Case 3.1
Name

Q1. Based on the information from the case, three specific facts that increase the risk of misstatement are listed as below. 1. A 15-year contract Enron signed with Brooklyn Union, transported gas through contracting with another company. The long term contract was risky because prices and cost could rise that make the contract unprofitable.

2. Enron served as an intermediary to collect as profits between the prices purchased and sold the gas. "Merchant Model" revenue recognition is used instead of ‘Agent Model’. At the same time, Enron allowed for the natural gas contracts it devised – which were quite complex and variable, depending on multiple parameters. Hence, wrong methodology revenue recognition under complicated conditions made misstatement more probable.

3. Enron "asset-light’’ strategy: Enron took advantages of having a presence in the physical market without the disadvantages of huge fixed capital expenditures. Enron divested its assets related to pumping gas and then set out to acquire assets related to midstream activities. In booking, Enron’s gas transaction represented far more than its existing pipeline capacity.

Q2. Inherent risk is the probability that material errors or frauds have entered the data processing system. Enron new strategies involved complex models that determined the present value of projected cash inflows and outflows under the contract. The inputs to these models were often highly subjective. Hence, it impacts the nature, timing and extent of auditors work as below: 1) Increase the substantive testing of the valuation of significant accounts at year end because of significantly deteriorating market conditions

2) Obtain more audit evidence from substantive procedures due to the identification of pervasive weaknesses in the company's control environment.

Q3. 1) To identify significant accounts and disclosures and their relevant assertions, the auditor should evaluate the qualitative and quantitative risk factors related to the financial statement line items and disclosures. Risk factors relevant to the identification of significant accounts and disclosures and their relevant assertions include –
Size and composition of the account;
Susceptibility to misstatement due to errors or fraud;
Volume of activity, complexity, and homogeneity of the individual transactions processed through the account or reflected in the disclosure;
Nature of the account or disclosure;
Accounting and reporting complexities associated with the account or disclosure;
Exposure to losses in the account;
Possibility of significant contingent liabilities arising from the activities reflected in the account or disclosure;
Existence of related party transactions in the account; and
Changes from the prior period in account or disclosure characteristics

2) Valuation basically checks whether the different components of the financial statement have been included in the right proportion. The components are assets, liabilities, expense and revenue. Assets capital expenditure needs to be checked but the portion will be deducted when Enron shift its business strategy

Q4. 1) Enron, as being served as an intermediary, who is defined as an "agent" provides a service to the customer. Service providers, when classified as agents, are able to report trading and brokerage fees as revenue, although not for the full value of the transaction. However, Enron collected as profits between the prices purchased and sold the gas. Very aggressive "merchant model" revenue recognition made Enron has inflated revenue, increasing 750% in the late 1990’s.

2) Create accounting documentations for key financial processing. When written and implemented correctly, your accounting procedures should provide this level of internal control. One of procedures in these documentations will be financial statements or P&L Flux analysis. Accountants, auditors, including reviewers review these analysis, figures, ratios, it is apparently seen the unreasonable increase or decrease. Hence, the potential frauds would be detected.