Enron Accounting Scandal - Case Study Example

Enron Accounting Scandal The rise and collapse of high profile business failuressuch as Enron, Tyco, Parmlat and Worldcom because of financial and accounting issues has been a subject of great discussion. Many sectors such as regulators, government, financiers, and academics have raised numerous issues, particularly regarding the rise and fall of Enron recently. In fact, the case of Enron was the greatest failure in the history of capitalism in the United States and had a major impact on financial markets since it caused great losses to shareholders. It is noteworthy that Enron was a company ranked by Fortune as one of the most ground-breaking company in America. This is because Enron exemplified the transition from the manufacturing to the information economy. Many lessons can be learnt from Enron’s rise and collapse. This paper seeks to provide an analysis of the dynamics that led to Enron’s rise and fiasco. It focuses of the fundamental part that energy deregulation and manipulation of economic statements played on the collapse of Enron. The paper finally summarizes the lessons learned with the aim of preventing another similar occurrence and restore confidence in the financial n markets, auditing, and accounting professions. Enron Accounting Scandal Introduction Enron was one of the biggest firms in the United States to reach dramatic heights, which later came to collapse. However, it faced numerous accounting and financial challenges that contributed to its eventual demise. The dynamics leading to the downfall of Enron may look simple because they are deeply rooted on individual and collective greed in an atmosphere of market euphoria accompanied by business egotism. Nobody would ever want to believe that the company was too good to be true. Many who never believed Enron were investors, analysts, its employees, the company itself, and many other people who witnessed when Enron was successful. Many investors continued to purchase stocks and the corporate mantra since the company focused on buying many high risk deals. The story ended with bankruptcy of Enron, which was the largest America’s corporation. Its collapse affected many countries and thousands of employees, many pension funds and it shook Wall Street to a greater level. To this day, many people still ponder concerning the manner in which a big corporation such as Enron would disappear almost overnight. This paper seeks to provide an analysis of the dynamics that led to Enron’s rise and fiasco. It focuses of the fundamental part that energy deregulation and manipulation of economic statements played on the collapse of Enron. The paper finally summarizes the lessons learned with the aim of preventing another similar occurrence and restore confidence in the financial n markets, auditing, and accounting professions. The Beginning Signals the End In 1985, following deregulation by the federal government on natural gas pipelines, Enron was born from a merger InterNorth, the Nebraska pipeline company and the Houston Natural Gas. During this merger, Enron accumulated huge debt and the result of deregulation lacked exclusive rights to its pipelines. For this company survive, it had to develop emergent business stratagems with the aim of generating profits and cash flow. The CEO of Enron at the time was Kenneth Lay, who hired McKinsey & Co. to help come up with Enron’s business strategy (Shwartz, 2001). The CEO, Lay was so impressed with the young consultant’s efforts of creating a new division in 1990 known as Enron Finance Corp. and hired Skilling to turn around things. Under the leadership of Skilling, Enron Finance Corp. soon dominated the market for natural gas contracts, with enormous access to suppliers and a number of consumers; thus, beating its competitors. With this kind of market power, Enron could forecast future prices with a lot of accuracy, which later guaranteed huge profits (Healy & Krishna, 2003). On the onset, Skilling aimed at changing Enron’s corporate culture to reflect the company’s transformed face as a trading corporation. He began with recruiting new workers with expertise required to achieve the organization’s objective. He hired some of the best brightest traders from top notch MBA schools in order to compete with its competitors. Healy & Krishna (2003), Enron had numerous people with the required experience and Skilling decided to reward production with merit-based bonuses without cap, permitting traders to enjoy “their kill.” One of those he hired was Andrew Fastow in 1990 with experience on leverage buyouts and other complex deals at the Continental Illinois Bank. He gained trust of Skilling just like Lay did. During this period, he helped Skilling oversee the building of the company’s vast trading operation and financing by very complicated means (Shwartz, 2001). This is the period when Enron’s reputation grew worldwide and the company’s internal culture started to get a darker tone. Skilling came up with a performance review committee, which became known as one of the harshest employee-ranking system in America. It was referred to as the “360-degree review,” which was based on Enron’s values in terms of respect, communication, integrity, and Excellence. However, the entire process was to determine those who were performing on the duties. Later, a fierce internal competition began and immediate gratification became the order of the day; thus, lowering the long-term potential. Paranoia flourished and most of Enron’s trading contracts started to contain highly obstructive secrecy clauses (Shwartz, 2001). Secrecy became the order of the day for a number of trading contracts at Enron and it went on further to its disclosures. Enron’s Success Fortunately, the United States’ economy experienced the longest bull market in the American history and Enron had to experience some problems with its young leaders. Enron’s corporate leadership, excluding Lay comprised of many young people without the experience of an extended bear market. Emergent investment opportunities opened up such as in markets in energy futures. Wall Street demanded for double-digits at all levels and by 1996, Skilling became the chief operating officer at Enron. He convinced Lay to make certain significant decisions such as the gas bank model, which he suggested that it could be applied to the market for electric energy too. They travelled around the country selling the concept to various power companies and energy regulators. In 1997, it made a number of acquisitions such as Enron obtaining electric service company called Portland General Electric Corp. for about $2 billion (William, 2002). Utilizing the same idea that had been so fruitful with the gas bank, they were prepared to make a business for anything that anybody was eager to exchange such as; coal, paper, steel, water among other things (Healy & Krishna, 2003). Collapse of Enron By the fall of 2000, Enron was beginning to disintegrate under its own weight. President Skilling had a method for concealing the monetary misfortunes of the exchanging business and different operations of the organization; it was called market-to-market accounting. This is utilized as a part of the exchanging of securities, when one figures out what the real estimation of the security is at that particular moment. This can function admirably for securities; however, it can be heartbreaking for different organizations (William, 2002). For Enron’s situation, the organization would fabricate a benefit, for example, a force plant, and promptly assert the anticipated benefit on its books, despite the fact that it hadnt made one dime from it. On the off chance that the income from the force plant was short of what the anticipated sum, as opposed to taking the misfortune, the organization would then exchange these advantages for an off-the-books company, where the misfortune would go unreported. This sort of bookkeeping made the mentality that the organization did not need benefits, and that, by utilizing the imprint to-market technique, Enron could essentially discount any misfortune without harming the organization’s main concern (William, 2002). The Scheme at Enron Enron is the best case of imprint market-to-market valuation. The thought behind market-to-market valuation is straightforward enough - that the estimation of an advantage that is exchanged the business sector can change relying upon economic situations. The estimation of the advantage on any Balance Sheet ought to therefore change alongside economic situations. The rationale behind market-to-market representing fittingly exchanged resources is exceptionally sound, and is really obliged bookkeeping practice by and large. Imprint to-market bookkeeping would not be fitting for any advantage whose worth is situated by a power other than the business sector, for example, an open utility commission. At an opportune time currently power deregulation, after California’s energy emergency, imprint to-market bookkeeping got something of an awful name due to how it was utilized by an organization called Enron. One of Enron’s cases to acclaim was evaluating how to control California’s recently deregulated power market, yet what brought the organization to insolvency at last was not the disgraceful exchange practices; however, Enron’s dishonorable bookkeeping practices. The market-to-market practice prompted plans that were intended to conceal the misfortunes and make the organization seem, by all accounts, to be more productive. Keeping in mind the end goal to adapt to the mounting misfortunes, Andrew Fastow, a climbing star became CFO in 1998 and came up with an insidious plan to make the organization give off an impression of being fit as a fiddle, regardless of the fact that a large portion of its subsidiaries were losing cash. That plan was attained through the utilization of Special Purpose Entities (SPE). A SPE could be utilized to conceal any benefits that were losing cash or business ventures that had gone under; this would keep the fizzled resources off of the organization’s books. In exchange, the organization would issue to the financial specialists of the SPE, shares of Enron’s normal stock, to repay them for the misfortunes. This diversion could not go on perpetually, in any case, and by April 2001, numerous analysts began to question the straightforwardness of Enron’s profit (William, 2002). There are diverse roles played by the market-to-market bookkeeping secluded from everything a considerable measure of Enron’s corporate misfortunes. Enron utilized long haul contracting and subordinates exchanging, (for example, prospects and alternatives) broadly to profit, so needed to check those agreement to market in its occasional monetary proclamations (i.e., each quarter or somewhere in the vicinity, it needed to announce its market value of those agreement and different sorts of arrangements). Enron’s ill-use of market-to-market bookkeeping essentially comprised of two related practices. In the first place, Enron would create misty numbers for what a vitality contract was really worth (recollect from the above analysis that regular gas fates costs are just accessible through NYMEX for a few years into the future; so Enron would create a quality for, say, a 20 year natural gas get that was passed off as being true blue however seemed to be, truth be told, simply immaculate hypothesis). Second, Enron would record the aggregate expected lifetime estimation of any given contract or extend on its Balance Sheet instead of its value in that specific quarter. These practices had the impact of making Enron seem a great deal more important than it really was. At last, the Enron undertaking really had a positive reaction of enhancing market-to-market bookkeeping through the improvement of standards for expanding the straightforwardness of to what extent term contracts and other tough resources were valued or estimated to be. Finally, Ms. Watkins, who worked in Enron’s money division, started raising her worries about potential bookkeeping improprieties at Enron around the third week of August. Andersen, where Ms. Watkins had in the past lived up to expectations, got to be mindful of her worries on Aug. 20, when she put a call to a previous associate at the bookkeeping firm to talk about the matter. Her worries included an arrangement of arrangements in the middle of Enron and a gathering of organizations initially framed to permit Enron to move resources and liabilities off its books. In any case, a panel of the Enron board has finished up; the organizations were in the long run used to dishonorably control the organization’s profit. The concerns of Ms. Watkins were brought to the consideration of different bookkeepers at the Houston office of Andersen. At practically the same time, a real bookkeeping slip was found. That mistake had brought about a $1 billion exaggeration of Enrons total assets and the first signs rose of different genuine budgetary issues at the organization. Such an exertion is fitting for any organization or association went up against by affirmations of potential wrongdoing and looking to focus reality, legitimate specialists said. Lasting Effects/Lessons from Enron’s Collapse Enron demonstrates to other companies, learners and analysts what an organization and its administration are likely to do, when they are fixated on making benefits at any expense. One of Enron’s enduring impacts was the making of the Sarbanes-Oxley Act of 2002 that tightened disclosures and increased the punishments for monetary control (Brody, Jordan & Kurt, 2003). Second, the Financial Accounting Standards Board (FASB) significantly raised its levels of moral behavior (Healy & Krishna, 2003). These are some of the challenges that affected Enron’s success; thus, making it collapse. Third, board of directors got to be more independent, observing the review organizations and hurriedly supplanting terrible supervisors. While these impacts are receptive, they are critical to spot and close the provisos that organizations have utilized, as an approach to stop dodging responsibility. Conclusion The rise and fall of Enron was a sad occurrence, and it is essential to know how and why such an occurrence had to happen. Understanding such significant financial and accounting problems is essential to help evade such circumstances in future. Reflecting back, the organization had acquired gigantic money related misfortunes because of egotism, covetousness and inanity from the top administration down to the subordinates. A large part of the organization’s misfortunes begun the crumple that could have been avoided, in the event that somebody had the nerve and the premonition to put a stop to it. Enron remains a fantastic case of voracity happened, and of the move that was made to help stop such accounting and financial issues. References Brody, R.G., Jordan LD., & Kurt, P. (2003). Could $51 Million be Immaterial when Enron Reports Income of $105 Million? Accounting Horizons. Vol. 17 - no. 2. Burns, J. (2001). SEC’s Herdman Urges Accounting Firms to Improve Auditing, Citing Enron’s Fall. The Wall Street Journal.  Dec. 7. Healy, P.M., & Krishna, G. P. (2003). “The Fall of Enron.” Journal of Economic Perspectives 17 (2): 4. Shwartz, N.D. (2001). Enron Fallout: Wide But Not Deep.  Fortune December 24, 2001: 71. William, T.C., (2002). Rise and fall of Enron: When a company looks too good to be true, it usually is. Journal of Accounting. Retrieved November 12, 2014 from http://www.journalofaccountancy.com/Issues/2002/Apr/TheRiseAndFallOfEnron.htm Read More