The Factors that Influenced Enron - Case Study Example

Name: Professor: Course: Date submitted: Abstract This report on Enron gives an insight on the reasons that can be attributed to its fall from one of the best performing corporates in the United States of America to a bankrupt corporate. A keen look on Enron’s sale of its assets and stocks to special purpose entities (SPEs), its marking up of all its investments to fair values and accounting for its non-consolidated entities reveals the reason why its stockholders’ equity, revenues and net income were significantly inflated in a short period of time. In looking into the company’s body of auditors and accountants, it is possible to unearth precisely what effect the financial statements produced by the body have on the company as a whole. This goes hand in hand with determining what hand the company’s top management officials have. These include its audit committee, the board of directors, its outside auditors and attorneys. With the above areas keenly looked into, it is possible to draw viable conclusions on the company’s decline by making a comparison of how the company was managed and what was expected of them using the GAAP and GAAS requirements. Finally, it’s important to deduce the implications that the unethical practices at Enron had on the company as well as the society in order to provide counsel to similar organisations to help them avoid such a pitfall. Introduction Enron had been on extremely impressive trend from the year 1990 to the year 2000 where it experienced a 311% rise in its stocks for the first eight years[cbc06]. The two next years saw the stocks rise by 56% and 87% in 1999 and 2000 subsequently[Kri03]. By the end of the year 2000, Enron’s stocks were priced at $83.13 and had they had a market capitalization exceeding $60 billion[Kri03]. Going by this trend, people had quite high expectations of the company in the future. By this time, the company proudly bore the title of the most innovative company in the USA as rated by the Fortune Magazine[Rog10]. The unforetold fall of the company came as a large surprise not only to its owners and employees but also to the rest of the world, most of whom already had massive stocks investments in Enron. In a matter of five months, beginning August, 2001 to December 2001, Enron plummeted from its towers of successes to a total failure in a sequence of sagas that razed its reputation to the ground. In the month of November, 2001, Enron experienced an 18% drop on its stockholders’ equity, a figure that accounts for $1.7 billion[Kri03]. By December the company was left with no other option but to file for bankruptcy in what was described as America’s largest bankruptcy. An investigation committee was promptly formed. The chair Dean William C. Powers led the team investigating Enron’s Board of Directors and had a report submitted on 1st February, 2002. This formed the basis of what was used to critique the Enron saga. Enron’s directors and its body of financial professionals played a major role its downfall as established in this report. Incentive problems and governance are also to blame. A functional capital market is supposed to create information linkages, incentives and governance between investors and managers. This is supposed to happen through a predefined network of selected intermediaries who together with the company they serve are subject to arising incentive and governance problems. Professional investors, information analysers, internal governance agents and assurance professionals form the network of intermediaries. They are usually regulated by several institution: bank and private sector regulators (Financial Accounting Standards Board and the American Institute of Certified Public Accountants), the Securities and Exchange Commission (SEC). Enron’s downfall was based on activities that arose from activities that were conducted in its network of intermediaries[Kri03]. These include the shredding of documents that viewed as of no use as directed by an Arthur Anderson lawyer, Enron providing suspicious information about its quarterly earnings and the restatement of its earning from the year 1997 to the year 2000[cbc06]. Notably, despite Enron having an elaborate network of intermediaries, it was able to acquire hefty capital inflows that were used in the funding of an unclear business model, hype the company’s stocks and to conceal its real performance by having their accounting and finance body use suspicious methods[Dic07]. Responses to the Case Questions 1. Describe the factors that influenced Enron and led to its fall in 2000 Since its foundation in the year 1985, the founders and managers of Enron were able to propel very fast growth in the company for the first fifteen years. It was founded as a natural gas pipeline company but was operating as a top energy trader and in the construction of international energy-assets. The company was by the year 2000 valued at $60 Billion and was rated as the most innovative company by the Fortune magazine[CNN16]. Within a single year, however, the company’s prowess and sterling performance faded from existence. The company’s top executives could not bear with the shame and so they fled leaving the company’s body of accounting officials taking the blame for the violations of international accounting rules. Its stock values dwindled down from $83.13 down to less than $ 1. Enron filed for bankruptcy and topped the list of Americas worst corporate bankruptcy cases. The fall of Enron occurred during the tenure of Jeffrey Skilling as CEO. He had managed to skyrocket the company’s reputation through the nine years of his tenure since 1990. What particularly led to the downfall of Enron? The once perceived as infallible company began digging its own grave by having Arthur Andersen as its auditor[cbc06]. US congress members and the press have pressed charges against this firm for its fraudulent activities in what has been termed as violation that needs to be regulated. Andersen was responsible for the presentation or wrong numbers to the public and for the incorrect financial statements. The accounting issues realised at Enron formed the basis of an even bigger downfall with all transactions that involved SPEs at Enron getting more complex. The accounting and auditing issues listed below provides the insight needed to clarify why its fall was inevitable: 1) The SPEs transacting at Enron were not consolidated, an accounting policy that led to Enron being in a position to conceal its state of affairs from its investors[Kri03]. 2) Enron’s accounting treatment of its merchant investment sales to unconsolidated SPEs with so much simplicity[Kri03]. 3) The inclusion of income from future services to be rendered in the current income recordings and having forward contract sales recorded as revenue created a scenario with disguised loans [Kri03]. 4) The practice of fair-value accounting which translated to merchant investments being restated, where untrustworthy numbers were included[Kri03]. 5) The company still accounted for those stocks it had already issued to SPEs, even with the SPEs still holding these stocks[Kri03]. 6) Enron also failed to fully disclose its related party transactions and ensuing conflicts of interest to its stockholders[Kri03]. 2. Why were Enron’s internal checks and balances system fail to prevent its demise? Enron, in trying to prevent its demise introduced a system of performance review, thus inevitably leading to the company having its employees get involved in unethical dealings. There was so much information that the company concealed to the extent that the company became tempted to have very important financial reports hidden[Kri03]. The complexity of the company’s trading resulting from its change from previous trading activities resulted in a situation in which the company would easily manipulate accounting standards set initially. It was thus impossible to save Enron with the initial system[Kri03]. External audits were corrupt deals and the company’s auditor, Arthur Andersen, failed to provide precise reports on the company. This was also related to the insufficient information that the board of Enron as entitled to. This led to them not taking appropriate measures on time to save it from collapsing[Kri03]. 3. How did the top leadership/Board of Directors at Enron undermine the foundational values of the Enron Code of Ethics? A former treasurer at Enron, Ben Glisan, was at the time of the company’s bankruptcy filing charged with several acts of fraud, insider trading, conspiracy and money laundering. His pleading guilty to a count of conspiring to fraud Enron saw him receive a term in prison[Joh01]. The company’s top executives: Ken Lay, Jeff Skilling and Andrew Fastow led to collapse of the company. Fastow faced 98 counts of fraud, conspiracy and money laundering, with relation to the partnerships he was involved in. He pled guilty to a conspiracy charge that saw him receive a ten year imprisonment term a $29.8 million forfeiture. Jeff Skilling faced 35 counts related to creation of false financial statements, conspiracy, fraud (wire fraud and securities fraud)[Joh01] . Bethany McLean, a Fortune magazine investigative reporter, wanted to have an article on how the company made its income. Bethany’s request was treated with sheer disregard as seen from the hanging up of Jeff Skilling to her call, stating that she was unethical in her line of questioning. Andrew Fastow and the company’s two other executives proceeded to meet Bethany in New York, but they still presented a false account of the company[The04]. Fastow was responsible for the formation and operation of related-party transactions from which the company exempted Andrew from practising Enron’s ethic code. Fastow was also involved in the concealing of the trading levels of Enron. Had he revealed this to the stock market, Enron would have received a higher valuation hence wouldn’t have collapsed [Kri03]. 4. How did Enron’s corporate culture promote unethical decisions and actions? Enron according to the released reports regarding its fall has been regarded as one that promoted arrogance. Employees were led into thinking that though could easily handle impending risk without being in danger. Sharron Watkins says that the company’s run on the basis of making numbers on whatever basis, provided that one was not discovered, and such employees would still stand a chance to be reemployed upon requesting for another chance[Dic07]. The company’s structure was a decentralized one and not everyone had the view of the company’s state of affairs at large. This presented a situation in which the amount of control that would be channeled from the chairman and board of directors would be insufficient and created a scenario in which its accounting body would not have their operations brought to light before all company members. This is how they ended up creating figures that were misleading[Dic07]. Jeff Skilling’s “rank and yank” performance review process posed a threat to employees who were underperforming. These employees turned to their peers and ensured that they ranked lower leading to them being fired[Kri03]. The company had a questionable compensation plan that is perceived as one that was intended to enrich its executives instead of creating profits for stockholders. This caused people to inflate contact values even with no cash being generated. The company also had a bonus program that in a way encouraged the use of accounting practices that would be regarded as non-standard[The04]. 5. If you were an accountant at Enron, how would you have responded to what was going on, and why? The accountants at Enron were all in a position to establish the state of their company at its best and at the times in which it was beginning to crumble. Professional accountants have a role to play in such situations. Some of the roles of accountants are as below: i) Provision of an oversight of a company’s financial health[Len13]. ii) Provision of independent assurance to a company’s management that its governance, internal control processes and risk management are being done properly[Len13]. iii) They help companies help to maintain the business code of ethics[Len13]. As an accountant at Enron, taking a move that would see me follow these above outlined roles would be in order. Enron’s financial health experienced a drastic transition from a high to a low within such a short period of time. An accountant following up closely should have in each instance been able to determine these changes. I would also be concerned with addressing the company’s internal control processes. These are responsible for the wellbeing of a company to a very large extent. Enron needed employees who would pin out the failing areas in its basic internal processes and subsequent action to survive its downfall. In my capacity as an accountant, upon the realization that Enron’s activities were not leading it to the right direction would come up with means to have the top management officials notified. Finally, ensuring that the code of ethics is followed is another role I would task myself to. It is quite clear that many GAAP and GAAS requirements were violated by key players in the running of Enron, something that eventually cost them a great deal. As an accountant in such a firm, I would come up strongly to ensure that Enron acted ethically. This would be in the best interest of the public, a good number of which had their stock investments at Enron. 6. Using the lessons learned from the Enron case; describe the implications of unethical business practices on society. As seen, the society did not also miss out on the list of those affected by the Enron debacle. The company saw its stock prices drop from $83.13 to less than $1 at the time of its collapse[The04]. This decline can be attributed to unethical practices that the company’s top officials and employees (both external and internal) involved themselves in that led to the company being unable to sustain the high stock prices. The presentation of false information on the company’s state of affairs was another area that Enron did indeed violate the code of ethics. This was through the presentation of false figures in the financial statements and the consent to such incorrect figures by the company’s auditors[Idd02]. The company’s outside attorneys also took part in the violation of the code of ethics by providing misleading information to stockholders. The stockholders who took interest in the Raptor deal were on the losing end after having followed the counsel of V&E[Rog10]. From the above, it is easy to deduce that a business not operating ethically has the following impacts on business: i) They experiences losses in their investments due to the decline in the value of their stock investments ii) The society are also on the losing end since they are entitled to false numbers which may see them make investment decisions that will cost them later iii) The provision of misleading information leads to the members of the society losing out in situations in which they cannot blame the companies they have invested in. Conclusion The structure and administration of the US GAAP by SEC, FASB and AICPA can be held responsible for Enron’s accounting debacle. The company’s outside attorneys and auditor were driven to a comfort zone by having to follow accounting requirements stated for the consolidation of SPEs. During this time, it is clear that the SEC would have stepped in to change the above rules but they were a bit laid back at the time hence Enron was able to have liabilities related to its SPEs off its balance sheets. Observers suggest the use of UK GAAP would have at the time been applied to save Enron from its downfall. With the UK GAAP, auditors are expected to provide a true and very fair view of an organisation’s financial situation[Kri03]. A blind eye cannot be turned to the company responsible for the auditing of Enron, Arthur Andersen. Andersen’s employees are seen to have neglected their duty and have carried out their proceedings with a lot of simplicity. It is the duty of the auditors to scrutinize a company’s valuations and determination of related-party transactions. It is likely that a company will face an inevitable crisis if the auditors are not able to detect and report errors related to such valuations and determinations[Kri03]. This was the case with the Andersen who did not confront Enron for this very specific issue. Andersen may have become reluctant in raising any alarm in the errors in Enron’s financial statements in order to maintain its relations with Enron thus not having to cut off its source of salaries and hefty bonuses[Joh01]. It is a possibility that the staff at Andersen may have failed to decipher properly the structure of the financial instruments and entities given by Andrew Fastow, Enron’s CFO. The task assigned to these auditors may have been manageable when Enron was at initial growth stages as a producer and distributor of gas and oil, but with the shift of Enron’s scope of work to dealing in new ventures and financial instruments, it was necessary to have a better skilled team replace the old one. References cbc06: , (news), Kri03: , (Palepu), Rog10: , (Donway), Dic07: , (Carozza), CNN16: , (CNN), Kri03: , (Palepu), Joh01: , (Smith), The04: , (Post), Len13: , (Len Jui), Idd02: , (Iddo), Read More