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Formed in 1985 by Kenneth Lay from an amalgamation of Houston Natural Gas and InterNorth, Enron Corporation was the first national natural gas pipeline network. Over time, the firm's business center of attention changed from the controlled shipping of natural gas to uncontrolled energy trading markets. The guiding standard seemed to have been that there was additional money to be made in buying and selling economic contracts associated to the value of energy asset than in genuine possession of physical assets.
Collins (2006:211) states that during the early 1990s, Kenneth Lay facilitated to instigate the sale of electricity at market prices and shortly after the United States Congress approved legislation deregulating the retailing of natural gas. The consequential markets made it promising for traders including Enron to put up for sale energy at high prices thus, drastically escalating their revenue. Following producers and local governments decrying the resulting price instability and hard-pressed for improved directives, strong lobbying on the part of Enron and other companies, was able to carry on the free market scheme in place.
Enron Corporation was one of the biggest international energy, services and Merchandise Company. Prior to it being filed bankruptcy; the company sold natural gas and electricity, distributed energy and other supplies such as bandwidth internet connection and made available risk management and pecuniary services to the customers around the globe.
As a consequence, Enron was named "America's Most Innovative Company" by Fortune magazine for five successive years, from 1996-2000. It was on Fortune's "100 Best Companies to Work for in America" list of 2000, and was renowned even in the midst of the elite workers of the financial world for the lavishness of its offices. Enron's worldwide reputation was damaged, nonetheless, by continual rumors of corruption and political pressure to acquire deals in Central and Southern America, in Africa and in the Philippines. In particular contentious was the $30bn pact with the Indian MSEB (Maharashtra State Electricity Board), where it is suspected that Enron representatives used political links within the President George W. Bush administration to put weight on the Indians. The Enron scandal was exposed in October 2001 and it ultimately led to the bankruptcy of the Enron Corporation. In addition to being the largest bankruptcy restructuring in American record at that time, Enron was ascribed as the leading audit failure.
After the formation of Enron in 1985 by Kenneth Lay, several years later, Jeffrey Skilling was taken into service as the head of the corporation. Skilling built up a team of executives that in the course of the use of accounting dodges, exceptional purpose entities and dishonest financial reporting, were able to conceal billions in arrears from unsuccessful contracts and projects. Chief Financial Officer (CFO) Andrew Fastow and other managers not only misinformed Enron's board of directors and audit committee members on high-risk accounting procedures, but also forced them to pay no heed to the issues.
Enron's financial accounts that were not transparent did not evidently portray its functions and finances with shareholders and analysts. Additionally, its multifaceted business representation and unscrupulous practices obliged that the company use the dilemmas of accountability to fake earnings and alter the balance sheet accounts to illustrate a positive interpretation of its performance. According to McLean and Elkid (2004: 253) The Enron scandal matured out of a sound buildup of behaviors and values and actions that began years prior to and at last curled out of control.
The permutation of these issues later led to the liquidation of the company and the greater part of them were brought about by the oblique knowledge or direct actions of Lay, Jeffrey Skilling, Andrew Fastow and other decision-makers. Kenneth Lay worked as the chairman of the company in its preceding few years and endorsed of the actions of Skilling and Fastow even though he did not always request about the details.
Enron and other power providers earned profits by giving services such as across-the-board trading and also risk management in adding up to the construction and maintenance of electric energy companies, natural gas pipelines, luggage compartment and processing services. Whilst taking on the risk of buying and selling products, traders are permitted to account the selling price as revenues and the good's costs as cost of sold goods. Contrary, an intermediary grants a service to the customer but does not take on the similar risks as traders for buying and selling.
When service providers are identified to as agents, they are able to give information on trading and brokerage charges as revenue, even though not for the full value of the business. Enron instead chose to account on the whole value of every of its trades as revenue. This 'merchant model' model was well thought-out much more belligerent in the accounting analysis than the agent model. Enron's method of accounting overstated trading revenue was later taken on by other companies in the energy trading industry in an endeavor to continue being competitive with the company's huge amplified revenue.
Federal securities law demands that the bookkeeping statements of openly traded corporations be practiced by a self-sufficient auditor. Enron's external audits received a lot of interest. Whereas outside audits prevent companies from building up financial mistakes, and not only to prevent bankruptcy, tribulations with the Enron audits may have added up to both the speedy rise and the pointed decrease in its stock price.
The task of a company's board of directors was to administer corporate management to defend the wellbeing of shareholders. The board allowed Enron to take on high risk accounting, unsuitable conflict of interest transactions, extensive undisclosed off-the-books activities, and excessive executive compensation. The Board members observed various indications of doubtful practices by Enron management over a number of years but preferred to disregard them to the disadvantage of Enron shareholders, employees and business associates. The sovereignty of the Company's Board of Directors was negotiated by financial ties involving the company and certain Board members. However, the Board also was unsuccessful in ensuring the independence of the company's auditor, hence, allowing Andersen to offer in-house audit and consultancy services while also serving as the company's external auditor.
Enron happened to the first non-financial corporation to use the Mark-to-marketing method to account for its compound long-term pacts. Mark-to-market accounting demands that once a long-term contract was signed, returns was projected as the current rate of net future cash flows. Frequently, the possibility of these contracts and their interrelated costs were complex to critic. Owing to the huge inconsistencies of trying to equal proceeds and cash, investors were usually given counterfeit or ambiguous reports. When using the method, returns from assignments could be recorded which improved financial earnings.
Nevertheless, in upcoming years, the proceeds could not be incorporated, so innovative and supplementary income had to be incorporated from more projects to extend further development to soothe investors. In July 2000, Enron and Blockbuster Video signed a 20-year agreement for one contract to bring in on-demand entertainment to different U.S. cities by year-end. After several pilot tasks, Enron identified projected profits of more than $110 million from the pact, though forecasters queried the technological feasibility and demand in the market of the service. When the set of connections became unsuccessful, Blockbuster dragged out of the contract. Enron went on to make out potential profits even if the agreement ended up in a loss.
Wetfeet (2008:43) states that Enron used special purpose entities such as limited affiliations or companies formed to discharge a short-term purpose to finance or manage risks associated with specific property. The company designated to make known least details on its use of special purpose entities. For financial accounting reasons, a sequence of policies says whether a special purpose entity is a split entity from the guarantor. In total, by 2001, Enron had used hundreds of special purpose entities to bury its debt. They used frauds on purpose deceptive giving of financial information by individuals who were members of the Enron company employees and/or management. As a result of manipulation, the company created or misrepresented documents and files; they withhold assets, registered fictive transactions; and false appraisals & valuations.
As a result of one contravention, Enron's balance sheet understated its liabilities and exaggerated its equity and its profits were overstated. Enron revealed to its shareholders that it had evaded shortcoming risk in its own illiquid savings using special purpose entities. On the other hand, the investors were unconscious to the fact that the special purpose entities were in reality using the company's own accumulation and financial warranty to funding these hedges. The system thwarted Enron from being confined from the shortcoming risk. Noteworthy instances of special purpose entities that Enron made use of were JEDI, Chewco, Whitewing, among others.
After a sequence of scandals, connecting uneven accounting procedures flanking on dishonesty involving it and its accounting firm Arthur Andersen, Enron set at the brink of enduring the major bankruptcy in history by mid November 2001. Andersen and Enron ragged thousands of documents associated to Andersen's audits of Enron. Andersen did not reveal how bad Enron's financial situation was, saying its books were good until Enron failed. The decrease of the cost of investors' equity per share in Enron during 2001 was from $85 to 30 cents. Because Enron was regarded as a blue chip stock, this is an unparalleled and devastating incident in the financial world. Enron's thrust in value came about after it was discovered that many of its proceeds and revenue were the consequence of deals with limited partnerships which it proscribed. The result of this is that many of the losses that Enron came across were not accounted in its financial statements (McPhail & Walters, 2009:38).
Enron's auditor firm, Arthur Andersen, was charged of pertaining to irresponsible standards in their audits because of a conflict of interest over the noteworthy checking with fees created by Enron. A conflict of interest refers to a situation in which an individual has opposing personal and professional interests. The auditors' methods were queried as either being concluded exclusively to obtain its yearly fees and for their lack of proficiency in appropriately evaluating Enron's revenue acknowledgment, special entities, derivatives and other accounting applications. Andersen's auditors were forced by Enron's management to postpone distinguishing the charges from the special purpose entities as their credit risks became clear.
In view of the fact that the units would never arrive at a profit, accounting principles demanded that Enron should take a write-off, where the value of the entity was removed from the balance sheet at a loss. To pressure Andersen into accumulating Enron's profits expectations, Enron would rarely permit accounting firms such as Ernst & Young and PricewaterhouseCoopers to finish bookkeeping tasks. Even though Andersen was prepared with domestic controls to save from harm against different incentives of local partners, they were unsuccessful in preventing conflict of interest. At one time, Andersen's Houston office, which carried out the Enron audit, was capable to exercise authority on any critical reviews of Enron's accounting judgments by Andersen's Chicago partner. Additionally, when news from the US Security & Exchange Commission's investigation of Enron were publicized, Andersen tried to wrap up any disregard in its audit by tearing up numerous tons of supportive files and deleting of almost 30,000 e-mails and computer folders. Exposure regarding Andersen's general performance led to the fall of the firm.
Roszak (2009:197) asserts that Company audit committees regularly meet for a number of times during the year and their members normally have only a humble background in accounting and finance. Enron's audit committee had more know-how than many corporations. It comprised of very many distinguished persons in the business world. The audit committee was afterward belittled for its short and snappy meetings that would envelop large quantities of material. The committee did not have the technological acquaintance to appropriately query the auditors on bookkeeping questions related to the company's special purpose entities. In addition, the audit committee was also incapable of questioning the company's executives due to pressures put on the committee. When Enron fell, conflicts of interest of the audit committee were looked upon with doubt. According to Hubert Saint-Onge, in its newer market-based activities, Enron Corporation did not have a sufficient base of understanding to direct itself and did not have the indispensable counterpoints in place. As a consequence, Enron became a structure without checks and balances. In Saint-Onge's view, when a company shifts more and more into an intangibles-based atmosphere, it requires to pass a comparable ground of values and doings as it would have in a more tangibles-based situation.
Enron's reward and performance management system was devised to maintain and recompense its most valuable employees and the arrangement of the system added to a dysfunctional corporate culture that became passionate with a focal point only on instant income to capitalize on bonuses. The staff relentlessly looked to begin high-volume contracts often taking no notice of the superiority of cash flow or profits in order to acquire a high ranking for their performance appraisal. Additionally, accounting end results were documented as soon as it could be achieved to carry on with the company's supply worth. The practice facilitated deal-makers and executives to receive huge cash bonuses and stock opportunities (Swartz & Watkins, 2003:386).
Skilling thought that if the staff members were regularly cost-centered, that would hold back innovative thinking. As a consequence, spendthrift spending was extensive all through the company particularly amongst the executives. Employees had hefty expenditure accounts and many executives were compensated occasionally twice as much as their competitors.
In conclusion, the collapse of Enron Corporation is one of the most renowned and deplorable events in the economic world in the entire history of the mankind and its aftershocks were felt on worldwide scale. Arbogast (2007:125) says that before its collapse in 2001, Enron was one of the US leading corporations and commonly considered amid top 10 well-liked companies and most preferred places to work. The Enron board was frequently renowned to be amongst the greatest five US companies in accord with the Fortune magazine. Whilst Enron Corporation was so vastly commended by the external observers, on the inside it had exceedingly decentralized pecuniary organization and decision-making structure which made it virtually impracticable to get consistent and apparent view on corporations' actions and operations.
It is obvious that the problem was not absolutely not due to bad managerial performance, but also that all the units of the corporation were implicated in the adulteration of the corporate moral values and ethics with the top executives and managers bearing prime blame for the deficiency of mutual culture, lucid accountability and transparency in the company. If the company's management toiled as it should be in its full strength, and if it was given an opportunity to work in such a way, there could be a likelihood of evading the tragedy (Rae, 2009:27).