Sarbanes-Oxley Act of 2002
Imagine over $60 billion of shareholder value, almost $2.1 billion in pension plans, and initially 5,600 jobs - disappeared (Associated Press, 2006). One would have to wonder how that is possible. These are the consequences the investors and employees of Enron Corporation endured after the Enron scandal started to unravel. This paper will focus on the infamous accounting scandal of Enron Corporation. It will also discuss how the company was able to fool investors by producing misleading financial statements, why they were not caught sooner, and new regulations enacted in response to the scandal.
Enron Corporation was a leading American energy company located in Houston, Texas. The company was started in 1985 when Houston Natural Gas Omaha-based InterNorth merged together (Thomas, Rise and Fall of Enron). Today, Enron Corporation is most widely known for their 2001 accounting scandal, which led to the biggest audit failure and largest bankruptcy in American history. After Mr. Jeffrey Skilling, Enron’s President, was hired, he began to build up a staff of top executives that were able to conceal billions of dollars of debt the company had incurred from failed projects and deals. Therefore, even when Enron was failing, they appeared to investors as profitable and growing. The staff worked together and was able to cover their debt through the use of complex accounting methods, special purpose entities (SPEs), various loopholes, and poor financial reporting standards. Enron aggressively recognized revenue using the merchant model (Haldeman, Fact/Fiction) which inflated trading revenue and helped create the notion that Enron was experiencing high growth and remarkable business performance. They adopted mark-to-marketing accounting which requires that once a long-term contract is signed, income is estimated as the present value of net future cash flows (Haldeman, Fact/Fiction) which also contributed to misleading numbers on Enron’s financial statements. Enron also used hundreds of special purpose entities, which are limited partnerships or companies created to fulfill a temporary or specific purpose-to fund or manage risks associated with specific assets, to hide its debt (Thomas, Rise and Fall of Enron). The company contained a compensation and performance management system that focused on temporary earnings to maximize bonuses, which only helped foster the reasons for the executives to conspire and mislead everyone, including Enron’s board of directors and audit committee of any accounting issues and Enron’s actual financial condition. Enron executives pulled every complex tactic in the book.
Even though the Enron executives were able to mislead Enron’s board of directors and audit committee, they should have been stopped. Public companies are audited on a yearly basis by external, independent auditors or CPA firms. During the external audit, auditors are reviewing the company’s financial statements to ensure that they are consistently following Generally Accepted Accounting Principles (GAAP), which are a dynamic set of both broad and specific guidelines that companies should follow when measuring and reporting information in their financial statements (Federal Accounting Standards Advisory Board). Businesses may deviate from GAAP however, they are responsible for explaining why they have deviated and that their current non-GAAP practice is ethical and appropriate for their situation. These audits take place to ensure that the company’s financial statements are as accurate and reliable as possible for investors and the general public. While GAAP provides guidelines on how financial statements should be presented, Generally Accepted Auditing Standards (GAAS) on the other hand are standards for the audit cycle of a company such as which tests to perform and to what extent (Business Definition). Arthur Andersen was the CPA firm responsible for auditing...
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