Arthur Anderson: Questionable Accounting Practices

 A Case Study and Analysis

            Arthur Anderson, one of America’s “big five” accounting firms, was forced out of business after nearly ninety years.  This was the result of employing a specific business model, and a chain of recurring events that followed the execution of that business model.

Facts

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            Arthur Andersen began as an accounting and audit firm in 1913.  By the 1990s the company developed a full service strategy offering consulting services in addition to the core accounting, tax, and audit services.  The goal was to create multiple revenue streams from the same client base.  Andersen used two different strategies to accomplish this.  First  was to separate the accounting and consulting services into separate operating divisions in 1999.  This led to unforseen internal competition, lack of cooperation,  and lack of communication between the divisions.  The next strategy was to create two separate companies under common corporate ownership in 2000.  Arthur Andersen continued as the accounting and audit firm.  Accenture became the consulting firm.  Both later operated under the umbrella of Andersen Worldwide.

            In 2001, with a new CEO in place, the auditing division began to receive a series of  lawsuits relating to Andersen clients that all shared very similar characteristics.  Baptist Foundation of America suit alleges issuing false and misleading approvals of financial statements.  It also alleges that Andersen had been warned of fraudulent activities by BFA employees.  In the case of Sunbeam, the SEC accused an Andersen  partner of authorizing financial statements while being aware of accounting improprieties at Sunbeam.   The SEC found that Andersen had assisted Waste Management in financial fraud by issuing unqualified opinion on misleading financial statements.  It was also discovered that the two had agreement for ‘special services’ in addition to auditing which constituted covering past and future fraud.  The Enron case brought criminal charges to Andersen and ended with an indictment for obstructing justice due to shredding documents and removing a name from incriminating documents.  Investors at WorldComm and Global Crossings also alleged that Andersen either failed to discover accounting irregularities or gave positive opinion on financial statements with known fraud or misstatements.

Issues and Problems

            The primary problem that Arthur Andersen needed to solve was how to offer accounting and tax, independent audit, and specialty consulting services to the one client while maintaining integrity and maximizing profit.  The strategy to separate into divisions and then into separate companies led to three operational issues that contributed to the final demise.  Inexperienced consultants and auditors were employed by Andersen.  They were not well trained and probably not paid as well which may have added money to Andersen’s bottom line.  Fewer partners were involved in issuing final audit opinions.  Some opinions were likely issued by these untrained partners without regard to company policy and possibly without adhering to standards set by the accounting and audit profession.  The result of Andersen’s business model is that clients were encouraged and facilitated in the commission of financial fraud. Also read Sunbeam corporation case study

            The most  negative impact  were the bankruptcy filings that followed the discovery of the audit errors.  Businesses shut down, or sold and reorganized.    Next was the shareholder losses that resulted when these companies restated earnings (or losses).  Investors and analyst lost confidence in these firms.   As the number of job losses at both Andersen and its clients increased, individuals involved felt the negative economic impact.  Many personal bankruptcies and foreclosures likely followed those job losses.  As a nonprofit charitable and religious foundation, the Baptist Foundation of Arizona’s situation also gave rise to questions about the integrity of religion and charity.

Proposed Alternatives and Implementation

            Have a senior partner head each audit team and require the senior to sign off all audits.

Have an team internal audit team conduct random audits of audit teams and the audits they sign off on.

            Require licensing, pre-education, and continuing education of auditors and audit team members.  Have detailed job descriptions of each audit team member to ensure that no one does an audit function that they are not qualified to do.

            Eliminate vagueness and ambiguity in consulting work.  Consulting is a general term applied to a specific function.  Consultants must be trained and experienced in the area that they will advise clients in.  Audit and consulting groups would work separately at all times.

Evaluation and Conclusion

            The Sarbanes-Oxley Act of 2002 facilitates implementation and regulation of accounting and audit activity.  Lawsuits lead to reduced profits or outright losses.  Some insight by Andersen with regard to the initial lawsuits should have put an end to the audit irregularities and allowed them to continue their business model.

References

Arthur Anderson: Questionable Accounting Practices.  Case 7.  359-367

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