Enron Corporation: The Rise and Fall

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ACG 4632
INTRODUCTION TO FINANCIAL STATEMENT
AUDITING
Spring 2015 Section 422
Instructor: Devin Williams, CPA

Today
• Introductions – hand out
• Syllabus
• High level – why auditing?
• Enron

Auditing
• Why do we have auditing?
• Lemonade Stand Example

Did ANYONE
Do ANYTHING

WRONG?

CONCLUSION
Did Anyone Do Anything Wrong?

YES!!

ENRON’S RISE
1985 – Internorth, based in Omaha, acquired Houston Natural Gas. 1986 – Changed name to Enron and moved to Houston.

OLD ENERGY SYSTEM
• Electricity
• State-regulated monopolies.
• Stable, but inefficient.
• Natural Gas
• Pipelines transported on fixed delivery routes with set prices.

Enron

Producers

Pipeline
Companies

Utilities

Users

NEW ENERGY SYSTEM
Enron Wholesale Services markets and delivers physical
commodities and financial risk management services to customers around the world.
We provide innovative and customized solutions to our customers -- solutions which few others can match. With our flexible networks and unique capabilities, we deliver the widest range of reliable logistical solutions at predictable prices.

RISK MANAGEMENT SERVICES

MARKET RESULTS
Analysts estimate that at its peak Enron accounted for about one-quarter of the nation's energy trading — not producing much energy itself, but serving mostly as a middleman.

FINANCIAL RESULTS

The ultimate “New Economy” company – movement away from hard assets.

PRESS RELEASE
Tuesday, October 16, 2001
ENRON REPORTS RECURRING THIRD QUARTER EARNINGS OF $0.43 PER DILUTED SHARE; REPORTS NON-RECURRING CHARGES OF $1.01 BILLION AFTER-TAX;
REAFFIRMS RECURRING EARNINGS ESTIMATES OF $1.80 FOR 2001 AND $2.15 FOR 2002; AND EXPANDS FINANCIAL REPORTING
HOUSTON – Enron Corp. (NYSE – ENE) announced today recurring earnings per diluted share of $0.43 for the third quarter of 2001, compared to $0.34 a year ago. Total recurring net income increased to $393 million, versus $292 million a year ago.

“Our 26 percent increase in recurring earnings per diluted share shows the very strong results of our core wholesale and retail energy businesses and our natural gas pipelines,” said Kenneth L. Lay, Enron chairman and CEO. “The continued excellent prospects in these businesses and Enron’s leading market position make us very confident in our strong earnings outlook.”

ENRON’S FALL

THE ACCOUNTING
“SLEIGHT OF HAND”

Special Purpose Entities (SPEs; now
known as Variable Interest Entities)

SPEs
• What is the business purpose?
• Bundle peripheral activities and have them done by an independent, but close, friend.
• Examples:
• Acquire financing for a project
• Package receivables and sell them to third parties
• Janitorial Services

SPEs (cont.)
• What is the accounting purpose?
• Move liabilities off the balance sheet.
• Provide favorable terms for some transactions.
• Example:
• The “Raptors” transactions

“RAPTORS”
• Established by Enron CFO to provide a quick buyer for Enron assets. • Option 1: Find a bona fide third party.
• Can’t find anyone?
• Option 2: Establish a SPE to take the other side of the transaction. • Where does the financing come from?
• 97% Sponsoring institution
• 3% Third party (now 10%)

CHEWCO

The Auditors:
ARTHUR ANDERSEN’S ROLE
• Did they know?
• Did they help?
• Why did they shred?
• Why were they convicted?

DID THEY KNOW?
• Feb 5, 2001 – Andersen partners meet.
• Discussed – Enron’s accounting, related parties, fees, etc. • For a significant amount of time, according to notes of the meeting, the

Andersen accountants debated a critical point: What should they do about two partnerships — called LJM1 and LJM2 — that had been set up 18 months earlier by Enron's chief financial officer, Andrew S. Fastow? • They drew up a "to do" list:

• Recommend a special committee of the Board to review LJM deals. • Review the SPE accounting tests.

DID THEY KNOW?
• February 12, 2001 – Andersen...
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