The Enron Corporation Accounting Scandal and Bankruptcy Essay

The prostration of the Enron Corporation in December 2001 led many to believe that this could go on once more to another company ( Niskanen, 2005 ) . The accounting dirts and bankruptcy by Enron and other major corporations have besides undermined the popular and political support for free market policies. This consequence led to increased federal ordinance of accounting, scrutinizing, and corporate administration and increased unfavorable judgment of any proposal for cut downing the function of authorities. The policy lessons that can be learned from the dirt semen from the jobs of conventional accounting and the restrictions of the monitoring theoretical account of corporate administration. The Enron dirt and its effects have had a important impact on the accounting industry, and the dirt has caused a demand for the authorities to reform accounting moralss in order to reconstruct public assurance in the unity of the accounting system.

After reading about the prostration of Enron, one can be outraged by its many prima accounting patterns. One of the accounting patterns includes the engagement of wash trades as grosss, in which Enron was basically merchandising with itself in order to pull in investors ( Niskanen, 2005 ) . Harmonizing to the United States Security and Exchange Commission ( 1997 ) , a wash trade can be defined as “ a securities dealing which involves no alteration in the good ownership of the security. ” Wash trades are illegal and normally affect in the purchasing and merchandising of portions within a really short period of clip so that there is no fiscal hazard in the dealing. Therefore, Enron ‘s intent for prosecuting in those minutess was to victimize clients, and to pull strings monetary values of future contracts.

Another pattern was the improper usage of mark-to-market accounting to increase the reported value of bing assets when no substantial economic value had been added ( Niskanen, 2005 ) . This meant that one time a long-run contract was signed, the present value of the watercourse of future influxs under the contract was recognized as grosss and the present value of the expected costs of carry throughing the contract were expensed ( Healy & A ; Palepu, 2003 ) . Unfulfilled additions and losingss in the market value of long-run contracts that were non hedged were so required to be reported subsequently as portion of one-year net incomes when they occurred ( Healy & A ; Palepu, 2003 ) . This allowed Enron to describe net incomes on the gross revenues, and about at the same time increase the book value of some assets ( Niskanen, 2005 ) . Mark-to market accounting was cardinal to Enron ‘s income-recognition pattern, and resulted in its direction devising prognosiss of energy monetary values and involvement rates good into the hereafter ( Healy & A ; Palepu, 2003 ) . In the Enron ‘s income-recognition pattern, Enron recorded current income fees for services rendered in future periods and recoded gross from gross revenues of forward contracts, which were in other words disguised loans ( Niskanen, 2005 ) . Therefore, Enron still owned the assets and had borrowed financess from Bankss, but recorded the dealing as gross revenues and did non enter the debt ( Niskanen, 2005 ) .

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The most extremely controversial pattern was the usage of some of its many particular purpose entities ( SPEs ) as inactive spouses in these patterns ( Niskanen, 2005 ) . For fiscal coverage intents, a series of regulations is used to find whether a SPE is a separate entity from the patron ( Healy & A ; Palepu, 2003 ) . These require that an independent third-party proprietor have a substantial equity interest that is at hazard in the SPE, which has been interpreted as at least three per centum of the SPE ‘s entire debt and equity ( Healy & A ; Palepu, 2003 ) . The independent third-party proprietor must besides hold a controlling, of more than 50 per centum, of fiscal involvement in the SPE. If these regulations are non satisfied, the SPE must be consolidated with the patron house ‘s concern ( Healy & A ; Palepu, 2003 ) . Enron had used 100s of SPEs by 2001, and many of these were used to fund the purchase of forward contracts with gas manufacturers to provide gas to public-service corporations under long-run fixed contracts ( Healy & A ; Palepu, 2003 ) . However, several controversial SPEs were designed chiefly to accomplish fiscal describing aims ( Healy & A ; Palepu, 2003 ) . Harmonizing to Niskanen ( 2005 ) , “ The most evident misdemeanors of accounting regulations appears to hold been the failure to consolidate three of its many SPEs on the Enron books, a error that when acknowledged in November 2001 led to a $ 586 million decrease in reported net incomes, and the failure to describe the sum of debt of the SPEs that was efficaciously guaranteed by Enron ” ( p. 47 ) . Enron finally failed to account decently for their investing in and traffics with SPEs, which were fundamentally organisations sponsored by and profiting Enron but owned presumptively independent outside investors ( Niskanen, 2005 ) . Enron besides accounted for its stock that was issued to and held by SPEs, of which the Generally Accepted Accounting Principles ( GAAP ) do non allow a corporation to enter income from additions in the value of its ain stock or to enter stock as issued unless it has been paid for in hard currency or its equivalent ( Niskanen, 2005 ) .

Enron had significantly manipulated its net incomes through its accounting patterns, as seen through the chart below. Figure 1 nowadayss three versions of Enron ‘s net incomes for financial old ages 1997-2000, along with the first two quarters of 2001 ( Lev, 2003 ) . Pursuant to its bankruptcy filing in December 2001, Enron did non describe quarterly net incomes beyond 2nd one-fourth 2001 ( Lev, 2003 ) . The three bars for each twelvemonth portray, from the left, fiscal analysts ‘ consensus prognosis of net incomes per portion, which was an sum of single prognosiss made before year-end ( Lev, 2003 ) . The corresponding net incomes figures publically reported by Enron shortly after financial twelvemonth or one-fourth terminal, and the restatement of these net incomes filed with the Securities and Exchange Commission on November 8, 2001, in the aftermath of Enron ‘s prostration ( Lev, 2003 ) . From 1998 on, Enron ‘s reported net incomes likewise shows that, get downing with December 1997, Enron round analysts ‘ prognosiss in every one-fourth but one, being the September 1999 one-fourth ( Lev, 2003 ) . In add-on, Enron ‘s one-year and quarterly net incomes from 1997 to its death appeared to exhibit a healthy and uninterrupted rate of growing ( Lev, 2003 ) . However, the world was different ; the right bars in each three of Figure 1 present Enron ‘s restated net incomes as of November 2001, bespeaking well lower figures than both originally reported and forecasted by analysts ( Lev, 2003 ) . However, even the restated net incomes are significantly overstated, as Enron ‘s new direction withdrew the restatement in April 2002 and has yet to publish an updated version ( Lev, 2003 ) . As is clear from Figure 1, the analysts that followed Enron and were purportedly capital market experts did non hold a hint about Enron ‘s jobs up to its bankruptcy or were so obliged to hide involvements as to neglect to warn investors ( Lev, 2003 ) . In decision, these net incomes show how the accounting patterns of Enron manipulated the net incomes, and baffled many analysts and exports about Enron ‘s true net incomes.

One of the major jobs in the accounting industry itself which allowed for such accounting mistakes to happen is the deficiency of competition among accounting criterions. The cardinal job with the Financial Accounting Standards Board ( FASB ) , which is a monopoly criterion compositor, is that there is no inducement to react rapidly to market forces, allow alone act in a mode free from political influence ( Niskanen, 2005 ) . It is of import that any monopoly that sets the accounting criterions is rapidly antiphonal to a alteration of concern patterns, such as derived functions, that calls for an amendment or add-on to the common criterions ( Niskanen, 2005 ) . The solution to monopoly is competition, as in private markets ( Niskanen, 2005 ) . As is the state of affairs for private companies, governmental bureaus seek credence of their merchandises and modify those merchandises to run into replacements produced by other bureaus ( Niskanen, 2005 ) . Consequently at a lower limit, Congress or the Securities and Exchange Commission ( SEC ) should allow corporations with publically traded stock to establish their fiscal accounting statements on U.S. or international accounting criterions ( Niskanen, 2005 ) . Therefore, a competitory system that would let corporations to fix their fiscal statements in conformity with alternate criterions, such as the International Accounting Standards that have been adopted by the European Community, should be adopted in the United States ( Niskanen, 2005 ) . By making this, the assurance in the accounting industry will better and take to less mistakes in the accounting system which lead to the Enron dirt.

The function of accounting ordinance in the Enron dirt had loop-holes in the system which had allowed for some of the accounting patterns. Harmonizing to Eichenwald ( 2005 ) , while the Enron executive squad gathered to make up one’s mind what to make, Jeff Skilling who was a senior executive and subsequently became CEO was quoted stating, “ If the authorities sets up the market, it ‘s traveling to be done incorrect. Merely cognize the regulations better than anybody else. Then you ‘ll do money ” ( p. 116 ) . This shows how finding and working loopholes in the jurisprudence was standard concern pattern at Enron. Enron was able to invent minutess that satisfied the jurisprudence, but violated its purpose such that the company ‘s balance sheet did non reflect its fiscal hazards ( Healy & A ; Palepu, 2003 ) . The Financial Accounting Standards Board ( FASB ) had recognized for several old ages that jobs existed with the regulations for SPEs, nevertheless FASB efforts to run by organizing a consensus between affected groups, and it had non been able to make a consensus on an option ( Healy & A ; Palepu, 2003 ) . Therefore, when criterions are passed as a consequence of intensive dialogues, they frequently tend to be extremely elaborate, mechanical, and inflexible.

In decision, the fiscal accounting of Enron was misdirecting, and frequently provided small information and adequate measurings to investors of the existent economic public presentation and conditions of the company ( Niskanen, 2005 ) . Niskanen ( 2005 ) suggests that GAAP should be principle-based alternatively of rule-based, so that investors are non to be misled by comptrollers happening loop-holes in a system by merely staying in proficient conformity. Such rules are clear and include concise thoughts of what gross and disbursals should be, every bit good as trusty Numberss to be reported in fiscal statements ( Niskanen, 2005 ) . By staying to the rules, traditional income statements would be just and consistent with the records of a company ‘s operations, and hence would carry through the proper map of accounting ( Niskanen, 2005 ) . Investors should recognize that there are restrictions in fiscal information reported in accounting fiscal statements, and accounting hence, can non bring forth both trusty and wholly equal steps of the economic public presentation and the status of a company.