Question

1.) What are the three major reasons why Enron should have been discovered before it was actually exposed?

2.) How does COSO defined internal control?

3.) List and describe the three of the five components of internal control as defined by COSO What are the five phases of the audit formulation process?

Answer 1

1. The analysis of the performance of Enron from 1997 to 2001 using Non-Financial Measures; Gross Margin Test; Altman’s Z-score Bankruptcy Predictor; Modified Altman’s Z-score; Chanos Algorithm; and Beneish Model have all showed that it was quite possible to have predicted its failure much earlier. This paper concludes that, it would have been possible to detect Enron’s fraud, as early as 1998 or at worst 1999. What the Enron case study has shown is that no company is too big to fail, and that there are already tools that could be used in predicting corporate fraud and failure.

2. The COSO framework defines internal control as a process, effected by an entity's board of directors, management and other personnel, designed to provide "reasonable assurance" regarding the achievement of objectives in the following categories: Effectiveness and efficiency of operations.

3.

In an “effective” internal control system, the following five components work to support the achievement of an entity’s mission, strategies and related business objectives.

1. Control Environment

• Integrity and Ethical Values
• Commitment to Competence
• Board of Directors and Audit Committee
• Management’s Philosophy and Operating Style
• Organizational Structure
• Assignment of Authority and Responsibility
• Human Resource Policies and Procedures

2. Risk Assessment

• Company-wide Objectives
• Process-level Objectives
• Risk Identification and Analysis
• Managing Change

3. Control Activities

• Policies and Procedures
• Security (Application and Network)
• Application Change Management
• Business Continuity/Backups
• Outsourcing

4. Information and Communication

• Quality of Information
• Effectiveness of Communication

5. Monitoring

• Ongoing Monitoring
• Separate Evaluations
• Reporting Deficiencies

These components work to establish the foundation for sound internal control within the company through directed leadership, shared values and a culture that emphasizes accountability for control. The various risks facing the company are identified and assessed routinely at all levels and within all functions in the organization. Control activities and other mechanisms are proactively designed to address and mitigate the significant risks. Information critical to identifying risks and meeting business objectives is communicated through established channels up, down and across the company. The entire system of internal control is monitored continuously and problems are addressed timely.