About Enron Scandal

The Enron scandal which was revealed in 2001, October finally resulted in the bankruptcy of Enron Corporation. It was an American-based company operating in the energy sector; it was based in Houston, Texas. The collapse of the company also led to the dissolution of Arthur Andersen, which was one of the largest accountancy and audit partnerships globally (Li, 2010). Besides being the largest scandal in American history during that time, it also became the biggest audit failure in history. The company was among the famous companies which managed to grow to fast in the 20th century. Still, surprisely it also became the company which collapsed within a short time after rising to prosperity.

The corporation was founded in 1985. Its yearly revenues increased from $9 billion in 1995 to a booming $100 billion in 2000. However, in 2001, it was reported that the company's financial position was being substantially sustained by systematic, creative, and institutionalized planned accounting fraud. On 2 December 2001, the company was declared bankrupt since it had been cooking its books of accounts in cooperation with its auditors.

The lack of truthfulness by the management of the corporation about the health status of the company was what led to the misrepresentation of the financial books of accounts (Barreveld, 2002). The top management felt that Enron had to be the best among the different companies. Therefore, they had to protect their own reputations and their good compensation package as most top executives in the United States (Thomas, 2002). So, they had to misrepresent the financial statements to deceive the users of these statements that the company was actually performing exceptionally well. By misrepresenting the earning reports while also continuing to enjoy revenue provided by investors not sure of the true financial position of the company, the top official of the corporation embezzled the funds from the investors while reporting to them fraudulent earnings (Cunningham & Harris, 2006). The fraudulent reporting not only increased investment from the current investors but also attracted more new investors who wanted to enjoy the lucrative gains enjoyed by Enron’s investors.

Andersen and Enron presented a number of the financial issues, some of the financial issues which were identified include, mark-to-market accounting, reporting of the shares issued ad finally financial reporting for the Special Purpose Entities (SPE). The corporation traded on the futures contracts, which are classified as derivatives since they are able to derive their own value from the underlying assets. The derivatives of the company were reported using the “mark-to-market accounting”. This method indicated the value of the derivatives using the fair market value instead of using the historical costs. This method of valuation assumes the availability of a well-developed market. At Enron, the revenues reported under the “mark-to-market accounting” were easily manipulated since the active market was not there for the contract.

The SPEs are mainly made for purposes which include leasing and owning real estate. The corporation had over three thousand SPEs, which is much more than any other company in the United States. At first, some of Enron’s SPEs were legitimate, mainly for risk management. However, most SPEs in the years before bankruptcy were mainly used to manipulate financial information (Cunningham & Harris, 2006). The SPEs of Enron had a lot of complex structures with interlocking ownership, and Enron, at times, held an equity interest. Some senior employees of the company besides, CFO held some equity interest, hence they were controlling both sides of the transactions in addition to enriching themselves. The majority of the financial issues at the corporation were related to the concept of the entity. Selective use of the equity method for entities was also used. Consequently, the corporation manipulated the financial reports in a number of ways, which include not reporting the debt on the balance sheet and selling services to the SPEs at inflated prices with the intention of inflating income and sales revenue (Cunningham & Harris, 2006).

The corporation issued shares of its stock to a number of executives, SPEs, and many others. The majority of the shares were being exchanged for the note receivable. However, the USGAAP never allows the recording of receivables in exchange for the issuance of the shares of the stock. And from the improper, the corporation managed to overstate equities and assets by $1.2 billion. This overstatement was a material amount, but the auditor just overlooked the amount. After revising the last five years' financial statements before 2001, it was found that the corporation had lost $586 million.

Enron was considered a huge failure, partly because of its complexity and size and also because of the massive collusion and greed of the key participants (Cunningham & Harris, 2006). The persons who failed to include management, the banker/creditor, regulators, and the auditor. Therefore, the intersection made by these failures sent some signal of structural problems. As a result of the structural failure, deceptive financial accounting was inevitable to hide the failure.

References

Barreveld, D. J. (2002). The Enron Collapse: Creative Accounting, Wrong Economics Or Criminal Acts? : a Look Into the Root Causes of the Largest Bankruptcy in U.S. History. London: iUniverse.

Cunningham, G. M., & Harris, J. E. (2006). Enron and Arthur Andersen. Global Perspective of the Global Education, 27-48.

Li, Y. (2010). The Case Analysis of the Scandal of Enron. International Journal of Business Management, 36-40.

Thomas, C. W. (2002). The Rise and Fall of Enron. Journal Accountancy.