Large number of corporate collapses gave rise to a worldwide scrutiny of the accounting profession and the implosion of Arthur Andersen, a global accounting firm and one of the then Big Five accounting firms.

In May 2001, Sunbeam's alleged accounting fraud resulted in Arthur Andersen making a settlement for a shareholder suit of $110 million. A month later, Arthur Andersen agreed to pay a $7 million fine after SEC charged it with issuing false and misleading reports bolstering Waste Management by more than $1 billion between 1992 and 1996. Arthur Andersen had also paid part of a $229 million settlement to shareholders of Waste Management. The year 2001 ended with the massive impact of Enron's bankruptcy in December.

The SEC began its investigation in late October, examining its accounting practices and the performance of Enron's auditor, Arthur Andersen. The accounting practices being questioned included complex debt hiding schemes using special-purpose entities, manipulation of the Texas power and energy markets, and bribes; its auditor, Arthur Andersen was alleged to have breached its independence by being involved as internal auditor for the company, and by allowing ex-audit partners to take part in its governance. Arthur Andersen was later indicted for its alleged obstruction of justice by destroying Enron documents. The firm was found guilty of a criminal offence in June 2002.

In Enron's case which involved manipulation of accounting books and the use of accounting services provided by Arthur Andersen as the accountant and management consultant. The company was alleged to have inflated revenues and cash flow figures to boost share prices and to satisfy analysts.

WorldCom was reported to have overstated its cash flow by booking $3.8 billion in operating expenses as capital expenses and provided its founder with a $400 million off-balance sheet loan. The company further stunned Wall Street by announcing it found another $3.3 billion in improperly booked funds, and taking a goodwill charge of $50 billion. The former chief financial officer (CFO) and ex-controller were arrested and charged with criminal activities. WorldCom's auditor was Arthur Andersen.

Required:

Your task is to read the following book;

Toffler, BL & Reingold, J 'Final Accounting Ambition, Greed and the fall of Arthur Andersen' Currency Doubleday, New York

In addition to the required reading above, you are also required to answer the following questions:

i) Every profession is concerned about the quality of services, and the public accounting profession is no exception. Quality audits are essential to ensure that the profession meets it responsibilities to clients, to the general public and to regulators who rely on independent auditors to maintain the credibility of financial information. To help assure quality audits, the profession and the regulators have developed a multilevel regulatory framework. For the purpose of describing the framework, these activities may be organized as follows:

• Standard setting
• Firm regulation
• Self or peer regulation
• Government regulation

Analyse whether Arthur Andersen had practiced the regulatory framework for ensuring quality services before its doom.

ii) The word 'ethics' is derived from the Greek word ethos, meaning 'character'. Whereas morality focuses on the 'good' and 'bad' human behaviour, ethics focuses on what is 'right' and 'wrong', and how and why people act in a certain manner. It focuses on a study of choices, standards and behaviour.

IFAC's mission is the worldwide development and enhancement of an accountancy profession with harmonized standards able to provide services of consistently high quality in the public interest. The IFAC Code establishes ethical requirements for professional accountants. A member body or firm may not apply less stringent standards than those stated in the IFAC Code.

The following are the threats to compliance with the Code of Ethics (IFAC Code) by professional accountants in public practice:

i) Self-interest threat

ii) Self-review threat

iii) Advocacy threat

iv) Familiarity threat

v)  Intimidation threat

vi) Public practice behaviour

Analyse whether Arthur Andersen had encountered any of the threats above and explain how it was dealt with before its doom.

iii) In the provision of auditing services, an auditor is liable to compensate a plaintiff if :

• A duty of care is owed to the plaintiff
• The audit is negligently performed or the opinion is negligently given
• The plaintiff suffered a loss as a result of the auditor's negligence
• The loss is quantifiable

Negligence has been defined as any conduct that is careless or unintentional in nature and entails a breach of any contractual duty. If the auditor has been negligent, then the client may sue the auditor for breach of an implicit term of the contract to exercise reasonable care and skill, so as to recover any consequential loss suffered.

In your opinion, was Arthur Andersen negligent during the provision in its auditing services to its many clients? Please describe the events that demonstrate their negligence.   

iv) Client evaluation is an important element of quality control. (ISA 220.14) states:

The engagement partner shall be satisfied that appropriate procedures regarding the acceptance and continuance of client relationships and specific audit engagements have been followed, and the conclusions reached in this regard are appropriate and have been documented.

The following steps are good practice in accepting an audit engagement:

a)    Client evaluation

• Evaluating the integrity of management
• Communicating with existing auditors
• Making enquiries of other third parties
• Reviewing previous experience with existing clients
• Identifying intended users of the audited financial statements
• Assessing a prospective client's legal and financial stability
• Evaluating the entity's condition of accounting records and internal control structure.

b) Ethical and legal considerations

• Evaluating independence
• Assessing competence to perform the audit
• Determining ability to use due care

Your essay should include:

• Cover Page
• Grading Scheme
• Executive Summary
• Table of Content
• A short description on the background information of Arthur Andersen.
• Answer to the question
• List of References/Bibliography
• Appendices (if relevant)