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 companys shareholders lost tens of billions of dollars after the stock price plummeted. The scandal surrounding Enrons 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 Enrons claim of $3 billion in cash flow in 2000, the companys 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 companys 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 Enrons 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.

Enrons 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.

Enrons 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 Enrons auditor, Arthur Andersen was responsible for ensuring the accuracy of Enrons financial statements and internal bookkeeping. Investors used Andersens reports to judge Enrons financial soundness and future potential, and expected that Andersens 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, 10^th Edition, Cengage Learning, USA).

Based on the Questionable Accounting Leads to Collapse Case, students are required to:-

• Explain any FIVE (5) relevant ethical issues (500 WORDS)