The Rise and Fall of Enron

Main focus of this article is to summarize the rise and fall of Enron, as well as changes in financial reporting, auditing and corporate governance proposed in response by Big Five accounting firms. Main reason to fall is company’s lack of transparency in financial reporting. Company hired consultant named Skilling to make new strategies.  Skilling instituted the performance review committee in this underperforming employees are fired within six months. Enron added lot of product lines and attained success. Company used its own models on the basis of their own assumption for long future contracts. FASB interrupted by asking company to disclose all assumptions and estimates. Due to new market entrant’s success, fall in energy prices and recession, Enron profit margins started falling by the end of 2000. In order to maintain ratings Enron used “Special Purpose Entities” to hedge risk. In turn, this increased ROA and reduced debt/Total Assets ratio. FASB requires that only 3% of the SPE be owned by outside investor. Enron added more complexity by keeping losses in Books. Company also increased notes receivable and shareholders’ equity to reflect transaction of stocks in exchange of notes receivables violating GAAP.  Due to Misrepresentation Company start losing trust and reputation in market. As a result both Lay and skilling announced retirement and after consolidation with SPEs restatements resulted in $591million in loss and stock price of Enron felt to 26 cents. Question rose on the integrity of independent auditor process.  Andersen, Enron’s external and internal auditor; also controller of internal accountants was dismissed by Enron. Andersen admitted that he destroyed thousands of documents and electronic files. Collapse of Enron leads to suicide of former vice-chairman, end of 4500 individual’s carrier. SEC responded and called for joint response from public and private sectors. The CEOs of Five accounting firms wants modernization of procedure to make sure about transparency, timely and relevant presentation. AICPA responded by issuance of an exposure draft “consideration of fraud in Financial Statements audit” to restore confidence in profession. AICPA also supported prohibitions that prevent audit firms from internal audit outsourcing for public audit clients.  Management Frauds outlined in SAS no 82 are as follows-

1)      Competition based on Financial, management compensation and earning targets.

2)      Use of aggressive accounting practices to maintain Price to Earnings trend.

3)      Balance Sheet and Income statements on the basis of assumptions.

The collapse of Enron has had lot of political and financial implications which have resulted in review of corporate regulation. Unethical reporting based on assumptions by Enron corporation e.g. for SPEs consolidation of financial statements and balance sheet reporting lead to a loss of trust by investors and financiers. Questions arisen regarding adequacy of accounting standards, SEC disclosure requirements and market disclosure rules. The regulation committees responded by instituting inquiries and reviews by the SEC and AICPA. Sarbanes- Oxley act was enacted in 2002 to make sure and restore faith in the market by ensuring that financial information issued by corporations is truthful. Under this act companies should give full disclosure of financial statements to stockholders and interested parties (Investors). Also company should have adequate internal controls for reporting purpose. The CEO or CFO has to certify that he established adequate internal controls. And if any unethical work is found he will be primarily responsible. The fact that Enron was global company and operated in approximately 40 countries, as such all countries got affected by the Enron collapse. Most of the countries started reviewing there accounting standards to ensure ethical reporting of financial statements.