The History Of The Enron Case Accounting Essay

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From 'one of the biggest firm in the US' to 'one of the biggest bankruptcies of US'; this is the story of Enron corporation. A company which started off as an energy firm, supplying operations and services in the energy sector, Enron had evolved themselves as of the most innovative firms of all time. (Stein, 2000) But in 2001, the company fell head over heels, hard enough to never recover back to life again.

This essay aims at reasoning the accounting and auditing failures of Enron Corporation in vicinities of corporate governance, business ethics and auditing standards. The wrong-doing of Enron are put under the microscope to derive the lessons to be learnt by future managers. Moreover, the essay concentrates on finding the answer to the question that many individuals have asked since the humiliation of Enron; 'What happened at Enron in the US ten years ago could never happen again?'

The case of Enron is a particularly important one of students as it highlights the fraud that was pulled off by Enron and that it was surprising they got away with it for that long of a period. The key architects were Chairman Ken Lay, CEO Jeff Skilling & CFO Andrew Fastow. (Chazan, 2002) The history they created will forever be remembered as one of the biggest financial deceptions by a company.

The Enron Case

In the current financial world, there exist four major auditing firms that are titled as the 'big four' (i.e. PwC, Deloitte, Ernst & Young and KPMG) (Anonymous, 2012).But before 2001, there was another auditing giant which was a part of this list making it the 'big five'. This company went by the name Arthur Anderson. But in 2001, Arthur Anderson intentionally relinquished its auditing license due to being found guilty against criminal charges in the dealings with Enron Corporation (Doost, 2003). Economists have tracked down the financial misconducts of Enron back to the 90s (Eichenwald and Brick, 2002). A company that started off as a natural gas providing company with visions to expand more than just piping gas by the chairman Kennet Lay, Enron was built in 1985. Over the years, it grew into a natural gas and energy provider of operations and services (Anonymous, 2002). Further expansions came when the new CEO Jeffery Skillings was appointed, who was said to be an extremely intelligent and visionary man. It was Jeffery Skillings who expanded into a company which dealt in the demand and supply of many different commodities apart from just energy. One of these commodities was broadband (Anonymous, 2002). Hence, Enron was no more just a regular wholesale energy company, rather a prominent financial figure in the US market.

Enron also dealt with many different derivatives like futures, forwards, swaps and options. Enron created an extremely complex structure and framework around itself, which it functioned in. This made it very difficult for outsiders to keep a track of the companies activates, as well as its financial statements. In an article published in Fortune magazine by McLean (2001), Enron has been called a 'black box' due to the secrecies and confidentialities of operations. In reality, Enron was doing so much more than anyone could have ever imagned. Enron had managed to get away with so much of fruad, for such a long time that its almost applaudable. Using techniques like creating partnerships with companies that did not exist and off balance sheet reports, Enron was able to keep debts off their balance sheets while borrowing at a large rate. Enron was able to value itself on the market at extremely high levels with showing great amounts of growth, when in reality it was a ticking timebomb (Baker and Hayes, 2005). This helped them manage a really high credit rating and hence, Enron was an attractive share for investors. Many of the analysis would call the Enron share a 'buy' without knowing in detail where exactly was all the money coming from. But in 2001, within a matter of weeks Enron went bankrupt. (Ackman, 2002) This was highly ironic as not long before this major disaster, Enron's assets were valued at about $60 billion dollars. Many reforms were made after the enron scandal and it also embarked the creation of the Sarbanes-Oxley Act for accounting regulations. (Dewing, 2003) Economist say one of the major reason of this disaster was the lack of disclousre and poor auditing laws in the country. Enron was simply corrupt and wanted to earn more manipulating accounts.

Corporate Governance in the financial world (Post-Enron)

After the Enron scandal, many empirical studies were published to emphasize the important of governance within a company as well as governmental implementation of corporate governance rules and regulations. Corporate governance is a topic of subject that still remains debatable but it can be described as "the rules, regulations and practices by which we hold managers and owners accountable and responsible for whatever performance society expects" (Haspeslagh, 2010). Many different studies were published on corporate governance and some also dealt with the Enron failure. Some of them were Greenbury Report (1995), Hampel Report (1998), Turnbell Report (1999 & 2005), Higgs (2003) and Smith Report (2003).

One of the biggest post-Enron reforms was the introduction of the Sarbanes-Oxley Act which includes many issues like auditing standards, disclousre and corporate governance. It was after the Enron incident that government realised that accountability is highly necessary within a company. In the Enron case, CEO Jeff Skillings denied having knowledge of any of the wrong or illegal practices of Enron. (Anonymous, 2002) Rules were then created which held chief executives accountable for the operations of a firm. This Act also concentrated on the opportunitst behaviour of managers. A major agency problem which is born in the principle agent model, is the fact that managers act only in their own interest. This was clear seen in Enron's case where managers falsified the entire company value to earn huge bonuses. This was not done in the best interet of the shareholders (Bozec and Dia, 2012).The opportunitst behaviour and informational asymmetry are the major agency problem that effective governance can solve.

After the introduction of the SOX act, companies found it much more comfortable to carry out their operations in the UK rather than the US. Rules were made much stronger and the penalties on breaking them also were harsh. The mastermind behind the idea of getting rid of debt in Enron by creating partnership with companies that did not exist was their CFO Andrew Fastow. He was charged with 10 years of imprisonment for the financial crime he had conducted. (Di Meglio, 2012 ) Hence, corporate responsibility was enhanced with the fact that accountable individuals could be put behind bars.

After Enron, many other scandals followed (i.e. WorldCom etc) but experts have not been able to clearly define the strength of corporate governance after Enron. One main reason can be the financial crisis of 2008 which has different characteristics than that of the Enron scandal, but on a whole was a huge corporate governance failure. Therefore, the statement that companies improved on governance to avoid another Enron scandal will always be faced by scepticism.

Ethical Considerations (Post-Enron)

According to Charles Holme, (2008), business ethics is simply moral principles which help in arriving at decisions of values for an organization. "What happened at Enron was not a failure of regulations and law. It was a failure of corporate culture, a failure of values, a failure of heart" (Pomeranz, 2004). One of the main reasons of the Enron collapse was because of the lack of ethical business standards.

In a journal article by Pflugrath, Martinov-Bennie & Chen (2007), it was stated that the presence of a code of ethics has a positive impact on the quality of the judgments made by professional accountants and auditors. For many years, Enron overstated their incomes in order to receive bonuses for a few executives at the cost of their employees and shareholders. On books they showed inflated profits and decrease in debts. It was mis-stated that they had earnings of $1billion for the past few years. It is of ethical issue that true company statements should be put forward to all shareholders and employees. The auditors overlooked the fact that Enron practices were in fact unethical. Securities and Exchange committee discovered about the false financial statements provided by Enron and requested the auditor's to show the relevant documentation and audit files. At this point, Mr Duncan the audit partner in charge destroyed thousands of pages of records and documentation in relation to the fraud. (Doost, 2003) This proved to be an unethical practice by the Auditor.

An ethical issue that could have been taken into consideration by Enron is to never ignore concerns. Several employees at Enron including some high ranked executives tried to warn the CEO Kenneth Lay of the accounting issues. One of their claims was taken into consideration, but no action was taken. Another employee was removed from his job and the last one was promised an investigation which never happened. Hence, to avoid another Enron event of failure, business ethics in global markets need improvement. Many educational professional courses have also included business ethics as an important learning element for future managers.

Changes in Auditing Standards

Arthur Andersen was a part of the "Big Five" - the top five accounting firms in the world. Now it's called the "Big Four" and it includes Deloitte Touche Tohmatsu, PricewaterhouseCoopers, Ernst & Young and KPMG (Susan E. Squires 2003). Arthur Andersen was responsible for the auditing of Enron Corporation. When Enron scandal took place in October 2001, Arthur Andersen was found guilty of the fraud. (Gary M. Cunningham 2006)

According to Faudziah Hanim Fadzil, Hasnah Haron, Muhamad Jantan, (2005), internal auditing has undergone changes which allow it to make greater contributions to the organization. It's performed in diverse legal and cultural environments. The management is most responsible for internal auditing. Internal auditors have to comply with the 'Standards for Professional Practice of Internal Auditors' (Faudziah Hanim Fadzil 2005)

When trading at Enron grew, assets shifted from fixed assets to commodities. For this, Enron did not have a unified strategy. The auditors were not prepared for this transformation and weren't able to recognize the further risks.

Enron blamed Arthur Andersen for applying irresponsible auditing practices in its audits because of conflicts of interests. Arthur Andersen earned $25 billion in audit fees and $27 million in consulting fees. They were questioned if they were looking to receive solely fees or they lacked in expertise in reviewing Enron's revenues.

Enron's audit committee did not have the technical knowledge to question the auditors on the accounting treatment. The auditing committee was accused of allowing conflicts of interest as they did not fulfil their duties of monitoring the company's accounting practices.

Changes in auditing standards have taken place, and something that happened to this company should never happen again to any other companies

Conclusion

A company that was believed to be 'too big to fall' and was also considered highly innovative and strong. Enron went for 'one of the biggest companies' to 'one of biggest failures'. It is undeniable that there were no excuses from the board that can be accepted (Anonymous, 2002). Enron got involved in so many risky investments and choose to keep its key information to them on the excuse of 'competition protect'. (McLean, 2001) In addition, the introduction of hypothetical future value (HFV) by Jeff Skillings, which is merely a projected value and no guarantee of the future, Enron valued itself so high on the market that it almost became inevitable to fall apart.

Enron ignored many aspects of modern business matters like corporate governance, ethics and auditing standards. This essay focuses on these key elements and helps understand that with the changes made after the Enron fiasco, is it possible that another disaster like this be possible or not. Along with the measures taken after the Enron case and the global financial crisis as well, firms and government have become more aware of the need of regulations and laws to keep companies within safe limits to protect themselves and the sector they are a part of and to ensure that similar mistakes are not to be repeated.

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