Enron: Questionable Accounting Leads to Collapse Once upon a time, there was a gleaming office tower in Houston, Texas.
Posted: Tue Jan 18, 2022 12:57 pm
Enron: Questionable Accounting
Leads to Collapse
Once upon a time,
there was a gleaming office tower in Houston, Texas. In front of
that gleaming tower was a giant “E”, slowly revolving, flashing in
the hot Texas sun. But in 2001 the Enron Corporation, which once
ranked among the top Fortune 500 companies, collapsed
under a mountain of debt concealed through a complex scheme of
off-balance-sheet partnerships. Forced to declare bankruptcy, the
energy firm laid off 4,000 employees; thousands more lost their
retirement savings that had been invested in Enron stock. The
company’s shareholders lost tens of billions of dollars after the
stock price plummeted. The scandal surrounding Enron’s demise
engendered a global loss of confidence in corporate integrity that
continues to plague markets today, eventually it triggered tough
new scrutiny of financial reporting practices. In an attempt to
explain what went wrong, this case examines the history, culture,
and major players in the Enron scandal.
Throughout the 1990s,
Chairman Ken Lay, CEO Jeffery Skilling and CFO Andrew Fastow
transformed Enron from an old-style electricity and gas company
into a $150 billion energy company and Wall Street favorite that
traded power contracts in the investment markets. However, a
bankruptcy examiner later reported that although Enron claimed a
net income of $979 million in 2000, it earned just $42 million.
Moreover, the
examiner found that despite Enron’s claim of $3 billion in cash
flow in 2000, the company’s actual cash flow was negative $154
million. By misrepresenting earnings reports while continuing to
enjoy the revenue provided by the investors not privy to the true
financial condition of Enron, the executives of Enron embezzled
funds funneling in from investments while reporting fraudulent
earnings to those investors; this not only proliferated more
investments from current stockholders, but also attracted new
investors desiring the enjoy the apparent financial gains enjoyed
by the Enron corporation.
According to CFO Fastow, Enron
established the “special-purpose entities” to move assets and debt
off its balance sheet ad to increase cash flow by showing that
funds were flowing through its book when it sold assets. Although
these practices produced a favorable financial picture, outside
observers believed they constituted fraudulent financial reporting
because they did not accurately represent the company’s true
financial condition. Most of the “special-purpose entities” were
entities in name only, and Enron funded then with its own stock and
maintained control over them. When one of these partnerships was
unable to meet its obligation, Enron covered the debt with its own
stock. This arrangement worked as long as Enron’s stock price was
high, but when the stock price fell, cash was needed to meet the
shortfall. After Enron restated its financial statements for fiscal
year 2000 and the first nine months of 2001, its cash flow from
operations went from a positive $ 127 million in 2000 to negative
$753 million in 2001. With its stock price falling, Enron faced a
critical cash shortage.
Enron’s stockholder
equity fell by $1.2 billion. Lay, the chairman of Enron, was
convicted on 19 counts of fraud, conspiracy and insider
trading.
On December 2, 2001,
Enron filed for bankruptcy and it was the largest in U.S. corporate
history at the time. Enron faced 22,000 claims totaling about $400
billion.
Enron’s demise caused
tens of billions of dollars of investor losses, triggered a
collapse of electricity-trading markets, and ushered in an era of
accounting scandals that precipitated a global loss of confidence
in corporate integrity.
In its role as
Enron’s auditor, Arthur Andersen was responsible for ensuring the
accuracy of Enron’s financial statements and internal bookkeeping.
Investors used Andersen’s reports to judge Enron’s financial
soundness and future potential, and expected that Andersen’s
certifications of accuracy and application of proper accounting
procedures would be independent and free of any conflict of
interest. In March 2002, Andersen was found guilty of obstruction
of justice for destroying relevant auditing documents during an SEC
investigation of Enron. As a result, Anderson was barred from
performing audits. The damage to the firm was such that the company
no longer operates.
(Adapted from Ferrell, O.C.,
Fraedrich, J. & Ferrell, L. (2015). Business Ethics:
Ethical Decision Making and Cases,
10th Edition, Cengage Learning, USA).
Based on the Questionable
Accounting Leads to Collapse Case, students are required
to:-
Leads to Collapse
Once upon a time,
there was a gleaming office tower in Houston, Texas. In front of
that gleaming tower was a giant “E”, slowly revolving, flashing in
the hot Texas sun. But in 2001 the Enron Corporation, which once
ranked among the top Fortune 500 companies, collapsed
under a mountain of debt concealed through a complex scheme of
off-balance-sheet partnerships. Forced to declare bankruptcy, the
energy firm laid off 4,000 employees; thousands more lost their
retirement savings that had been invested in Enron stock. The
company’s shareholders lost tens of billions of dollars after the
stock price plummeted. The scandal surrounding Enron’s demise
engendered a global loss of confidence in corporate integrity that
continues to plague markets today, eventually it triggered tough
new scrutiny of financial reporting practices. In an attempt to
explain what went wrong, this case examines the history, culture,
and major players in the Enron scandal.
Throughout the 1990s,
Chairman Ken Lay, CEO Jeffery Skilling and CFO Andrew Fastow
transformed Enron from an old-style electricity and gas company
into a $150 billion energy company and Wall Street favorite that
traded power contracts in the investment markets. However, a
bankruptcy examiner later reported that although Enron claimed a
net income of $979 million in 2000, it earned just $42 million.
Moreover, the
examiner found that despite Enron’s claim of $3 billion in cash
flow in 2000, the company’s actual cash flow was negative $154
million. By misrepresenting earnings reports while continuing to
enjoy the revenue provided by the investors not privy to the true
financial condition of Enron, the executives of Enron embezzled
funds funneling in from investments while reporting fraudulent
earnings to those investors; this not only proliferated more
investments from current stockholders, but also attracted new
investors desiring the enjoy the apparent financial gains enjoyed
by the Enron corporation.
According to CFO Fastow, Enron
established the “special-purpose entities” to move assets and debt
off its balance sheet ad to increase cash flow by showing that
funds were flowing through its book when it sold assets. Although
these practices produced a favorable financial picture, outside
observers believed they constituted fraudulent financial reporting
because they did not accurately represent the company’s true
financial condition. Most of the “special-purpose entities” were
entities in name only, and Enron funded then with its own stock and
maintained control over them. When one of these partnerships was
unable to meet its obligation, Enron covered the debt with its own
stock. This arrangement worked as long as Enron’s stock price was
high, but when the stock price fell, cash was needed to meet the
shortfall. After Enron restated its financial statements for fiscal
year 2000 and the first nine months of 2001, its cash flow from
operations went from a positive $ 127 million in 2000 to negative
$753 million in 2001. With its stock price falling, Enron faced a
critical cash shortage.
Enron’s stockholder
equity fell by $1.2 billion. Lay, the chairman of Enron, was
convicted on 19 counts of fraud, conspiracy and insider
trading.
On December 2, 2001,
Enron filed for bankruptcy and it was the largest in U.S. corporate
history at the time. Enron faced 22,000 claims totaling about $400
billion.
Enron’s demise caused
tens of billions of dollars of investor losses, triggered a
collapse of electricity-trading markets, and ushered in an era of
accounting scandals that precipitated a global loss of confidence
in corporate integrity.
In its role as
Enron’s auditor, Arthur Andersen was responsible for ensuring the
accuracy of Enron’s financial statements and internal bookkeeping.
Investors used Andersen’s reports to judge Enron’s financial
soundness and future potential, and expected that Andersen’s
certifications of accuracy and application of proper accounting
procedures would be independent and free of any conflict of
interest. In March 2002, Andersen was found guilty of obstruction
of justice for destroying relevant auditing documents during an SEC
investigation of Enron. As a result, Anderson was barred from
performing audits. The damage to the firm was such that the company
no longer operates.
(Adapted from Ferrell, O.C.,
Fraedrich, J. & Ferrell, L. (2015). Business Ethics:
Ethical Decision Making and Cases,
10th Edition, Cengage Learning, USA).
Based on the Questionable
Accounting Leads to Collapse Case, students are required
to:-