The Enron Accounting Scandal Accounting Essay

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Enron was one of the largest corporations in the United States of America until its decline in 2001. Enron grew as a trading giant from a natural gas pipeline company. Enron initially ventured off as a broker between energy consumers and suppliers, then expanding its part as a dealer of non-energy dealings, and later adding a range of diverse investments. Enron was a market leader in the energy business and played an important role in restructuring energy markets in the United States (Swartz 2004).

According to McLean (2003), Enron revealed large amounts of debt and enormous losses in non-energy and overseas partnerships for the first time in October 2001. Enron Executives kept these losses off the balance sheets for a few years and managed to hide them from stakeholders to keep the share prices up. When these debts and losses were known to public everyone in the marketplace lost confidence in Enron. Due to the loss in confidence, for the first time in the history of Enron Shareholders were selling the stock and credit agencies slashed Enron's rating. McLean (2003) further claims that this resulted in partners asking for more collateral dues and as a result drained Enron's cash funds, forcing executives to take on more debt which resulted in further Enron loss.

Enron stock price had a stunning collapse by the end of November 2001, the stock prices fell to less than a dollar from a peak of $90 in the year 2000. This caused the credit agencies to downgrade Enron's liabilities as "JUNK". Enron looked forward to protection from creditors when an anticipated union with Dynegy Inc. fell through in late November (Fox 2003).

Accounting Scandal of 2001

According to Fox (2003), Enron was classified as the largest Accounting disaster in the history of United States of America which resulted in closure of accounting firm Arthur Anderson. A number of disclosure showed Arthur Andersen did not reveal Enron's losses on balance sheets, which misled public and shareholders. The U.S government took number of steps to prevent future Enron where helpless employees lost a life time fortune. Enron and Arthur Andersen bankruptcy stood on the verge of largest bankruptcy due to accounting fraud.

Fusaro (2002) believes Enron was classified as a blue chip stock in the market place. The Exposure of Enron scandal was a disaster for many firms in the U.S. Enron's fall occurred after it was discovered that much of its earnings and profits were the result of deals with special purpose entities. These entities were controlled by Enron as a result its debt and losses were not projected in balance sheets, which is breaching accounting laws.

Fusaro (2002) claims Enron had Incentive Plans and huge bonuses for Executives which cultivated greed and as a result the executives started to hide company losses. Moreover compensation plans for shareholders tightly geared the stock price to a peak of ninety dollars. Enron as a middleman in the energy business gave a lot of incentives to promote earnings growth and stock price. It was seen that many people benefited from Enron's business which resulted in people turning a blind eye to the root cause (Fusaro 2002).

December 2, 2001, Enron filed for bankruptcy. At the same time Arthur Andersen the largest accounting firm in the U.S was forced to stop auditing public companies due to the involvement in Enron. Arthur Andersen was found guilty for destroying docu­ments related to Enron and hiding financial statements to mislead the public. These convictions were laid off in 2005 by the Supreme Court but the damage has prevented them for returning in the market (Hodak 2007).

Accounting practices

Partnoy (2004) mentions in his findings that Enron's offshore entities were used to plan and avoid taxes; this resulted in larger profits for the company and made it easier for Enron to hide real time financial data. Overseas entities provided Enron executives the freedom to make overseas transactions without government/shareholder intervention. These overseas entities and businesses made Enron look more profitable than it actually was. Every quarter Enron executives would lead financial deceptions to create illusions of billions in profits while Enron was actually loosing revenue. Due to overseas subsidiaries it was hard to track actual profits for Enron (Partnoy 2004).

Overseas collaborations and mergers lead Enron stock to outrageous levels. Realising the profits involved Enron executives traded millions of dollars in Enron stock for personal profit. Only the executives and top level management knew of the offshore accounts that were running in losses for Enron, however this was not portrayed to the shareholders. Andrew Fastow, Enron (CFO) led personal dealings in which he benefited hundreds of millions of dollars in revenue at the expense of Enron and its stakeholders which is totally against the ethics (Swartz 2004).

Enrol Online an internet based trading operation used by all energy companies across America. Enron Online made Enron as the market leader in the energy market. Jeffrey Skilling President of Enron advocated the idea of aggressive investments in the global energy market for Enron; this made Enron the biggest wholesaler of electricity and gas. In 1999 Enron traded over $27 billion each quarter on balance sheets. These figures had to be accepted as stated on balance sheets (Baker 2003).

According to Baker (2003), Jeffery Skilling came up with the idea of mark to market accounting. Under the mark to marketing theory future profits for Enron were anticipated on assumptions regardless whether Enron would make a profit or loss in the future. Enron executives were more concerned about the stock value at Wall Street then company's financial health. According to Jeff Skilling actual balance sheets are of no value if the company's success is measured by statements emerging from a "black box", a term used by Skilling. Enron's innovative ideas were gambles to keep the illusion of an energy giant, and push the stock prices higher. Increasing stock prices meant larger investments from the investors; any financial audits could collapse Enron's house of cards.

Richard, Wall Street analyst questioned Skilling on Enron's accounting practices. This resulted in aggressive Skilling abusing Richard. In the recorded conversation Grubman complained why Enron could not release a balance sheet of its profits, to which Skilling replied, "Well, thank you very much, we appreciate that ... asshole." This comment resulted in a shock and was classified as unprofessional (Bryce 2004).

Enron stock prices had a rise and decline in August 2000, at one stage Enron's stock price hit its highest value of $90. When the stock prices were at the highest, top executives with the inside information started selling their stocks. During this period Enron investors and shareholders were advised to buy stocks as they were told stock prices would reach $130 - $140 each (Bryce 2004).

Effect on Enron collapse

Mclean (2003) states that collapse of Enron had less effect on consumers. Soon after Enron collapse there was no difference in prices of electricity in the market and electricity continued to flow. Even though Enron was a market leader in the energy business there were large numbers of vibrant companies as competitors. These companies rapidly and successfully picked up the market after Enron's departure. Enron bankruptcy affected a lot of employees that had their retirement fund held by Enron. A lot of larger firms associated with Enron saw their share prices dropping which affected employees further. It is estimated around 21,000 employees lost their jobs due to Enron.

Simplified Vision

Enron Collapse

Eichenwald (2005) argues that Enron had a substantial impact on business and governments. The collapse didn't affect only the United States, but the entire world. At the time, the bankruptcy of Enron was the largest recorded bankruptcy to date. When Enron was founded it had banked on a brand new idea to act as a "gas bank" and this was one of the core reasons Enron had flourished. Enron's employees were some of the smartest and youngest individuals. They were afraid to question Enron's business practices; mainly for fear of termination. In some ways this was good for the company and in other ways not so much. Eichenwald (2005) also states that Enron, before and after the collapse, had a huge impact on politics and business in many other ways.

Partnoy (2004) mentions that before the collapse of Enron, political action was a major part of their strategy. They sought to promote deregulation and reduce government interaction. Enron had many lobbyists that helped promote these ideas and sway opinion in Washington, D.C. Some of the successes that Enron had attained were:

Petitioned the CFTC (Commodities Futures Trading Commission) to exempt energy derivatives and swaps

SEC (Securities and Exchange Commission) - granted exemption for foreign subsidiaries from provisions of the Invest Company Act of 1940 (which prevented shifting debt off the books and prevented executives from investing in partnerships)

Commodity Futures Modernization Act - Allowed Enron to operate an unregulated energy trading subsidiary

Partnoy (2004) further states that Enron achieved some goals of deregulation, it ''took care" of the people who made it happen. This was just the beginning of a line of corruption that would eventually lead to the end of Enron.

However, after the collapse of Enron, Sarbanes-Oxley became the largest impact in the political environment. Enron was not the only company who had committed accounting scandals in the late1990s and early 2000s. However, it was one of the major reasons that the act was legislated in the first place. A few other firms that contributed to the legislation of this act were: Tyco, Worldcom, and Peregrine Systems. The Sarbanes-Oxley act of 2002 was designed to prevent the violations of trust Enron had committed by reducing the accounting mischief and increasing the reliability and thoroughness of accounting data. It promotes corporate responsibility, enhanced financial disclosures, auditor independence, corporate and criminal fraud accountability, white collar crime enhancement, and corporate fraud accountability. With Sarbanes-Oxley in place, IOOre people are personally responsible for their actions in the accounting functions of a corporation (Munson 2005).

Munson (2005) further states, fear from the collapse of Enron caused investors to think that accounting practices of Enron were a wide spread problem. The stock market dropped sharply after Enron and other companies with similar problems collapsed. Many companies, like Enron, treated their trades with other companies as revenue. In the case of Enron, they had traded with their own subsidiaries to create illusionary revenue. This became an assumed widespread issue, particularly in the power and telecommunications businesses. Some of the world's best companies have been known to use aggressive accounting practices to lift their earnings. The erosion of confidence has resulted in a decline of trust with routine transactions. Government action such as Sarbanes-Oxley has helped the situation, but there is still work to be done.

Energy market response to collapse

The marketing and trade of energy supplies were not hampered when Enron faced tough times. The competitiveness of the energy industry that was created while Enron operated kept the energy supplies going as other companies carried on from where Enron left. There were undisturbed supplies of energy and there were no fluctuations of prices (Geisst 2004).

Effect on consumers

Enron's fall into bankruptcy became hot topics of countless investigations among various authorities. There were various questions raised on the roles of third-party auditors, the effect created on pension plans and employee section investments. Answers were sought to prevent a similar incident of a giant company collapsing again in the future.

Reshuffling of the energy industry will assist in providing consumers with better choices, fast and efficient services with competitive pricing (Geisst 2004).

Sarbanes-Oxley: Document Destruction

Sarbanes-Oxley has introduced criminal provisions, 18 U.S.C. section 1519, which details the different circumstances in which the government can prosecute individuals for document destruction. Section 1519 details that it is a criminal offence to alter or knowingly destroy a document (Eichenwald 2005).

Best Practices for a Company

According to Eichenwald (2005), the Act provides protections for the Audit Committees by having a requirement that members of the Audit Committee will be independent auditors. It also specified that at least one member of the audit committee is to be a financial expert. Sarbanes-Oxley provides authority to the Audit Committee in appointing, compensating and supervising auditors. It also confirms that the Audit Committee creates procedures for actioning complaints related to accounting, audit, or any other employee issues.

The Act requires each company to have their individual code of ethics for its financial officers and details its code of ethics in its public filings or advice if the company does not have such code of ethics. Sarbanes-Oxley also makes it illegal for any company employee to bribe or unlawfully influence an auditor or tamper with the findings of the audit for the purpose of misleading company's financial information (Eichenwald 2005).

Conclusion - Lessons for Managers

Some of the lessons learnt from Enron Case are as follows:

Every executive of a company has the legal responsibility under Federal securities laws to lead the company ethically, and provide transparency to its shareholders and employees.

Enron has resulted in changes in business practices (regulations) like Sarbanes Oxley law. Every company has to legally follow these rules and provide financial statements to shareholders and auditors for review (Bromwich 2003).

Some of the laws that have changed due to Enron are as follows:

Possible prison sentences for up to 10 years for a fraud of over $100 million under the new federal law.

Corporate record keeping and corporate governance has to be transparent and every company has to provide quarterly balance sheets and financial projections.

Enron has improved greater oversight by regulators and improved codification of best practices. This has resulted in changes with auditing and reporting practices, and result in higher percentages of independent directors on corporate boards.

Enron has increased influence of audit committees and information flow to and through audit committees.

Enron collapse has resulted in increased monitoring of accounting practices and financial statements. Longer review of proxy statements and more thorough review of securities registrations.

Stronger penalties apply for financial frauds.

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