

"Working together, our five firms are committing our attention and resources to evaluate and chart a course to address issues important to investors," the group said.

"We are also committed to future action based on insights gained from current events."

They called for the Securities and Exchange Commission (SEC), the US stock market regulator, to help draw up new rules to make company accounts more transparent to shareholders.

Outmoded rules

The five firm's statement was echoed on Tuesday by Joe Berardino, Arthur Andersen's chief executive, in an article in the Wall Street Journal.

"The current financial reporting system was created in the 1930s for the industrial age," he wrote.

"That was a time when assets were tangible and investors were sophisticated and few."

Now, widespread share ownership, combined with freer - and sometimes less reliable - flows of financial information, leads to increasing confusion over companies' genuine stability, Mr Berardino argued.

New rules promised

Regulators have started to take action, too.

The American Institute of Certified Public Accountants (AICPA), which issues auditing standards through its Auditing Standards Board, said it would propose a new auditing standard early next year for detecting fraud.

The AICPA plans to issue guidance for company management and audit committees, as well as revised auditor standards on the review of quarterly financial statements.

It also said it would make recommendations to the SEC on disclosing special purpose entities, complex financial vehicles often kept off a firm's balance sheet - precisely the sort of structure that may have played a role in Enron's downfall.

Reputation knocked

Enron is merely the latest and most dramatic in a series of incidents shaking the reputation of auditors.

Since the internet boom of the late 1990s - and the subsequent bust - shareholders have become more wary of official financial statements.

Some internet firms used "optimistic" accounting methods to give the impression of solidity - an impression that quickly vanished when market sentiment turned sour early last year.

The willingness of the financial establishment, including auditors and venerable investment banks, to play along with this chicanery has been widely condemned.

Critics allege that banks and business-services companies enjoy so much spin-off business from the firms they serve that they have no incentive to rock the boat by exposing malpractice.

Government joins the charge

Coincidentally, the SEC on Tuesday published a warning against reading too much into "pro-forma" profits, a type of earnings that bears little relation to actual cash flow, and which has been a popular yardstick among dot.com firms.

The US government is also lumbering into action, and is launching a series of Congressional hearings into the collapse of Enron at the end of this week.

The hearings will be extremely broad in subject, ranging from the effects on the energy markets through to the regulation of corporate activity.

Arthur Andersen and the SEC are both scheduled to testify.