Enron Corporation was an energy, commodities and services firm based in Houston, Texas. The company went into bankruptcy on December 2001. At its peak, the firm had a staff of about 20000 and rated as one of the leading providers of electricity, natural gas, communications, as well as pulp and paper. The company's revenue was approximately $101 billion in the year 2000. For six consecutive years, Enron held the position of America's Most Innovative Company (Fox, 2003). In the late 2001, audits revealed that Enron's purported financial prowess resulted from institutionalized, systematic, and creative accounting fraud, otherwise called the Enron Scandal (Eichenwald, 2005). The scandal led to the questioning of the accounting practices of many corporations in the United States of America. In fact, the creation of the Sarbanes–Oxley Act of 2002 is a direct effect of the Enron Scandal. This paper will look at the Enron scandal from an accounting perspective.
The first analyst to disclose the accounting flaws of Enron Corporation was Daniel Scotto in 2001 (Fusaro & Miller, 2002). Scotto released a report called All Stressed-up and no Place to go. This report asked investors to dispose of Enron stocks and bonds. Further auditing revealed that there was inflation of most of Enron's assets and profits (Healy & Palepu, 2003). In addition, other assets were wholly fraudulent and nonexistent. An example of fraudulent dealings was in 1999 when the company tried to bribe Merrill Lynch and Company investment in order to post profit on its books (Fox, 2003). This involved putting debts and losses into entities formed “offshore”. Such entities were never in the company's financial statements. Besides, the company used other sophisticated and mysterious financial transactions to remove unprofitable entities from its books (Eichenwald, 2005). The 2001 scandal led to a drop in Enron's shares from approximately $90.00 in 2000 to just pennies (Fox, 2003). The primary cause for the drop of the company's shares was the revelation that its profit resulted from deals involving purpose entities. Enron had limited partnerships that it controlled. The public discovered that most of Enron's debts and losses went unreported in the company's financial statements.
As already noted, Enron came up with offshore entities. These refer to units used for planning and avoiding taxes and, as a result, raising the profits of a business. Enron’s offshore entities ensured that the ownership and management had freedom of currency movement as well as the anonymity that enabled them to conceal losses (Eichenwald, 2005). As a result, Enron appeared more profitable than the reality. The practice had adverse effects as it created a dangerous spiral that saw corporate officers perform further financial deception in each quarter. This was in order to maintain the illusion that the company was making profits. However, in actuality, the company was losing billions. The practice moved up the company's stock price to new levels. At this point, the executives started working on insider information and trading a lot of money worth of Enron stock (Fox, 2003). This was despite the knowledge that there were offshore entities that hid losses for the company. On the contrary, the investors were not aware of this practice. The chief financial officer, Andrew Fastow, was in charge of the team that came up with the off-books accounting. Besides, Fastow manipulated these deals to benefit himself, his family and friends with millions of money in guaranteed revenue. Fastow did this at the expense of Enron Corporation and its stakeholders (Fusaro & Miller, 2002).
Enron launched Enron Online in 1999, which was an Internet-based trading operation. Almost all energy companies of the United States of America used Enron Online. The president of Enron Jeffrey Skilling started advocating a novel idea suggesting that the company “did not need any assets” (Eichenwald, 2005). Skilling, who also was the chief operating officer, pushed the firm’s aggressive investment strategy, as a result, making Enron the largest wholesaler of electric power and gas, trading about $27 billion per quarter. However, the company's figures were only acceptable at face value.
Under the watch of Skilling, Enron took up market accounting. This is accounting that involves tabulating anticipated future profits from deals as if already realized today (Fox, 2003). As a result, the company recorded profits from what over time could turn out to be massive losses. This led to the firm’s fiscal health to become secondary to the manipulation of its price in stock on Wall Street in the period of the Tech boom (Healy & Palepu, 2003). We should note that when the success of a company is dependent on agreeable financial statements coming from a “black box” (Skilling himself admitted this term), the actual balance sheets lose their convenience (Fox, 2003). This practice led Enron's actions to be gambles meant to maintain the deception and, as a result, keep up the stock price. The presence of an advancing profit would translate to an ongoing infusion of the investors’ capital that Enron, now heavy with debts, largely subsisted. Richard Grubman, a Wall Street analyst, questioned Enron's errant accounting practice in a recorded conference call (Eichenwald, 2005). Grubman complained that Enron was the sole company that failed to release a balance sheet together with its earnings’ statements. Skilling saw this as an offensive and launched a scathing attack on Grubman. Skilling accused Grubman of meddling with the internal affairs of Enron. This was totally against the accounting ethics of transparency (Fox, 2003).
The year 2000 saw the company's stock price at its highest value ($90) (Eichenwald, 2005). Enron's executives, who knew about the hidden losses, started to sell their stock. In the same period, the executives asked the public to buy the stock. The executives assured the investors that the stock price would continue to appreciate to further heights ranging from $130 to $140 (Fox, 2003). What the public and investors did not know was that the executives were secretly unloading their shares. The continued sale of shares by the executives led to falling of the stock price. In spite of the drop, the executives told the investors to continue buying the stock from Enron. The executives did this with the promise that the price would pick up in the near future. One of Enron’s executives, Kenneth Lay, adopted the practice of issuing false statements and making appearances with the purpose of assuring the investors (Eichenwald, 2005).
By August 2001, Enron's stock price reached a new low of $42 (Eichenwald, 2005). However, many of the investors still believed the position of the executives that the company would rebound. The equity value continued to depreciate. By October, the stock price was $15. The investors saw this as a great opportunity to buy stock basing on what the executives had been telling them. Lay sold over $70 million stock at this time. He used the proceeds to pay back cash advances on the firm's lines of credit. Further, Lay sold a stock of $20 million in the open market. Besides, his wife, Linda, sold $500,000 shares of Enron totaling $1.2 million in the same year (Healy & Palepu, 2003). Exposure of the accounting flaws happened in the same year, an event that saw the stock price fall below one dollar. Besides, the former executive of the company, Paul Rieker, obtained 18,380 shares for $15.52 a share. In 2001, she sold the stock at $49.78 a share, despite knowing the accounting fraud that Enron was partaking (Fox, 2003).
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Worse still, Enron tried to conceal its fraudulent dealings by destroying evidence (Eichenwald, 2005). Maureen Castaneda, an executive in the company, told the court that Enron had been shredding accounting documents in its headquarters' offices (Fusaro & Miller 2002). In addition, there were accusations of intimidation of persons in order for the company to win deals or ward off investigations (Fox, 2003). A conspiracy to create artificial power blackouts in 2001 is an example of such intimidation. Besides, there was summary firing of uncooperative staff. These misdeeds further led to the fall of Enron.
Fusaro and Miller (2002) argue that the accounting fraud at Enron was like an organized crime syndicate. This is because the efforts to deceive a large number of investors needed the organized efforts of many people. Equity losses to the shareholders of the company were $65 billion while losses to creditors were $51 billion. In court, Lay and Skiing focused on arguing that there was no crime at Enron instead of showing that they did not understand the involved accounting (Eichenwald, 2005). This meant that the executives indeed knew what was happening.
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The Enron scandal is one case showing the extent companies can go to ensure profitability. Though making a profit is the primary purpose for any business, companies should always seek to uphold accounting integrity. This is possible through shunning away from fraudulent accounting. As in the example of Enron, accounting fraud will lead to the fall of any company. As a result, businesses should always endeavor to uphold proper accounting practices. Let the Enron scandal be a warning to all companies in the world.