Enron's Accounting Fraud

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Financial Accounting

Assignment : ENRON’s Accounting Fraud

MBA (2011-2013)

Submitted To: M Jameel
Submitted By: Maliha Aziz Butt


Northern Natural Gas Company (the ancestor of ENRON) was established in 1930. In 1979, Inter North Inc. bought Northern Natural Gas Company and placed it under a new management. In the 1980s, the United States Congress passed legislation deregulating the sale of natural gas. At the beginning of the 1990s, Congress passed a similar legislation targeted at the sales of electricity. These steps launched a new era in the energy market, allowing companies like ENRON to prosper. In 1985, Kenneth Lay, CEO of Houston Natural Gas devised a new company and changed Inter North’s name to ENRON Corporation. This newly formed company was at first involved in distributing gas and electricity in the US and in selling power plants and pipelines worldwide. However, the company started to deviate into many non-energy-related fields i.e. non-core businesses, such as weather derivatives – weather insurances for seasonal business, risk management, and internet bandwidth. Even though ENRON’s core business remained gas and electricity, most of the company growth came from those non-core businesses. ENRON was involved in the following fraudulent activities:

1. Fraud to Shareholders
2. Fraudulent Accounting Practices
3. Creating off Balance Sheet Entities to Cover-up Losses 4. Fake Energy Crisis
5. Deregulation of ENRON

Fraud to Shareholders:
When the employees of a corporation deliberately deceive the company’s shareholders by misrepresenting information. ENRON was involved in the phenomenon named “cook the books”, companies cook the books when they don’t tell us their real earnings. Managers cook the books and present us fake earnings to improve their earnings per share (EPS) of stocks. Companies cook the books because they have the pressure to present good earnings in order to attract investors to invest in them and most importantly to keep current investors happy. By misrepresenting earnings reports, the executives of ENRON misused funds directed from investments while reporting fraudulent earnings to the 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. Since, Executive bonuses are tied to the company’s earnings so managers are tempted to manipulate company’s earnings to receive these large earnings. During 2001, ENRON shares fell from US$ 85 to US$ 0.30. The result of this accounting scandal was that many of the losses that ENRON encountered were not reported in its financial statements.

Fraudulent Accounting Practices:
The ENRON fraud case was extremely complex. The roots for the ENRON scandal lie in the beginning of the 1990s. In fact, in 1992, Jeff Skilling, who was the president of ENRON’s trading operations, convinced federal regulators to allow ENRON to use market-based accounting. Companies can use market-based accounting unethically i-e one party deliberately misinforms another party during the trading of stocks, bonds, and other securities, which is what ENRON did. ENRON used market-based accounting for its energy segment in the 1990s and used it excessively for its trading transactions. Under this accounting rule, when companies have outstanding contracts or energy-related contracts on their balance sheets at the end of a quarter, they must appraise them using fair value and record unrealized gains and losses to the quarterly income statement. The point is that there are no quoted prices upon which to base valuations for long-term future contracts in commodities such as gas. Using market-based accounting allowed ENRON to count projected earnings from long-term energy contracts as current income. Those contracts represented money that might not be collected for many...
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