The Enron Scandal Accounting Essay

Enron began its life in 1985 and appeared to be a rising star in the business world. In conjunction with the accounting firm Arthur Anderson Enron became one of the biggest accounting scandals in history. There were numerous ethical dilemmas in addition to the many illegal acts during rise and fall of Enron. This paper will discuss the history of the company, the actual crisis inside of Enron, and an analysis of how the company responded to the scandal.

The Enron scandal was the biggest bankruptcy in United States history which cost 4,000 employees their jobs. Once it was obvious that something was amiss with Enron’s bookkeeping, there was action on behalf of the Securities and Exchange Commission.The Enron Scandal Accounting Essay.  By October 31, 2001 the inquiry had upgraded into a formal investigation and on December 2, 2001 Enron filed for bankruptcy. It was an event that will always be remembered as one of the most disastrous events in the financial world. In late 2001 Enron’s shares drastically dropped from over $90.00 to just pennies which was seen as a catastrophe to the many investors, employees and the watching nation.

Enron’s plunge occurred after it was revealed that much of its profits and revenue were the result of deals with special purpose entities. The result was that many of Enron’s debts and losses that the company suffered were not reported in the financial statements. Enron had created offshore entities that were being used for planning and avoiding taxes, which in turn raised the profitability of the business. The executives and insiders at Enron faced an ethical dilemma because they knew about the offshore accounts that were hiding losses for the company and the possible ramifications of this information being released. However the investors knew nothing of the fraudulent practices.

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On August 14, 2001, Jeffrey Skilling, the chief executive of Enron, a former energy consultant at McKinsey & Company joined the company in 1990, announced he was resigning his position after only six months. People noticed that in the months leading up to his exit, Skilling had sold at minimum 450,000 shares of Enron at a value of around $33 million. During this time the Enron executives were encouraging people to invest much of their life savings into the company as they were simultaneously selling there own shares.

Enron’s European operations filed for bankruptcy on November 30, 2001. On the day that Enron filed for bankruptcy, the company’s employees were told to pack up their belongings and leave the building within the following thirty minutes. Thousands of Enron investors and employees lost all their savings, children’s college funds, and pensions when Enron collapsed. The lawsuit accused twenty-nine of the executives and directors of insider trading and misleading the public. Had one of the executives or directors spoken up when they learned of these unethical acts the company may not have had to declare bankruptcy and ruin their business and reputations. The Enron Scandal Accounting Essay.

Former Enron CFO Andrew Fastow was the mastermind behind Enron’s complicated network of offshore partnerships and questionable accounting practices. Fastow was indicted on November 1, 2002 by in Houston. He was convicted on 78 counts including fraud, money laundering, and conspiracy. Fastow was sentenced to serve a ten year prison sentence and forfeit $23.8 million.

Another key player in the Enron scandal Ben Glisan Jr., a former Enron treasure, was the first man to be sent to prison for the scandal. His conviction really got the public interested in the shameful events. He pleaded guilty to one count of conspiracy to commit security and wire fraud. John Forney, a former energy trader, was also indicted in December 2002, on 11 counts of wire fraud and conspiracy.

The chief executive Jeffrey Skilling, who left his position only 6 months after being hired, was arrested on February 11, 2004, by the FBI. Skilling was convicted of 19 of 28 counts of securities fraud and wire fraud and acquitted on the remaining nine. Skilling was sentenced to 24 years, 4 months in prison for his illegal acts.

Kenneth Lay was the former Chairman of the Board and Chief Executive Officer for Enron and went to trial for the part he played in the scandal in January 2006. He was convicted of all six counts of securities and wire fraud for which he had been tried, and he faced a total sentence of up to 45 years in prison. He passed away on July 5, 2006 before his sentencing was scheduled.

This scandal quickly set off a wave of other accounting scandals. Enron’s collapse also contributed to the creation of the U.S. Sarbanes-Oxley Act, signed into law on July 30, 2002. The purpose of this act is to protect people from the types of deceptive acts that took place within Enron. The act changed the way corporate records are to be stored because of the poor decision Arthur Andersen made to shred many of Enron’s financial documents. The act also strives to protect the individual that reports unethical or illegal acts. Sarbanes-Oxley is considered the most significant change to federal securities laws since FDR’s New Deal in the 1930’s.

Rather than Enron restructuring, they faced liquidation and later changed the company’s name to “Enron Creditors Recovery Corporation” to reflect its new task of managing payouts it owes from litigation and creditors.

The company’s response to the scandal seemed to be evasive, with finger pointing and a great deal of executives tried for some type of conspiracy or fraud count.The Enron Scandal Accounting Essay.  Criminal investigations began early January 2002. Fastow invoked the Fifth Amendment, while Skilling said that Enron had no problems when he left, Waktins said Fastow and Skilling had “duped” Lay, and Lay declined to testify. Enron did come up with a plan to reorganize and try to sell off their assets for as much as possible in November 2004, when it emerged from bankruptcy.

This plan did take a while to formulate, and in the time it took to write it, Enron had not come up with a response to defend their actions. Realizing that there is no way to spin the events in their favor, Enron executives went to trial with a goal of simply getting through the scandal. It is hard to say how ethical or effective this lack of response is. They did brave the storm, so to say, and are now in the process of paying back what they owe, so it is effective in that manner. As for the ethical side, executives were brought to justice in the court of law, and the reasons for this scandal are simply explained away with greed and large ego.

Now that Enron is known as Enron Creditors Recovery Corporation, its response to the crisis is to just come up with as much as the cash as possible by any means. They are receiving money from MegaClaims, from businesses said to participate and profit from their collapse. With settlements of about $1.76 billion made, and declined claims of about $1.38 billion, they are still pursuing more from Citigroup. They have filed a suit to reclaim fraudulent commercial paper debt prepayments, and have received over $170 million and still pursue over $400 million. They are also involved with equity transaction litigation, and have received around $250 million. Enron Creditors Recovery Corporation is slowly, but effectively, paying people back. So long as payments are being made this response is ethical as well.

Enron had initially appeared to be a successful and blossoming company. But the unethical and illegal decisions that were made throughout Enron’s history caused thousands of employees to loose their jobs and many others to loose very substantial amounts of money. The Enron scandal will forever live in history and has prompted the Sarbanes-Oxley Act to prevent a catastrophe like this from ever taking place again. Hopefully the future of business will be a more ethical and law abiding one.The Enron Scandal Accounting Essay.

Resources:

About ECRC. October 2007. Enron Creditors Recovery Corp. 15 Mar 2008 .

“Employers Beware: Sarbanes-Oxley Requires Reinstatement for Real.” Morrison & Foerster. June 2005. 20 March. 2008 .

Gerth, Jeff, Marko, and Richard A. Oppel Jr. “Regulators struggle with a marketplace created by Enron.” The New York Times (Nov 10, 2001)

Litigation Overview. October 2007. Enron Creditors Recovery Corp. 15 Mar 2008 http://www.enron.com/index.php?option=com_content&task=view&id=10&Itemid=19.

Oppel, Richard A., Jr, and Alex Berenson. “Enron’s chief executive quits after only 6 months in job.” The New York Times (August 15, 2001)

“Timeline.” The Fall of Enron. September 2006. Houston Chronicle. 15 Mar 2008 .

Fowler, Tom. “Enron’s implosion was anything but sudden.” Houston Chronicle 25 Dec 2005. 17 Mar 2008 .

The Enron scandal emerged in 2001 and led to the collapse of Enron Corporation, one of the largest America’s companies at the time. The scandal involved Enron and its external auditors, Arthur Anderson, and it was associated with audit failures about the company’s operations and cash flow. The company filed for bankruptcy after a sharp decline in the value of its shares and problems financing debts. Andersen was convicted of obstructing justice for destroying files on Enron audits with the knowledge that the evidence would be required in investigations by regulators.The Enron Scandal Accounting Essay.

As of 2000, Enron was ranked number seven on the Fortune 500 list of the most successful companies and in August the same year, its share priced reached a peak of $90.75, but sharply fell to $0.67 by January of 2002 (CNN Library, 2015). The scandal started unraveling in 2001 when financial analysts started questing after the company’s way of reporting its accounts and its sources of earnings. These queries were dismissed until the Security Exchange Commission (SEC) started investigations following the resignation of the CEO, reduced earnings and a decline in the company’s share prices. In December 2001, Enron filed for bankruptcy protection, making it the largest bankruptcy in the US history at the time (CNN Library, 2015). The investigations into the scandal found the top executives guilty of fraud related charges for their role in the company’s downfall.

The company’s bankruptcy is mainly associated with the management of its operation debts using its subsidiaries, referred to as the Special Purpose Entities. Enron would create smaller companies, SPEs, to serve in facilitating its deals without recording the related costs of the deals. However, these companies were funded using Enron’s stock or the company served as their guarantor when dealing with external financiers. Therefore, when these entities incurred losses, the parent company was affected on the value of its stock, but could not record the losses in its financial reporting. By managing risks using its own subsidiaries, Enron retained all the risks associated because of its responsibilities in funding and guarantee for these entities’ operations. Many of the operations financed through SPEs collapsed, but the company did not indicate the losses in financial reporting. Practically, these entities were used to transfer and hide losses that would have appeared in Enron’s financial reporting. Also, the company had used an accounting system that inflated its market value to unsustainable levels.

Where did internal controls fail?
The company failed to manage its business model. The employees at Enron did not have the necessary skills to deal with risks related to intangibles in the diverse business model (Cunningham & Harris, 2006). The Enron Scandal Accounting Essay. Enron began in 1985 as a company in the energy industry but later diversified to operate as a service company and was applauded for its innovative approach to exploiting new markets. It started dealing with projects in natural gas and electricity and then diversified to include projects on internet broadband and intangibles. However, the management was not prepared for the change in business model and did not understand the risks. According to Cunningham & Harris, many top executives interpreted the new business model in terms on managing reported cash flow and managing numbers, instead of selling goods and services (2006).

The organizational culture at Enron promoted unethical business practices as executives and employees were preoccupied with making deals without considering the risks and the status of the company’s cash flow. The Board had approved the exemption of the Chief Financial Officer from the company’s code of ethics on issues related to conflict of interest, so as to facilitate the creation of the special purpose entities (Cunningham & Harris, 2006). This move was to allow the chief financial officer to operate and control the special purpose entities. By exempting the chief financial officer from the requirements on the code of ethics, the board encouraged an unethical conduct in managing the company’s operations. According to Cunningham & Harris, there was an organizational culture change at Enron when the company started dealing with intangible assets and the executives at the company were highly focused in generating revenues without accounting for risks and operational costs (2006). Similarly, the involvement of Arthur Andersen in consultancy services weakened its organizational culture as an audit firm. The Enron Scandal Accounting Essay.

Where did internal or external auditors fail?
The internal auditors promoted the wrong accounting approach for the company’s nature of business. Enron used the “mark-to-market” accounting practice in a scheme that was used to inflate the value of the company. The mark-to-market practice involves determining “what the actual value of the security is at the moment” (Seabury, 2016). In the case of Enron, this practice would be used to add the projected profits from certain projects to the company’s earnings even before the projects started delivering. The main aim of this approach was to increase the value of the company’s shares in the market. Also, the company’s executives used special purpose entities (SPEs) to hide losses from financial reporting. These SPEs were meant to serve as hedge entities but in reality, they were owned by Enron and thus could not guarantee its financial stability.

The auditors failed to uphold professional ethics on conflict of interests and honesty. One of the major roles of external auditors is to point at the weaknesses of internal control systems in their client companies, but Arthur Andersen ignored the weaknesses in Enron (Cunningham & Harris, 2006). The failure by the external auditor to report on problems in the internal auditing system is associated with its interests in providing consultancy services to the same company. Andersen received 70% of its fees from Enron through consultancy services (Cunningham & Harris, 2006). The role of an external auditor to a firm and as a consultancy at the same time creates a conflict of interests when reporting internal issues. The Enron scandal shows that the external auditors had the knowledge of the accounting issues in the company but failed to uphold their professional standards on reporting.

What was the remedy?
The Enron scandal had a lot of negative impacts, and this led to various changes in the regulation of public companies and operation of auditors in public firms. The Enron scandal affected many people including the company’s thousands of employees whose pension had been invested in Enron’s stock. The company had managed to misrepresent its accounting status to investors and the regulators using accounting systems that could hide the operational losses and inflate the value of the company. The Enron Scandal Accounting Essay. The scandal exposed weaknesses in the US regulation system in dealing with off-balance-sheet operations and the weaknesses in accounting standards in enforcing professional conduct (The Print Edition, 2002). The executives at Enron were able to mislead regulators and investors using various loopholes in the regulations on auditing.

The Enron scandal led to the establishment of the Sarbanes-Oxley Act of 2002, to protect investors from corporate fraud (Cunningham & Harris, 2006). The Act provides guidelines on company financial disclosures to the public. The requirements for financial disclosure are meant to ensure public companies are transparent in their financial status and value of their shares in the market. To ensure the implementation of the new accounting and reporting standards, the Sarbanes-Oxley Act established the Public Companies Accounting Oversight Board to oversee the operations of audit firms involved in public companies. Currently, the SEC and state securities agencies indicate the nature of the information that should be provided in financial reporting by public companies. Besides, the Financial Accounting Standards Board (FASB) raised its requirements on ethical conduct among accountants (Seabury, 2016). The ethical standards are meant to guide accountants to maintain professionalism in their work. The Enron scandal shows ethical failures in reporting and conflict of interests by the external auditors in the firm. The Enron Scandal Accounting Essay. Also, the new ethical standards promoted the use of the Generally Accepted Auditing Standards in public firms from 2002 (Cunningham & Harris, 2006). Until the collapse of Enron, auditing was largely self-regulated, and audit firms could engage in services that affected their role of auditing. For instance, Arthur Andersen compromised its role as an auditor by doubling up as a consultancy to the same firm.

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• CNN Library. (2015). Enron Fast Facts. CNN. Retrieved 18 March 2016 from http://edition.cnn.com/2013/07/02/us/enron-fast-facts/
• Cunningham, G. & Harris, J. (2006). Enron and Arthur Andersen: The case of the Crooked E and the Fallen A. Global Perspectives on Accounting Education, 3, 27-48.
• Seabury, C. (2016). Enron: The Fall of a Wall Street Darling. Investopedia. Retrieved 18 March 2016 from http://www.investopedia.com/articles/stocks/09/enron-collapse.asp
• The Print Edition. (2002). The lessons from Enron. The Economist. Retrieved 18 March 2016 from http://www.economist.com/node/976011

The Enron Scandal Accounting Essay