Case 4.1 Enron and Arthur Anderson LLP
Enron Corporation and Andersen, LLP
Accounting Fraud and Auditor Legal Liability
1 - What were the business risks Enron faced, and how did those risks increase the likelihood of material misstatements in Enron’s financial statements?
The business risks that Enron faced included foreign currency risks and price instability, which is common for the energy industry. In addition, Enron faced pressure to perform well so that the stock price would rise.
These risks increased the likelihood of material misstatements in the financial statements for several reasons. Since Enron operated in other countries, there would be a foreign currency risks and those could lead to gains/losses not being properly calculated or accrued on hedging activities. By operating in foreign countries, there are political risks such as policy changes, lack of understanding of culture and business practices. The biggest risk is having the pressure to report good financial results. The deals with the special purpose entities (“SPE’s”) depended on a high stock price. The company used its stock as collateral if the stock price fell below a certain price. At that point, Enron would have to use the stock to pay out the investors. The company also had pressure from its business partners to perform well and meet it’s future obligations. If the company performed poorly, the investors may hesitate to do business with Enron.
3 - In your own words, summarize how Enron used SPEs to hide large amounts of company debt.
Enron created SPE’s (usually other LLP’s) in order to create cash inflow but did not record the investments and related liabilities (the loans used to create the SPE). Enron used outside investors to secure the new SPE’s. The new investors would bear the risk of the investment and Enron used its company stock as collateral to entice the investors and saying that Enron would basically bear the risk if the investment should turn sour. Enron used large
Accounting Fraud and Auditor Legal Liability
1 - What were the business risks Enron faced, and how did those risks increase the likelihood of material misstatements in Enron’s financial statements?
The business risks that Enron faced included foreign currency risks and price instability, which is common for the energy industry. In addition, Enron faced pressure to perform well so that the stock price would rise.
These risks increased the likelihood of material misstatements in the financial statements for several reasons. Since Enron operated in other countries, there would be a foreign currency risks and those could lead to gains/losses not being properly calculated or accrued on hedging activities. By operating in foreign countries, there are political risks such as policy changes, lack of understanding of culture and business practices. The biggest risk is having the pressure to report good financial results. The deals with the special purpose entities (“SPE’s”) depended on a high stock price. The company used its stock as collateral if the stock price fell below a certain price. At that point, Enron would have to use the stock to pay out the investors. The company also had pressure from its business partners to perform well and meet it’s future obligations. If the company performed poorly, the investors may hesitate to do business with Enron.
3 - In your own words, summarize how Enron used SPEs to hide large amounts of company debt.
Enron created SPE’s (usually other LLP’s) in order to create cash inflow but did not record the investments and related liabilities (the loans used to create the SPE). Enron used outside investors to secure the new SPE’s. The new investors would bear the risk of the investment and Enron used its company stock as collateral to entice the investors and saying that Enron would basically bear the risk if the investment should turn sour. Enron used large