Enron Failure
ENRON: A FINANCIAL REPORTING FAILURE? Anthony H. Catanach Jr.1 Associate Professor 610-519-4825 anthony.catanach@villanova.edu and Shelley Rhoades-Catanach Associate Professor Both at Villanova University College of Commerce and Finance Department of Accountancy
INTRODUCTION The dramatic collapse of Enron Corporation, following a series of disclosures of accounting improprieties, has led many to question the soundness of current accounting and financial reporting standards. Within Enron’s reported financial statements, including related note disclosures, were there signs of Enron’s accounting and economic issues? Should an astute investor or analyst have been suspicious of Enron’s reported results? How did management hide debt, inflate profits, and support a stock price that considerably overstated the firm’s value? Did Enron incorrectly apply existing standards, or do these rules permit the accounting “gimmickry” that allowed Enron to obscure its true financial position? This paper attempts to answer these questions by examining the two financial reporting issues that contributed to Enron's most significant accounting restatements: the consolidation of special purpose entities (SPEs) and the issuance of stock for notes receivable.
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The authors gratefully acknowledge the financial support and resources provided by Villanova University's College of Commerce and Finance. The authors also thank Noah Barsky for comments and suggestions received on earlier drafts of this paper.
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First, we examine Enron’s financial performance during the 10 years prior to its declaration of bankruptcy. This analysis reveals increasing variability of key performance measures from 1997 through 2000, a time during which Enron’s stock price generally outperformed the NASDAQ composite. Additionally, using metrics developed by Beneish (1997) to measure the likelihood of earnings management, we find a high probability of earnings manipulation in Enron’s financial statements
INTRODUCTION The dramatic collapse of Enron Corporation, following a series of disclosures of accounting improprieties, has led many to question the soundness of current accounting and financial reporting standards. Within Enron’s reported financial statements, including related note disclosures, were there signs of Enron’s accounting and economic issues? Should an astute investor or analyst have been suspicious of Enron’s reported results? How did management hide debt, inflate profits, and support a stock price that considerably overstated the firm’s value? Did Enron incorrectly apply existing standards, or do these rules permit the accounting “gimmickry” that allowed Enron to obscure its true financial position? This paper attempts to answer these questions by examining the two financial reporting issues that contributed to Enron's most significant accounting restatements: the consolidation of special purpose entities (SPEs) and the issuance of stock for notes receivable.
1
The authors gratefully acknowledge the financial support and resources provided by Villanova University's College of Commerce and Finance. The authors also thank Noah Barsky for comments and suggestions received on earlier drafts of this paper.
1
First, we examine Enron’s financial performance during the 10 years prior to its declaration of bankruptcy. This analysis reveals increasing variability of key performance measures from 1997 through 2000, a time during which Enron’s stock price generally outperformed the NASDAQ composite. Additionally, using metrics developed by Beneish (1997) to measure the likelihood of earnings management, we find a high probability of earnings manipulation in Enron’s financial statements