An Analysis of Accounting Scandals: Lessons from Enron

The provided content appears to be a collection of various research papers, articles, books, and online resources on accounting, business ethics, corporate governance, and finance. The texts primarily focus on the Enron scandal, discussing its impact on accounting practices, corporate governance, and financial markets. Additionally, some of the sources touch upon related topics such as qualitative research in accounting, educational research approaches, and statistical analysis methods.

Accounting
research project

DECLARATION OF AUTHENTICITY
I hereby declared that, the present investigation is conducted while considering all the
ethical norms. The issue of plagiarism is avoided throughout the study and nothing is copied. I
have personal collected the secondary information from books, journals and online sources and
nothing is copied and pasted. The information is further collected from the authentic and reliable
sources. The secondary is properly cited in accordance with right authors.

ABSTRACT
Accounting scandal of Enron is major case of fraud and manipulation in US. This scandal
was resulted due to unethical practices of directors and auditors of the company. It is seen in the
case that initially the company was able to generate good value for the business but later these
practices leaded to the situation of insolvency.
Insolvency of the company had affected various stakeholders such as shareholders,
employees, public, investors and government. Investigation in present study shows that the
company had manipulated their financial values in order to hide their increasing debt. Due to this
aspect, shareholders of the company had faced huge capital loss and employees of the company
had lost their money saved in retirement account of company.
Enron had made use of creative accounting practices for the misstatement of financial
values in the accounting records. As a consequence, there was a huge hidden cumulative profit
that had later made drastic reduction in the value of business. The fraudulent accounting
practices were adopted by the company through creation of Special purpose entity and
application of revenue recognition concept and mark to market accounting. Further, auditing
issues shows the manner in which auditor of the company failed to report accounting frauds
conducted by managerial parties.

TABLE OF CONTENTS
1: Introduction..................................................................................................................................1
1.1: Enron's Beginning or Background........................................................................................1
1.2: Overview of research............................................................................................................1
1.3: Aims......................................................................................................................................1
1.4: Objectives.............................................................................................................................2
1.5: Chapter summary..................................................................................................................2
2: Literature review..........................................................................................................................3
3: Research methodology.................................................................................................................9
3:1: Introduction..........................................................................................................................9
3:2: Approaches, design and justification....................................................................................9
3.3: Selection of the research.....................................................................................................10
3.4: Data collection and analysis...............................................................................................10
3:5 Limitations of research........................................................................................................10
4: Results/Findings/Discussion and Analysis................................................................................12
4.1 Special purpose entities (SPE).............................................................................................12
4.2 Mark to Market accounting..................................................................................................12
4.3 conflict of interest................................................................................................................13
4.4 External audit.......................................................................................................................13
4.5 Truthfulness.........................................................................................................................14
4.6 Internal and external governance.........................................................................................14
4.7 Credit rating agency.............................................................................................................15
4.8 Corporate governance..........................................................................................................15
5: Government respond after eron Collapse..................................................................................16
5.1 Sarbanes-Oxely act..............................................................................................................16
5.2 Fasb reaction and reconsideration of standards...................................................................16
5.3 Was Sarbanes-oxley act enough..........................................................................................17
6: conclusion..................................................................................................................................18
7: Recommendations......................................................................................................................19
8: References..................................................................................................................................20

1: INTRODUCTION
1.1: Enron's Beginning or Background
Enron is an American energy company which is formed in the year 1985 through merger
of Intermonth and Houston Natural Gas by Kenneth Lay (Chairman and CEO). This merger was
completed after deregulation of the natural gas pipelines. In the process of merger, huge debt was
taken by the company due to which they were not allotted exclusive rights to its pipelines. After
some years of merger, Jeffery Skilling (former President, COO, and CEO) was hired by the
company. Within 15 years, the organization had attained the seventh position in the energy
industry.
The company was operating with the staff of 20000 and it was considered as the major
supplier of communication, natural gas, electricity and pulp and paper (Grey, 2003). In the end
of year 2000, the company had claimed revenue of $111 billion. Enron had built good reputation
in the market through their effective operating strategies. As a consequence, it was considered as
the most innovative company in America for six consecutive years. Enron was trading in more
than 30 different products and prior to the bankruptcy their corporate structure was bifurcated
into seven distinct business units.
1.2: Overview of research
This research has been conducted with a motive to evaluate major reasons that had leaded
to the collapse of Enron. For this, data has been collected from secondary sources. Further, it has
been analyzed by using qualitative techniques. From this study, it has been inferred that
management of company had taken benefit of accounting and auditing loopholes in order to
manipulate financial statements.
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1.3: Aims
The major aim of study into consideration is to identify reasons which had leaded to the
insolvency of the Enron. The research aims at showing loopholes in accounting and auditing
practices that had assisted company in hiding financial losses and debt portion in their financial
statements. The performance of the cited organization is judged in terms of finance i.e. revenues
and profitability. Further, analysis is conducted on government policies for corporate governance
and auditing practices in order to prevent such accounting scandals in the future.
1.4: Objectives
Objective of the present study is to evaluate key literatures regarding accounting scandal
of Enron. In addition to this, the study focuses on assessment that whether regulatory norms
developed by governing authorities are able to manage such scandals. For this aspect, various
provisions of Sarbanes-Oxley Act and IFRS are e considered. On the basis of this investigation;
recommendations are provided in context to auditing and accounting loopholes.
1.5: Chapter summary
Chapter 1 introduction provides description regarding background of Enron and route
map of present study. In second part of the study key literature is assessed by considering view
points of various authors. In third chapter, research methodology is discussed that is used to
attain aims and objectives of the study. On the basis of key literature, analysis is done in fourth
chapter in order to draw valid conclusion and to provide recommendation for the prevention of
accounting scandals in the future.
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2: LITERATURE REVIEW
Accounting scandal of Enron is major accounting fraud in the American economy.
Financial statements provided by the company were complex to understand due to the use of
window dressing and creative accounting norms. Jeffery Skilling had formed a team of senior
executives by taking advantage of loopholes in accounting practices. Moreover, the company has
created special purpose entities so as to provide misleading information (Enron: The real
accounting scandal, 2012). With the support of developed team, the company had hidden their
debt of billions of dollars in their financial position statement. This aspect resulted in the
situation of poor financial reporting of the company. High debt pressure on the Enron disclosed
in the end of 2001 and on 2nd December it was declared insolvent. Further, Andrew Fastow
(Chief financial officer) and other team members of executive committee had provided
misleading information to the Boards of directors and audit committee. Along with this, they had
pressurized Andersen for the ignorance of financial issues.
Financial statements provided by the company were not in accordance with the
qualitative characteristic of under-stability. Along with this aspect, there was also incorporation
of unethical business practices and complex business model (Nelson, Price and Rountree, 2008).
Financial manager of the company had used accounting limitation for the misrepresentation of
the profitability. As a consequence, they had successfully modified the position statement of
Enron in order to show favourable financial position. Further, they had supported the actions of
financial blunders without making detail enquiry of material transactions. In accordance with the
study of Petrick and Scherer (2013), Jeffrey Skilling had made use of mark to market accounting
for reporting inflated profits and assets. . In addition to this, he had also pressurized the other
senior executives to find a suitable way to hide their debt (Petrick and Scherer, 2013).
Study of Dharan and William (2008) has shown that revenues of the company were
increased by 750% in the 1996 to 2000. In 1996, revenue of the organization was $13.3 billion as
compared to revenue of $100.8 billion in 2000. Continuous expansion by 65% in each year is
above normal growth standards. By considering financial facts of reputed companies it can be
said that industry has standard growth of 2-3% (Dharan and William, 2008). On the other hand,
in nine months Enron had reported revenue of $138.7 billion in the year 2001 due to which they
were able to attain the sixth position in the Fortune Global 500. The company was able to report
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inflated revenue by adopting merchant model instead of agent model in revenue recognition
(Enron: The real accounting scandal, 2012). Other trading companies such as Merrill Lynch and
Goldman Sachs were making use of agent model to recognize their revenue. In this model, only
brokerage or trading fee is considered as revenue. However, merchant model is comparatively
aggressive in nature because it considers entire receipt as revenue (Crutchley, Jensen and
Marshall, 2007). With this strategy, management of the company was able to show prosperous
position to the stakeholders and board of directors. In order to show better competitive position,
rivalry firms such as Dynergy had also implemented this strategy and got listed in Wealthiest 50
declared by Fortune 500.
As per the study of McPhail and Walters (2009), auditor of the company had admitted
that there was an error of judgement on their side. It is because, debt of the company was
considered as off-balance sheet item (McPhail and Walters, 2009). This aspect had resulted in
overstatement of profit by $600 million during the period of 1997-2000. Grey (2003) had
highlighted another issue in this aspect that other partner in charge of Enron's audit was fired by
Andersen because he had demanded documents which were disposed off (Grey, 2003). This
action was taken by Andersen despite the fact that SEC had subpoenaed the firm as part of its
investigation into Enron.
Similar to the other companies, Enron had created Special Purpose Entities (SPE) for
assessing the capital and hedging the risk. In accordance with the Petrick and Scherer (2013),
SPE assists in increasing the leverage ratio and return on assets without affecting the debt side of
the balance sheet. In addition to this, these organizations provide hard assets in relation to a debt
from the SPE in exchange of an interest. For this aspect, huge amount was borrowed on behalf of
SPE from the financial institutions or bank (Petrick and Scherer, 2013). From the funds
generated, assets were purchased or operations of business were conducted without showing
accounting entry of assets and debts. In addition to this, the company had also sold the leveraged
assets to the SPE in order to book profit. For such accounting transactions, disclosure is not
required as corporate entity is in the position to avoid classification of SPE as subsidiary.
Study of Grey (2003) has claimed that special purpose entities had been used by Enron.
For this aspect, they had created companies and limited partnership firms in order to generate
funds and reduce the risks linked to the specific assets (Grey, 2003).. As per the study of Brewer
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(2007), series of accounting rules are dictated in order to show separate legal entity of special
entities from the main company. These rules had been considered by the management of Enron
for the purpose of financial reporting (Brewer, 2007). This research has also brought forward a
fact that by the end of 2001 there were 100 of special purpose entities by Enron in order to hide
their debt. In this aspect, main special purpose entities were following: Partnership with the
Thomas and Condor tax shelters, REMICs and real estate investment trusts (REITs) in the
Cochise deal, Financial asset securitization investment trusts (FASITs) in the Apache deal and
Real estate mortgage investment conduits (REMICs) in the Steele deal.
Matoussi and Jardak (2012) had stated that objective of these special purpose entities
were not only manipulating the conventions of accounting. Moreover; these entities had assisted
in undervaluation of liabilities and overstatement of the equity (Matoussi and Jardak, 2012). As a
consequence, the company was able to make overall increase in their earnings in order to show
their prosperous financial position. In accordance with the research of Cornelius and Kogut
(2003), the company had hedged the downside risk of equity shareholders through manipulative
financial position (Cornelius and Kogut, 2003). However, investors of the company were not
aware of the fact that the firm is making use of their own branches and stock to provide
guarantee of the investments in their own company for the purpose of hedging of risk. In this
aspect, example of Chewo, Whitewing, LJM and JEDI can be considered.
According to the analysis done by Steiger (2002), Enron had manipulated their leverage
ratios in accordance with the acceptable range in order to satisfy Moody’s and Standard.
Moreover, the respective manipulations had helped in satisfying criteria for Poor’s credit rating
agencies (Steiger, 2002). In this aspect, Fastow constantly lobbied the ratings given by these
agencies in order to enhance their rating. For the attainment of the higher ratings, the
organization’s main focus was on reduction of debt equity ratio. For this purpose, they had found
various ways such as disposal of hard assets in order to uplift the paper revenue.
Ailon (2011) had provided the fact that, in the guidance provided by Fastow,
management of Enron had adapted the approach of SPEs to the new heights of sophistication and
complexity for the purpose of capitalizing their business valuation by using their tangible assets
and obligations (Ailon, 2011). Along with this, the company had also used their complex
derivative financial instruments by making restriction of their stock, right of acquiring stock and
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other related liabilities. According to the study of Mishkin (2007), this transaction had made
financial dealings of the company more complicated. Apparently, the company had also used
their SPEs in order to park their business assets which were proposed to reduce the valuation of
the business. In this strategy, the main assets were stock or broadband operation in corporate
entities which had been spun off to the public and various overseas energy facilities (Mishkin,
2007).
According to the study of William (2012), Enron had established a joint venture in
energy investments along with the CalPERs (California state pension fund). This energy
investment funds were considered as JEDI (Joint Energy Development Investments). In 1997,
Skilling had proposed CalPERS for the investment in Enron (William, 2012). Management of
CalPERS was interested in this proposal only if they were terminated from partnership in JEDI.
In this aspect, Jeremiah (2006) had stated that Enron did not want to show any debt in their
financial statements. As a consequence, CFO of the company had developed special purpose
entity i.e. Chewco Investments limited partnership (L.P.). This organization had raised
guaranteed debt and these funds were used by Enron to take joint venture stake of the CalPERS
for $383 million (Jeremiah, 2006). Through the formation of this organization, management of
Enron was able to hide loss of joint venture in the balance sheet.
In the report of Benston and Hartgraves (2002), this arrangement of Enron and CalPERS
was disclosed. In addition to this, further inquiry in this subject matter had leaded to the
discontinuation of accounting method that was used by Enron for recording of financial
information of JEDI and Chewco (Benston and Hartgraves, 2002). By considering the
implication of this disqualification, it was disclosed that reported earnings on part of Enron from
1997 should be reduced by $405 million and debt portion of the balance sheet should be
increased by $628 million. Similar to this accounting fraud, another special purpose entity that
was formed by Enron was Whitewing. This organization was formed through - investment of
$759 million by Enron and $500 million by the outsider investor in 1997. After two years,
alterations were made in the arrangements of this organization through continuation of
consolidation of this company was not required. As per the viewpoint of Unerman and
O’Dwyer (2004), Whitewing was mainly used for the purchase of Enron miscellaneous
assets. In between 1999-2001, the company had transferred the assets of worth $2 billion. These
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transactions were approved by the board of company even by considering the fact that these
transfers were not actual sales (Unerman and O’Dwyer, 2004).
Enron had transferred assets of worth $1.2 billion to Raptor. These assets were inclusive
of millions of the shares of company, notes payable and long term right to purchase. In
accordance with the report of Welker (2004), values were not included in debt instruments.
However, in footnotes it was declared that worth of instrument is $1.5 billion and in addition to
this notional amount of $2.1 billion is used by the company for entering into derivatives contract
with Enron. However, this derivative contract had faced significant reduction in face value
because stock price of Swaps established at that time was reached to its maximum price. In order
to ensure the value of portfolio under the swaps reduced by $1.2 billion as stock price was
reduced company had used to approach of mark to market accounting (Clikeman and Lemon,
2010). With this method, they were able to claim the profit of $500 million in the annual report
of 2000. However, actual loss occurred was $1.1 billion in accordance with the provisions of
derivatives contract. The profit that was claimed on part of the company had resulted in
offsetting the losses of stock portfolio and actual loss that was restated in the year 2001.
Study of Thomas (2002) has shown that this strategy did not work well for the company.
It is because, Enron began to raised high obligations through issuing their own stock by making
reduction in their value as a consequence there was devaluation in the assets of partnership firms
(Thomas, 2002). As a consequence, there was huge downfall in the stock price of Enron because
of the issue of compounding. In this aspect, most controversial SPEs of Enron were LJM2, Co-
Investment LP and LJM Cayman LP. These SPEs were operated by Fastow himself. The
objective of these organizations was to make improvement in the financial statements of
company by buying stocks of the company. This aspect shows that LJM 1 and 2 were formed
mainly to serve as the outside equity investor that was being used by Enron. For this formation,
Fastow had to take permission from the board of directors in order to apply exemption from
Enron's code of ethics in order to manage corporate entity. It is because; he had title of CFP in
SPE. These partnerships were formed by the funds of $390 million. The main contributors of this
amount were Credit Suisse First Boston, J.P. Morgan Chase, Wachovi and Citigroup. This
approach had generated funds of $22 million for the company.
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In accordance with the accounting records of company, these organizations had paid
management fees of more than $30 million during the period from 1999 to July 2001. This
amount was excessively high in comparison to the approval provided by board of directors of
Enron. In this aspect, Stolowy (2005) had stated that LJM partnership had made investment in
another group of SPEs i.e. Raptor vehicles. This SPE was formed for the purpose of hedging in
Enron investment in Rhythm NetConnections (a broadband company that was proposed to be
bankrupt in near future). For the capitalization of this entity, Enron had issued a receivable note
of $1.2 billion. With the benefit of this transaction, they had made an increase in the
shareholder’s equity and receivable amount (Stolowy, 2005). This accounting transaction had
completely violated the provisions of Generally Accepted Accounting Principles (GAAP). In
addition to this, they had failed in consolidating the transactions of Raptor and LJM into their
financial statements wherein n subsequent information was mandatory to be disclosed. Lashinsky
(2001) had stated that Enron Scandal was not sole result of misfortune in the commercial energy
industry or personal crookedness. This was due to reason that collision of Enron was possible
due to severe flaws in the provisions of American capitalism (Lashinsky, 2001).
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3: RESEARCH METHODOLOGY
3:1: Introduction
Methodology is a vital part of research study because it provides assistance for evaluating
the appropriate approaches that can be used for completing the report in a proper manner. Present
research is focused on accounting scandal in Tesco which creates various issues for the
company. By making use of research methodology, learner will be able to understand the
accounting issues of corporate entity in an effective manner. In addition to this, better
information will be collected by the researcher in order to achieve aims and objectives of the
study.
3:2: Approaches, design and justification
At the time of carrying out any kind of research, there are four main type of research
approaches which are generally used by a scholar. This includes qualitative, quantitative, case
study and mixed approves. Further on the basis of nature and objectives, adequate research
approach is employed (Modell and Humphrey, 2008). In case study approach, the scholar deals
with number of and carry out in depth study of those cases with the help of various techniques
and methods. In the present study, case study approach of research has been adopted. Further the
scholar has carried out an in-depth analysis of the entire case of Enron failure. With the help of
case study approach, the scholar has been able to become aware and understand various kind of
complex issues which were associated Enron's failure. Along with this, the theory is also tested
in context of accounting and auditing standards which were associated with Enron’s case. It can
be stated that a case can be drawn on qualitative, quantitative and on both. For the present study,
qualitative case study is employed as it describes and identifies various kind of event and facts
associated with Enron case.
In context of research design, it can be stated that there are various kind of research
design which can be adopted by a scholar. This includes descriptive, exploratory, interpretive,
instrumental, evaluation and explanatory (Jackson, 2010). In the present study, exploratory
research design has been adopted with the motive to explore the complete case associated with
Enron's failure. Moreover secondary data has been taken into consideration in this entire study.
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3.3: Selection of the research
Every research is carried out by using any one of the two approaches which are inductive
and deductive (Howell, 2013). Deductive approach aim at testing existing models and theories
which supports a particular scholar in accomplishment of all its aim and objectives. On the other
side of this, inductive approach deals wit generation of new theories wit the help of existing data
(Johnson and Christensen, 2008). in order to discuss and carry out research in more effective
manner, deductive approach has been used in this study. Further with the help of this approach
the researcher has tried to focus in all those people who were associated with the scandal of
Enron.
3.4: Data collection and analysis
Data collection is important part of the methodology because it provides appropriate facts
and figures for the analysis. Research data can be mainly collected from two sources i.e. primary
and secondary sources (Vaivio, 2008). Primary data is collected from sources such as interview,
questionnaire and observations. Further, secondary data is available through journals, books,
articles, annual report of the company and other internet sources.
Present study has been conducted on the basis of secondary data. Data has been collected
from this source because information on Enron scandal is already collected by other researchers.
This information can be attained through research journals, books, magazines, newspapers and
online website. Data collection from this source is cost and time saving.
In this research, collected secondary data has been analysed in order to draw valid
conclusion. Collected data for the research can be analysed through various techniques such as
narrative analysis, textual analysis, documentary analysis, content analysis and historical analysis
(Fiegen, 2010). For the present study, historical approach of analysis has been considered. This
method has been selected for data analysis because past information is collected on Enron case
study. Further, this study will provide lesson to the corporate firms for the prevention of
accounting manipulation in their books of accounts.
3:5 Limitations of research
Present study is conducted on the evaluation of accounting scandal of Enron. Major
limitation of present study is lack of primary data in analysis. It is due to time restrictions and
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lack of resources. In addition to this, present study is based on the historical case due to which
exact information is not precisely available. Accomplishment of entire course of study is a
prolonged procedure. It is because; in a research variety of tasks and activities are required to be
completed in a sequential manner. This procedure comprises of data collection, its analysis and
conclusion and recommendation. Further, entire research is based on the secondary data.
Available information from secondary sources was not completely reliable.
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4: RESULTS/FINDINGS/DISCUSSION AND ANALYSIS
The story of Enron Company is very interesting as it reached a great height of success
and ended by with bankruptcy. Majority of the workers had an impact of this bankruptcy and
entire community of Wall Street was in a great shocked. This was because of all the fake book
accounts presented by Enron. Many scholars ave done researcher in order to examine the entire
process of Enron success to failure (Gwilliam, 2008). Some of the major facts which are
excluded in study were wrong identification of income, misleading statements related to
finances, unsuccessful corporate governance of the company and other issues related to finances.
To a great extent the techniques used to carry out the financial transaction was also unfair.
4.1 Special purpose entities (SPE)
One of the core purpose behind development of SPE is to carry out an task or a particular
activity. Further this activity is funded by integration of sources such as debt finances and
equity. In order to accomplish its purpose of financial reporting, there were many SPE's
developed by Enron. Back in the year 1991, the company was eager to purchase stake of
partnership in one of its already running joint ventures (Mizrach, 2011). Along with this, there
was no debt recoded or reflected by the company in its balance sheet. Such kind of unfair
practises were adopted by Enron several times. The company utilized many of its SPE with an
objective of carrying out off treatment of its balance sheet. In some situation there was no
increase or decrease in the assets and liabilities side of the company even if it was carrying out
various kind of financial transactions. This served Enron as an tax benefits and also reduced the
cost of company. During the time when, the company collapsed,majority of its investors have
lost millions of their money (Criado-Jiménez, 2008). The existing executives are considered as
the reason for such a big financial loss for all investors. At the time of its bankruptcy, the
company has paid a large sum of $56 million dollars to one of its auditor Artur Anderson.
4.2 Mark to Market accounting
One of the main reason regarding the use of mark to market accounting by CEO of the
company Jeffrey Skilling was that he having knowledge regarding the hidden loses of other
operations. It was the security exchange commission of America which allowed the Chief
executive offerer and Chief financial officer to employ methods such as mark to market
accounting (Jamal, 2008). On the other side of this,it can be stated that use of MTM accoutring is
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more beneficial to businesses with the objective of security. People also argued that it was the
lack of knowledge regarding the accounting method adopted by SEC which has resulted into
such big financial scam. The MTM accounting method was also used by the company during the
time when it entered long term gas contract with Cuiaba which is an Brazilian enterprise
(Balkaran, 2008). People saw that Enron was integrated with Cuiaba to control the gas market
but in reality what it was doing was manipulation of incomes. Other than this, the brand also
created a joint venture with Blockbuster Inc. and at the same time formed a partnership with
Braveheart. Enron used to record income even in case if there were only few customers (Bing,
2009). An amount of $115 million dollar was issued in the form of bank loan to create
partnership with Braveheart. The company ensured bank that it will be providing money in
terms from its new ventures formed. Another interesting fact in this case is that as per the view
of bank, the money provided was loan but in view of Enrow, it was merely a transaction as
sales.
4.3 conflict of interest
Artur Anderson which was the auditor of Enron was found faulty for applying wrong and
misleading standards related to accounting. This was due to the sum of $27 million which was
received for carrying out the entire process of auditing (Steiger, 2002). 27% of the entire auditing
fees was received by Artur Anderson and another $24 million as an consultation for auditing.
Along with this, he is also considered as the person which motivated Enron to use various kinds
of CPA's so that the loopholes can be overcome (McPhail and Walters, 2009). Another objective
behind this was to capitalize the loss which some of the projects were having. It was very much
clear that all the accounting standards were breached by Artur Anderson with an prime objective
of self interest (Stolowy, 2005).
4.4 External audit
One of the major turn in the case of Enron came when Artur Anderson accepted the
errors (Nelson, Price and Rountree, 2008). Further it was the 4 Special purpose entities which
were providing some assets of the company with hedge counterparts. Along with this, it became
very much clear that the auditor assisted the company to create an unconsolidated Special
purpose entity which in order to fence the sum of total $10 million dollars (Thomas, 2002). All
this was done in stock of Rhythms Net Connections and in the year 1999, the amount was raised
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to $260 million dollars. It can be also stated that it was only because of the unconsolidated entity
as consolidated entity would have lead to elimination of all the income received. The auditor of
Enron who was Artur Anderson also played a very significant role in development of transaction
such as FAS 140 and prepay transaction and other related tax transactions. One of the most
interesting fact about prepay transaction was that there main objective was to generate ample
volume of money which can be treated as cash flow from all the operating activities (Thomas,
2002). Instead of rising profits, these transactions were doing completely different thing. In
addition to this, with the help of FAS 140, Anderson was also able to convert all those assets into
cash which were not convertible easily. After doing this, he eliminated all those assets from
balance sheet. Along with this, he developed transaction of tax in such a manner that they
increased the company's new income before tax.
4.5 Truthfulness
Another factor which can be considered as the reason for Enron bankruptcy is that all its
management staff lacked truthfulness (Unerman and O’Dwyer, 2004). When studies and
researches were carried out on Enron, there was no information and facts identified with regards
to the conversation which took place between employees and CEO related to sale and increased
prices of stocks. Majority of the company's shareholders were not aware of the fact about stock
sell of Enron's. It was the investigators which found and provided this information to all
shareholders of the company (Vaivio, 2008). The reason which was associated behind sale of
stock was to pay the amount owned by CEO to Enron.
4.6 Internal and external governance
In the year 2007, Gillan and Martin carried out a study where they revealed the fact that
lack of independence and complete failure in internal governance are the two main issues
associated with the failure of Enron. The company was having direct financial relation of some
of the external sources (WELKER, 2004). This includes the market pressure which was not
considered by all the regulatory bodies of government. In addition to this, private businesses
such as credit rating agencies were also in direct financial relationship with the company.
The company has received a number of warning sign and its broad of management failed
to recognize any one of those signals. The special purpose entities which were having off balance
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sheets got approval for the company's broad of management. Other than this, the chief financial
officer of Enron also failed to disclose some of its major transactions.
4.7 Credit rating agency
To a cretin extent businesses such as credit rating agency and equity analysis are also
considered as a major reason which lead to the decline of Enron (Will, 2006). At the time of
evaluation, equity analysis was not able to determine the actual amount and value of the
company's stock. At the time of operating at such a huge level, businesses are required to identify
and reveal actual amount of all their stock. Along with this, entities such as credit rating agency
also failed to make solve the problem and issues which the company was facing at that time
(Mishkin, 2007). It was also observed that the agency provide people and other parties with
wrong information regrading the financial situation of Enron. This is treated as one of the factor
which has resulted in collapsing the entire system of the company.
4.8 Corporate governance
There were several kind of twits and turns which occurred at the time when Enron was
operating. The role of corporate governance in the failure of Enron is also very significant the
company failure the shareholder were having almost zero percent contribution (Model and
Humphrey, 2008). At the time when Enron failed, majority of shareholders were perceiving a
very good and bright future of the company. Furthermore, the corporate governance authorities
was also found in ineffective in carrying out its task. Some reason which are being clubbed with
SEC collapse includes low staffing, under-resourced and very less monitoring and review of the
new registration (Petrick and Scherer, 2003). This all things made the different components of
entity weak and resulted in its collapse.
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5: GOVERNMENT RESPOND AFTER ERON COLLAPSE
It has been spotted that after a collapse of Eron the employment and saving of 19000
employees has been affected. Due to extreme level of loss, number of people has faced issues
regarding security and future aspects. Financial issues has also impacted negatively on the role of
its shareholders as well as workforce. It also forces the governance authority to design new
policies that can control such type of conditions.
5.1 Sarbanes-Oxely act.
Sarbanes-Oxely act has been established by United States congress in year 2002. It is law
that has great involvement in auditing and corporate disclosures. In the support of this, number
of changes in regulations has entitled business firms to establish auditing system that will ensure
about financial statements. Sarbanes Act section 404 has focused on the importance of inner
controls that maintains management accountability in adequate manner. It can be said that the
classification of diverse control systems are taken into account as per corporate annual reports. It
is also necessary to ensure that the CEO and CFO has signed the statements in order to improve
the control system. Moreover, Sarbanes Act also ensure that the corporate officers are not
involved in any kind of mislead or issues in context of auditing. Few guidelines has been
provided to make adjustments and balance the liabilities. Factors involved in act are also
beneficial for Enron as it provides better protection in context of collapse. It is considered as
combination of ethical codes. The requirements of Sarbanes act discussed above was not the only
ones but there are many several provisions which were made to prevent the Enron type of
collapse in the future and satisfied the public that the government responded to this collapse
(Clikeman and Lemon, 2010). One of key negative aspect relates with the law was that it was not
applicable to the private business organizations, non profit organizations and governance
authorities. It was only applicable to Enron and other auditing firms.
5.2 Fasb reaction and reconsideration of standards
Auditor standard board is accountable to ensure about unethical activities and
identification of fraud as per the standards which are developed after Enron Collapsed. One of
standard is named as SAS 82. It ensure about fraud in financial statements and provide
guidelines to auditor for effective identification of risk. It also provides better control to various
activities of management . Other than this, it has also been spotted that after the case of Enron
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the FASB has focused on various changes that can improve accounting procedures and provide
ethical working. Moreover, FASB has also focused on development of SPEs in order to improve
the conditions but authority has failed in effective accomplishment of goal. It has been spotted
that the SPEs can be misused so FASB has revised the accounting standards in year 2002 to
ensure about the overall issue. As per the consideration of standards it can be said that the key
issue in Enron was due to manipulating aspects present between management and auditor. It has
impacted the financial statements and forced to raise the prices of stock in order to improve value
of stock (Desai, 2011). It has also caused various issues for top management level and influenced
financial statements in negative manner.
5.3 Was Sarbanes-oxley act enough
Financial analyst has accepted the governance efforts and establishment of law has
reduced the issues like Enron collapse. With an assistance of Sarbanes Act, the issue of Lehman
Brothers has been resolved as it has provided effective auditing system. It has been spotted that
the organization hides large amount of debts. In the support of this, it can also be said that the
Sarbanes Act section does not indicates various conflict in context of audit companies. But has
provided an ability to maintain balance between income and good. Other than this, PCAOB has
focused on various changes in order to overcome conflict and improve situations. There was
some loops holes in law that can impact auditing system so various alternative principles has also
been enforced for better outcomes. Certain standards in section 404 has also been required to
improve internal and external auditing system.
Other than this, the reconsideration of auditing standards has also been required to
expand the audit profession in context of quality and regulation. In this support, PCAOB has
focused on various random inspections of audit firms in order to maintain the effectiveness of
standards. Number of audit firms and professionals were not sure about the law and its principles
as it also creates the confusion in respect of legal outcome (Mizrach, 2011). It has resulted that
the selective enforcement of specific rules was also one of alternative method. However, the act
has also created various obstacles for mistakes and misstatements which was also advantageous
for accounting profession. In respect of section 44 it can be said that the internal and external
auditing activities were time consuming as well as expensive so the auditors has started charging
high from clients in respect of auditing.
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6: CONCLUSION
On the basis of analysis, it has been concluded that the auditors of Enron were more
biased and partial. Due to this, aspect, they failed to represent the fair view of financial health
and performance of an organization in front of the various stakeholders. It is the main cause due
to which business value of Enron was decreasing. It can be seen in the report that several
employees were employed due to financial scandal. In addition to this, shareholder had suffered
the loss in billions of dollars. Further, it can be concluded that Enron had adopted the unethical
accounting practices to show the high profitability aspect with the aim to attract investment.
Besides this, it can be inferred that the company was focusing on hiding of their financial
scandals rather than making strategies to improve their financial aspects. The unethical and
fraudulent practices adopted on part of Enron resulted in a big scandal. The same could be
avoided by following simple accounting procedures and rules. Moreover, the government’s
efforts to prevent all such kinds of scandals had not succeeded. The country’s government should
therefore bring up changes in legislations so as to leave no room for adoption of fraudulent
practices.
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7: RECOMMENDATIONS
 Government authorities are required to develop standard norms for the accounting and
auditing practices without any material loopholes to prevent accounting scandals such as
Enron. They should assure that same auditor do not serve auditing services in the continuous
manner. Further, Arthur Anderson LLP was a private firm conducting the audit and their
objective was to earn profit instead to assure financial accuracy. By considering this aspect,
government should control auditing firms for better transparency.
 They should develop strict guidelines for the auditors through which they cannot
compromise their independence for material benefits. In this case, Arthur Anderson had
taken high fees in order to support the company in their financial blunders. If this aspect was
avoided, then true financial position of the company had been disclosed to the shareholders
previously.
 SEC is required to establish the accounting body in which experienced and qualified
individuals should be recruited for monitoring the auditing firms.
 This body should operate without interference of public bodies. Standard guidelines should
be developed by Financial Accounting Standards Board for preventing manipulation of
accounting norms in the financial statements.
 In situation where there is doubt or possibility of conflict of interest then the restriction
should be imposed by the government. Shareholders and directors must be involved in the
decision making process to be aware of company’s operations.
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