The Enormous Growth of Enron - Case Study Example

Case Study: Accountants in the Profession Name Institution Course Date Abstract A merger of two giant gas pipeline companies in 1985 gave rise to Enron. Enron success was tremendous giving it more financial power to widen its investments. The positive success meant that accounting system was to become more demanding than before. The management on the other hand could not cope along with these demands. It was further complicated with long-term contracts whose real values could not be evaluated. Enron experienced a series of unprofessionalism in management and accounting for many years. Examples of unprofessionalism included alteration of balance sheets and accounting reports. Eventually all these accounting errors came back to drag down Enron. Important lessons on the need of professionalism in accounting are learned from the Enron case. The relevant code of ethics of accounting is gained. Both the Association of Accounting Technicians (AAT) codes and the International Federation of Accountants (IFA) set out these codes of professionalism. This report analyses the chronological events of the rise and fall of the Enron Company. Relevant literatures to support the discussion are used. More stress is on accounting professional and its role in the fall of the Enron. Reasons as to why the company earned so much reputation are reviewed. Accounting unprofessionalism that led to fall of Enron are determined and discussed. The reasons as to why checks and balances could not prevent fall of Enron are analyzed. Other issues analyzed include; accounting unprofessionalism and ethical issues; role of management in the fall of Enron; deleterious Corporate culture of the Enron; lessons gained from the fall of Enron; and what effects do unethical corporate practices have to the surrounding community. Introduction A merger of two giant gas pipeline companies in 1985 gave rise to Enron. This company experienced huge success that almost made them dictate the market. Enron gained so much financial power and influence to further invest in other areas. More long-term contracts were signed by the company that runs for up to 20 years. This huge success brought about big profit. On the other hand, it also meant that accounting system was to prove more complicated than before. Enron management did not seem to be ready to handle such complicated accounting with required efficiency. Long-term contracts real values could not be established. Unprofessionalism in management and accounting took center stage with accounting ethics being breached. Balance sheets and accounting records were frequently altered to cover up for losses. Auditing was also unprofessional, Anderson who was to be a watchdog, was colluding with the company’s management. It was established that liabilities values were reduced on record while profit value increased. It was later found out that total liabilities exceeded the company’s assets making the company bankrupt. Top management did not exercise honesty on disclosure. It was established that the company was being overpriced. The audit committee could not be able to handle all the issues concerning audit. This made many accounting instances go unnoticed. Sell side analysts did not do enough to warn of the impending danger of bankruptcy. Many of these side sellers had personal interests to grant Enron a strong buy in the market share index. Accounting regulations were ignored. The financial accounting standard board had branded special purpose entities as risky but Enron ignored. Case Question Why Enron is an Admired Company After the merger that saw emergence of Enron, business operations also expanded. Enron turned out to be a huge company that boasted of almost 37,000 miles of pipeline. This pipeline was basically for transporting gas within and between states. Such a large network made Enron Arguably the largest distributor of gas in early 1990’s. The company’s profit by then was enormous due to flexibility and high quantity of gas supplied. Enron further invested in trading of natural gas, electricity production, coal, steel among others. The company went further to fund energy projects across the globe. All this ventures saw Enron conduct businesses on a diversified front by the year 2001. The businesses included owning electricity, water, pulp and paper plants. The company also owned broadband assets and was active in the stock exchange market. Growth of the company almost monopolized the energy trading market. With so much dominance and acquired skills, many new comers found it hard to penetrate into the business. The business strategies employed to steer Enron to success was so shrewd and exemplary. Positive trends emerged with the twist and turns in Enron business dealings. For instance the venture into new business fields diversified profit incomes. The company developed a level of competence that competitors could not keep up with. All this success and competencies made Enron admirable. Causes of Enron Fall The enormous growth of Enron complicated the financial system of the company. This complexity resulted from the total physical assets and extensive operations in trade that was international. Enron became a victim of accounting limitations. Only its positive side was public and the shortcomings went unnoticed. (Benston & Hartgraves, 2002). One real problem that surfaced was a result of the contracts Enron had signed. The contracts were to be active for a long time and were generally complex. Accounting professional only gives a transactional account of current transaction (Healy and Palepu, 2003). The management is then tasked with using these values to predict the future prices and trends in business. Healy and Palepu, (2003) refer to this practice as mark to market accounting. In this system, it was difficult to identify the real value of a contract. It is at times impossible to determine the value such contracts add to Enron in the long run. This is a typical problem of failing to conduct professional accounting (Frank and Graeme, 2003). Enron got involved in much special purpose entity. The company failed to consider accounting requirements in these deals. As a result Enron’s balance sheet reduced the company’s real liability and inflated the total income. It was worse in such a way that if it were to be rectified, the company will make a huge loss by the end of four years. Enron failed to disclose its shortcomings in the contracts and made investors to believe they had hedge the situation. Enron’s internal and external checks and balances system There were many loopholes already that could not stop the collapse of the company. Many of the company’s investments were recognized as monetary assets whose real value could not be established. In all contractual projects, total profit was calculated basing on prediction. This would make estimating of net profit a difficult task. Internally, Enron had an audit committee that rarely met. Whenever the committee met, only a few issues could be discussed. The external audit team was supposed to verify consistency and credibility of Enron’s financial records. Andersen who was the main external auditor initially reported that Enron was operating under high risk. This financial situation was later referred to as significant by the management. Andersen’s suspicious report about Enron were retained and never presented to the internal audit committee. According to Association of Accounting Technicians, (2014) there are some rules and principles upon which financial auditing should be done. The auditor should be a well trained professional and competent. The auditor must not be easily manipulated or gullible to incentives when on duty. It is important that an auditor understand all the complexity in firm to be audited like the Enron (Graeme and Frank, 2003). This will ensure that no suspicious financial statements go unnoticed. While auditing, the auditor must ensure he or she gathers sufficient material to compile a comprehensive report. Professionalism and standards of auditing should be maintained (Association of Accounting Technicians, 2014). Breaches of accounting and ethical conduct that occurred within Enron There are a range of ethical issues that Enron breached. According to the Association of accounting technicians (2014), a code of ethics is necessary for accounting. The codes include integrity, objectivity, professional competence, confidentiality and objectivity. Professionalism requires that accountants make use of all legal accounting skills. Dubious and underhand transactions should be avoided. This kind of professionalism is what Enron was lacking during it reign of success. Many accounting requirements were breached. An example is in the understating liabilities and inflating returns in the balance sheet. Integrity was not considered in signing of the long-term contracts. In 2002, the financial statement had wrong values. All this errors accumulate to technical incompetence. According to the international federation of accountants, Accounting professional should consider all the shareholders. Enron consistently breached this code of ethics in signing of its long term contracts. Top leadership foundational values of the Enron Code of Ethics According to Butt (2015), an organization must generally be liable to actions of its decisions. An organization itself cannot be ethical; it is the people who bear this aspect of ethics (Wayne and Mark, 2010). It is morally oblige to some set of ethics and so are the entire management and staff. The top management of Enron failed to shun poor practices especially in professional accounting. This exposes the management failure to; exercise a healthy process; control outcomes in professional accounting. A culture in an organization is embedded in mission definition (Butts, 2014). Enron’s top management failed to define this explicitly. Any business is meant to grow; however, the growth should be developed upon firm foundation and standards. A variety of issues have been identified by Boyle et al (2001) that are perceived as unethical in organizations. Enron’s management failed to shun such behaviors. They include corporate fraud, greed, engaging in questionable contracts, falsifying negotiation terms, overconfidence in personal decision that may not be right, replicating uncertain contractual terms and inefficiency. Alteration of the company’s balance sheet is typically corporate fraud (Boyle et al (2001). Deregulation was one major goal of Enron that was steered by the top management. This eventually led to the company conducting a variety of businesses that were totally unregulated. Lawyers did not play their role well in the Enron case. The professionally equipped 250 lawyers did not raise a finger in the suspicious contracts the company got involved with. The legal counsel was supposed to review the legal impacts of every step the company made. How Enron’s corporate culture promoted unethical decisions and actions Enron developed a culture that seemed to approve unethical activities within the organization. In professional accounting, it is unethical to alter a balance sheet to make it impressive. That is a technical fraud that the company management condoned. The company’s total liabilities were understated while the value of income expanded on paper. Even after this was realized, the situation was not rectified. There were conflicting parties within Enron that included several professionals. When professionals tend to disagree on almost everything n a firm, poor decisions can be made (International standard on auditing, 2009). Auditing should be independent of internal manipulation to reveal actual state of a business (Frank and Graeme, 2003). Lessons learned as an accounting professional from Enron case Accounting and auditing issues must be well addressed. All accounting irregularities should be quickly identified and worked upon. Failure of such can lead to accumulation of false documents which can turn to be a huge liability (Graeme and Frank, 2003). Accounting professionalism should be well exercised in this case. It may require services of an external body like government or a representative of the investors intervene to detect this irregularities (international standard on auditing, 2009). Some of the appointed watchdogs can at times be enjoined in a company’s fraudulent activities. An example is Mr. Andersen in the Enron’s case. It is therefore necessary for a frequent certified financial audit that is strictly regulated by the government. It is important to understand that auditing acts to boost organizational confidence. Conflicts between professional in an organization can be tragic. This will prevent flow of information and also prevent uniformity in decision making. It is more serious when conflict of interest hits the finance docket. There will be neither uniformity nor follow-up of financial. Conflicting interests in most circumstances jeopardize the mission and vision of an organization (Butts, 2014). Ethical steps should be undertaken to solve conflicts. A company should establish principles that guide in situations of conflicts resolution. This method can either be formal conflict resolution or informal conflict resolution. A means should be established to address all facts and ethical requirements. Principles and flexibility to alternatives should also be involved. According to the AAT code, fundamental principles should be the basis of any cause of action in conflict resolution. The code also recommends continuous consultations. Threats and safeguards are always part of an organization. According to Association of accounting technicians (2014), conflicts are human circumstances that contribute to threats in an organization. This situation may create many threats to a firm at the same time. Threats may fall into several groups that include egocentric threats, advocacy, familiarity and intimidation. To get rid of these threats, an organization may need to install safeguards. Corrective safeguards can be created basing on professional guide, legislative stipulation and internal regulation by an organization. Professionalism can be realized through education and training, seminars, professional monitoring, setting professional standards and measures. In a situation like Enron, external scrutiny of company’s report, financial records and communication documents is necessary. According to Association of accounting technicians (2014), part B and C of the code requires that a company adopts a well managed and effective complains system that should be public. Ethical issues and morality should be upheld within an organization. This can useful in achieving professionalism within an organization (KRUGER and DE KLERK, 2005). Enron had a significant deficiency of these qualities. The management should be the architect of morals and ethics in an organization since it forms part of their core functions. Ethics in a firm like Enron comprise of fair competition within the legal framework. Enron played a bigger role in deregulation hence ended up competing unfairly. Ethics upholds a firm’s reputation within a society. Culture Professional development is one important tool in promoting ethics within an institution. An institution that upholds ethics should set out ethical standards applicable to all members. Professional Ethical codes should find a balance within diversity of cultures in an organization. Effects of unethical business practices on society & community Unethical business practices sets out a poor example to other businesses. In most cases when a reputable firm engages in unethical or dubious means to excel, small firms tend to trail along. Unethical business practices tend to kill competition within a market. Lack of competition will ultimately create a monopoly where quality of products or services can be compromised at will. Poor organizational ethics creates room for corruption and unhealthy business practices that disregard laws and regulation. Companies can opt to engage in corruption in order to make profits The case of Enron has provided a good lesson to the society which every company will work hard to avoid. It is evident that unhealthy business practices will lead to failure. Human rational thinking is reliant on situation and this case applies to business. There is a psychological pattern among human beings to avoid being associated with unethical firms. This shunning can affect all business partners of an unethical firm. This situation can lead to losses even if partner firms uphold excellent ethical and moral standards. Conclusion The Enron Company experienced enormous growth. This was immediately after a merger that saw the business scope widened. Enron invested in trading of natural gas, electricity production and coal. Its success was so admirable but it came with a demanding and complex financial system. This accounting system was further complicated by the numerous long-term contracts. Estimating the real value of these contracts became problematic. The profit and losses could not be easily accounted for. Faults in the accounting records were only identified long after it had happened. Some of the individuals who were to inspect these accounting records colluded with the company to fool the other partners. An example is Anderson. Financial record was further altered to create a false impression that the company was excelling. Enron had initially fostered for deregulation which is one major contributor of unprofessionalism. It was later established that Enron was technically insolvent and declared bankrupt. Liabilities had by far exceeded the company’s total assets. The case of Enron creates a good lesson for accounting students. Professionalism should be exercised in all accounting activities. This should comprise of all codes and ethics of accounting. The top management should be at the forefront in encouraging ethics and professionalism. Covering up for fraud will only but make an accounting situation worse. An organization should develop a new culture that sets out a mission and vision for the firm. Another important lesson gained is the need for a frequent quality audit. This is important in preventing accounting errors from accumulating. Honesty, transparency, accountability and professionalism are essential in professional accounting. It has been established that unethical behaviors in a company not only tarnish the company’s image but also affects the society. Companies should establish a means of enhancing professionalism through training and development. List of References Assiciation of accounting technicians, 2014. AAT Code of Professional Ethics. Retrieved on October 13th , 2015 from Read More