Enron in Ruin

8/3/2019 Enron in Ruin

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ENRON CASE OF ACCOUNTING FRAUD

PRESENTED BY :- GROUP 5


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In 1985 Enron was born from the merger ofHouston Natural and Inter NorthContracts with gas sellers and buyersSoon got the control of over 25% of all gasbusinessEntered into the derivative businessBegan trading in commodities like steel, coal,pulp, paper, etc.By 2000, stepped into the dot com business Enron OnlineJudged as the most innovative company for sixconsecutive years by FORTUNE


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The companys success was based on artificially inflated profits, Creative accounting practices, and fraud


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WHAT WENT WRONG FOR ENRON

Global energy crises by late 90s.

In India, lost the Dabhol Power project, in whichEnron had committed $2.9bn.

Beginning of Dot.Com bubble crises and fallout ofblockbuster internet deal.

Enron delivered smoothly growing earnings (butnot cash flows).


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CREATIVE ACCOUNTING

Accounting practices that may follow theletter of the rules of standard accountingpractices, but certainly deviate from thespirit of those rules.

Non-operational incomes (sale of fixedassets) being major source of income.

Extension of Accounting year to includemajor gains in coming months.

No provision for doubtful debts to inflatebottom line


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Enron and other energy suppliers earnedprofits by providing servicesGenerally service providers use agent

methodEnron used merchant modelBetween 1996 to 2000, Enron's revenuesincreased by more than 750%, rising from

$13.3 billion in 1996 to $100.8 billion in 2000.This means extensive expansion of 65% peryear.


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To revalue the Value of Assets and Liabilitieson the basis of fair market value.

Any increase (decrease) in the net value isadded to (subtracted from) any profitdistributions to shareholders in determining thebusiness' profit or loss.

In theory, mark-to-market gives investors themost useful information


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Long Term Contract to Supply Power

Under ConstructionPower Plant

City MunicipalDeptt

Revenue to be Generated once the Dealis Executed

Mark to Market Accounting(Enron style)


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Special Purposes Entities

These " financial vehicles" were originally defined asentities created for a limited purpose, with a limitedlife and limited activities, and designed to benefit asingle company

They may take the legal form of a partnership,

corporation, trust, or joint ventureThey are basically used to keep Debt off theBalance Sheet


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(Enron style)Enron used SPEs in ways that nobody had everyheard of before:

They formed an SPE, which formed an SPE,

which formed an SPE

They also did interactions between SPEs andthemselvesSome of the SPEs created were:

ChewcoWhitewingLJM and Raptors


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ENRON

Partnership

SpecialPurpose

Entity(SPE)

AccountIn

Profit

3

4

2

1

5

1. Enron sets up partnership using stock as funding2. Partnership sets up SPE3. SPE agrees contract to pay Enron if its investment

declines in value4. Payment made as investment declines5. Payment posted as profit, even though it is Enrons own

money



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Enron's auditor firm, Arthur Andersen

Arthur Andersen was one of the worlds

five leading accounting firms

Andersen executives including chief Enron auditor David Duncan, decided toconsult lawyers over whether or not the

partnerships were legal Andersen told Enron that it had no other

choice but to change the way it wasaccounting for its special partnerships


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Andersen's auditors werepressured by Enron'smanagement to deferrecognizing the charges from thespecial purpose entities


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Was paid $27mn in 2000, for non-audit relatedconsulting services.

At some point after this, staff in Andersens Houston office

began shredding documentsrelating to Enron.

30000 emails were deleted.

AUDIT BECAME SECONDARY


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Year Reported

Income

Revised

Income

True debt

restated by

True equity

restated by

2000 $979m $880m Up $628m Down $754m

TRUE ACCOUNTING FIGURES


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Decline in Investors Confidence Restructuring Losses and SECInvestigationLiquidity ConcernsCredit Rating DowngradeProposed buyout by DYNEGYFiling of BankruptcyTrials


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The Enron scandal , revealed in October2001

Eventually led to the bankruptcy ofthe Enron Corporation on Dec 2 , 2001

Dissolution of Arthur Andersen


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Sarbanes- Oxley Act of 2002 (SOA) enacted July 30, 2002 Corporate scandals (Enron, WorldCom) provided impetus forCongress to act quicklySOA approved by near unanimous vote in Congress (vote of 99-0 in the Senate and 423-3 in the House)Fast pace of approval likely to result in need for numerousinterpretations and explanations

Potential for far reaching impact on Corporate Governance andConduct, Financial Reporting and the Public AccountingProfessionAlso impacts legal community and investment banking analysts


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Several provisions of the SOA require detailed regulations bythe SEC and other regulatory bodies

SOA aims to restore investor confidence in financial reportingand public capital marketsBroadly speaking the Acts provisions seem to be builtaround the following principles:

IntegrityIndependenceProper OversightAccountabilityStrong Internal ControlsTransparency

Deterrence


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Enron in Ruin