In Your Opinion Why Did The Enron Scandal Happen
Special Purpose Entity
Enron had high levels of debt. To attract new investors, Enron needed to find a way to hide those debts. Andrew Fastow, CFO of Enron, turned to Special Purpose Entity (SPE). Several legal entities such as LJM and raptors were created and the poorly performing stocks were transferred to these entities. Then, the SPE were used to borrow large sum of money from investors with Enron’s overpriced stock as collateral. These SPEs were not reported on the financial statements. In this way, the debts were hidden from the stakeholders. Also, the borrowed funds were treated as income. From the perspective of the potential stakeholders, Enron seemed to have low debts and high level of income, which was further overprice the shares of the company. Andrew Fastow had personal financial stake in these SPE (in the form of silent partners). He used these SPE to raise funds. In this way, he would make millions of dollars by defrauding Enron.
Mark-to-Market Accounting
The revenues of Enron were overstated due to the “mark to market” accounting treatment introduced by Jeffrey Skilling. Under this accounting treatment, Enron would report potential future profits the instant the contracts were signed off. The difference between the net present value and the amount paid was regarded as profits. However, these number were misleading because the net present value was highly optimistic and overstated.
Auditor
Arthur Andersen has been the auditor of Enron for 16 years. When Enron unexpectedly suffered a collapse, the focus quickly turned on him. He was accused of not following GAAP, and destroying documents related to Enron during the investigation.
Arthur Andersen provided a good audit report for several years despite knowing that “Mark to Market” accounting violated the revenue recognition principle. In addition, it was discovered that Arthur Andersen was a consultant to Enron. There was obviously a conflict of interest. He improperly categorized millions of dollars
Enron had high levels of debt. To attract new investors, Enron needed to find a way to hide those debts. Andrew Fastow, CFO of Enron, turned to Special Purpose Entity (SPE). Several legal entities such as LJM and raptors were created and the poorly performing stocks were transferred to these entities. Then, the SPE were used to borrow large sum of money from investors with Enron’s overpriced stock as collateral. These SPEs were not reported on the financial statements. In this way, the debts were hidden from the stakeholders. Also, the borrowed funds were treated as income. From the perspective of the potential stakeholders, Enron seemed to have low debts and high level of income, which was further overprice the shares of the company. Andrew Fastow had personal financial stake in these SPE (in the form of silent partners). He used these SPE to raise funds. In this way, he would make millions of dollars by defrauding Enron.
Mark-to-Market Accounting
The revenues of Enron were overstated due to the “mark to market” accounting treatment introduced by Jeffrey Skilling. Under this accounting treatment, Enron would report potential future profits the instant the contracts were signed off. The difference between the net present value and the amount paid was regarded as profits. However, these number were misleading because the net present value was highly optimistic and overstated.
Auditor
Arthur Andersen has been the auditor of Enron for 16 years. When Enron unexpectedly suffered a collapse, the focus quickly turned on him. He was accused of not following GAAP, and destroying documents related to Enron during the investigation.
Arthur Andersen provided a good audit report for several years despite knowing that “Mark to Market” accounting violated the revenue recognition principle. In addition, it was discovered that Arthur Andersen was a consultant to Enron. There was obviously a conflict of interest. He improperly categorized millions of dollars
Bibliography: Hg.org. (2015). The Fallout of Arthur Andersen and Enron on the Legal Landscape of American Accounting. Retrieved 18 February 2015, from http://www.hg.org/article.asp?id=31277 Fpc.state.gov. (2015). Retrieved 18 February 2015, from http://fpc.state.gov/documents/organization/926 Ccsenet.org. (2015). Retrieved 18 February 2015, from http://ccsenet.org/journal/index.php/ijbm/article/viewFile/7627/5855 Scu.edu. (2015). Lessons from the Enron Scandal. Retrieved 18 February 2015, from http://www.scu.edu/ethics/publications/ethicalpers The Economist. (2002). The real scandal. Retrieved 18 February 2015, from http://www.economist.com/node/940091 Gibney, Alex. [knockitpocket]. (2014, Jan 16). Enron - The Smartest Guys In The Room. [video file]. Retrieved 18 February 2015, from https://www.youtube.com/watch?v=gxzLX_C9Z74