Enron’s Accounting Malpractices

HT120095 - Accountants in the profession

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10/16/2015

Table of Contents

1.        Abstract:        3

2.        Introduction        3

3.        Demise of Enron:        5

3.1 An admired company        5

3.2 What led to fall        5

3.3        Failed Check and Balances        7

3.4        Breach of accounting and ethical conduct        7

3.5        Board of Directors        8

3.6 Corporate Culture        8

3.7 Lessons Learnt        9

4.        Conclusion:        10

5.        References:        11

1. Abstract:

This case is about the analysis of Enron’s accounting malpractices, related to its trading business. The company was the 7th largest corporation in the United States by revenue in 2001. Enron transformed from a regulated natural gas distribution company to a worldwide energy trading company. The company was a globally dominated energy trader with more than $100 Billion revenue(Healy and Palepu, 2013). Enron got bankrupt in 2001 due to obscured huge debts which were kept off the Balance sheet and mark-to-mark accounting for its commodity trading business and this led to $74 Billion wiping out of Enron’s shareholder(Benston and Hartgraves, 2002). The case analysis is based on existing research finding, theoretical concepts and other authentic online resources. We read journals related to the Enron bankruptcy case explaining different aspects of business. To understand the impact of the scandal on society. The case highlights four key learning points as an accounting professional that are related Enron financial misled and obscured accounting practices. The case argues that had there been transparent accounting, an astute level of financial analysis and a more realistic view about the company’s business operation and related return, bankruptcy could have been avoided. This is a live case of undermining the objective of accounting and accompanied unethical practices by its professionals. It looks into the role of the Enron’s board of director, auditors and existing regulations at that time. Company’s corporate culture also stimulated to continuance of practice to report inflated revenue, net income, shareholder equity and understate its liabilities. This case, therefore also reveals the weakness in our corporate system. The case is great learning for accounting professionals shows the conflict of interest between parties can lead to manipulation of overall operating structure.

1. Introduction

Enron was recognized as a global player in energy trading and international energy-asset construction. It was founded in 1985 as a natural gas pipeline company by recognizing the opportunity after deregulation of natural gas and trade like a commodity.

The Enron was one of the most reputed companies known for employing bright and talented employees. The companies' boards of directors were constituted of Kenneth Lay as a chairman of the board and CEO. There were Emeriti, Professors and former Secretaries of State. Kenneth Lay was the person behind establishing Enron in 1985. One of the key spokesman of deregulation. He was known for his social and charitable activities. Jeffrey Skilling was chief operating officer of Enron. He was the man behind implementing mark-to-market accounting in the organization.  Under his supervision, Enron launched an internet based platform EnronOnline, for trading of Energy contract, which lost all of its invested capital. Andrew Fastow was the Chief Financial Officer of Enron; under his supervision hundreds of SPE’s were born to facilitate the illegal trades. McKinsey was Enron’s strategic client, Vinson and Elkins acted as a legal advisor, financial manoeuvred by investment bank including J.P. Morgan and Citibank. Arthur Andersen was the accounting firm which was liable for its internal and external Auditing since the inception of the firm in 1985. In 2000 Enron was the second largest client of the CPA firm.

The company was known for its aggressive compensation structure. The compensation was closely pegged to closing deals. As  a  result,  executives  focused much  more  on  sales  rather  than  on  the  long  term  cash  flow  generated during the projects’ implementation (Silveria, 2013). Kenneth Lay was one of the highest paid CEOs of America, earning a $42.4 million compensation package in 1999. Senior Executives were used to exploiting company’s asset for personal benefit.

“Prior to 1985, the Federal Energy Regulatory Commission (FERC) required interstate pipeline firms to make long term commitments to purchase minimum gas volumes from wellhead producers at regulated prices that exceeded market spot prices (Healy and Palepu, 2013)”. The deregulation of gas increased the risk of price volatility in high demand season. Enron started making contracts with its customer as an intermediary to provide the long-term gas contracts at prior fixed price and thus taking the risk of price volatility. In these circumstances, Enron used long-term fixed-price contracts with gas producer and financial derivatives like swaps, and forward and future contracts, to hedge the risks of volatility. This provided the stage to begin  an Enron Journey from a pipeline company to a largest energy trading company of the world.

Enron was working through many special purpose entities (SPE) which used to work as counter party of Enron. The asset of the SPE’s was Enron restricted stock and loan guarantees, but did not qualify for consolidation in the financial statement. The company took a number of simultaneous transactions with SPE’s for hedging its risk and making operation essentially a loan transaction.

1. Demise of Enron:

The company was pioneer of energy trading and very soon became the largest. But fallen off the cliff with a speed which no one expected.