Enron case analysis

Topics: Enron, Audit, Enron scandal Pages: 23 (5552 words) Published: October 9, 2014

Enron debacle: Case Report
Table of Contents

I. Understanding the Entity: Business Risk Assessment
1. Nature of the entity

1.1. Brief introduction:
Enron Corporation, a Houston based giant company, conducted energy trading business and gas pipeline transportation and distribution business in the energy and industrial sectors. 1During the 1990s, Enron transferred from a natural gas supplier and to an intermediary midstream company facilitating distributions between the suppliers and downstream customers. The company also focused on finance derivatives.2 1.2. Entity business operations break down: Line of business Table-1 Enron Line of Business Sector

Table-2 Enron Line of Business Sector EBIT (1999)

Table-3 Geographic dispersion of Enron Business Sector3

As we could see from table-1and table-24, Enron fractionized its business sector into four main subdivisions: energy wholesale services, traditional natural energy extrapolation, supply, marketing, and refinement business, transportation and distribution business, and broadband services business. The online trading platform is the subsidy from Energy wholesale services group. Furthermore, half of the revenue of Enron came from wholesale sector, which was highly volatile under the influence of financial market, geopolitical issues, macroeconomic. Table-4 Enron Management team

Noted from above information, Skilling became Enron’s CEO and quickly resigned six months later, which might be a red flag for the external agencies. 1.3. Financing: Related parties to the entity
1.3.1. SPE: Special Purpose Entities, which are the source of funding as well as non-financing activities of Enron, are organized as partnerships. Enron utilize the SPE under the 3% rule5 to give rooms to transfer loss to SPE and spin off part of the corporate debt to those SPEs, which had to use Enron’s stocks as collaterals to the creditors of the company, thus possessing huge potential credit risks and operation risks of the entity. 1.4. Financial Reporting: Considering the internet technology that time, certain specialists of auditors might be needed and materiality might be affected because the complexity of valuation of Enron’s energy supplying, extrapolating, trading, and marketing assets. 2. Industry, regulatory, and external factors

2.1. Industry:
2.1.1. The market and competition:
By the end of 1980s, energy market had stepped into a pace of competition of increasing each entity’s own market share. Enron not only thrived in the energy market, where crude oil or natural gas price became more marketable and transparent. Plus, Enron broke forward to the industry of financial derivatives. 6 2.1.2. Product technology relating to the entity’s products: It’s the entity’s first time entering a total unrelated market and the financial derivative market that time was not well developed with established risks management system. Therefore, Enron dumped into the energy market as well as broke through a relatively new market that was pegged to the Wall Street financial analysts’ perspectives and other investors’ unpredictable scrutiny. 2.2. Regulatory:

2.2.1. Accounting principles and industry-specific practices: Prior to the Sarbanes-Oxley Act, some of the accounting principles (GAAP) lied with loopholes and problems, which in practice allowed audit firms to provide certain non-audit services to the same client. Hence, audit firms that also offered consulting services to the same client were loath to maintain proper level of professional skeptism in order not to be dismissed by the client of their profitable consulting businesses. Gradually, the possibility and degree of acquiescence7 of auditors rose and the overall audit risks increased thereafter. What’s more, the Private Securities Litigation Reform Act (PSLRA) that time reduced the cost of auditor doing acquiescence by transferring the lawsuit and defendant difficulty and barrier to the...

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