Group Assignment: Enron's Financial Downfall Case Study Report

This report analyzes the Enron case study, focusing on the company's financial practices and eventual downfall. It defines and explains the mark-to-market accounting approach, providing examples of its misuse by Enron's management to portray a favorable financial picture. The report also explores the role of special purpose entities (SPEs) and how Enron used them for funding contracts and manipulating financial reporting objectives. Furthermore, it examines the high compensation and stock options granted to Enron's top management, analyzing the purpose of these schemes through the lens of agency theory. Finally, the report assesses the ethical conduct of the accountants and auditors involved, evaluating their adherence to the code of ethics for professional accountants, and providing specific examples related to the case. The report is based on the provided assignment brief which requires critical arguments and a clear introduction and conclusion.

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Table of Contents
Introduction......................................................................................................................................3
Conclusion.....................................................................................................................................12
References......................................................................................................................................13

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Introduction
The focus of the journal was independently based on the fall of Enron Corporation. It dug
into the issues related to the ups and downs faced by the company throughout its lifetime. The
problems regarding its market to market accounting approach. The journal discussed and
elaborated the matters regarding the use of this market to market accounting approach used by
the company itself (Healy & Palepu, 2003). Discussion regarding this topic might help in
deciding whether the strategy used by the company in this matter was helpful or not. A study of
special purpose entities was done in this journal. This particular study helped in deciding how the
company used this strategy in gaining financial support (Braun, 2019). This study found that the
management and of Enron corporation enjoyed high remuneration and compensation. The
question thus comes out that what was the primary purpose behind this opportunity to the
management body, high amount of stock options to the management is a matter of question
(Eger, 2013). This particular benefit is the high amount of stock options were given to the top
management only and not the others. The examination to find out the purpose behind the same
was needed to be done. Therefore, the study focused on finding the reasons behind the same. The
study further focused on the examination of the code of professional ethics. It tried to dig into the
correlation of code of professional ethics with the auditors or accountants of the company. It
focused on finding out whether the auditors or accountants of the company followed the code of
professional ethics or not. The entire journal was attentive towards the rise and fall of the Enron
Corporation and the reason behind the same.

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The method of valuing an asset to its immediate level of the market is termed as Mark to
Market accounting method. It shows the amount and the value that one would receive based on
the asset value in the market on that particular day. It is also termed as market value accounting
or fair value accounting (Li 2010). The replacement value of the insurance policy is similar to
the Mark to market accounting method. Another alternative method of Mark to market
accounting policy is the historical cost accounting method. It helps in keeping the value of the
asset at the original level. It is somewhat similar to the condition of making insurance of the
depreciated value of an asset.
Enron's one of the major shift was the transition of the system of accounting from the
traditional historical cost accounting system to the mark-to-market or MTM accounting method.
For this reason, Enron received SEC approval officially in the year 1992. MTM can be defined
as the fair value of the market and the accounts that is dynamic and is subject to change with
time. The basic aim of MTM is to create a platform for a realistic appraisal of the company's
current solution on finance. This is a legitimate method and is widely used by
companies. However, one thing is to be kept in the mind that the method is manipulative as the
process of MTM is based on the fair value and not the actual cost (Bhaskar & Flower, 2019).
However, management or accountants perhaps misused this approach and led to its steady
decline. Here we will discuss the error made by the team of Enron of the MTM approach of the
company. The MTM had a role in hiding a lot of corporate losses of Enron. Enron was engaged
in derivatives and long term contract trading. This was used by them predominantly to make
more money. For this, they were needed to mark those contracts to market in its periodic

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financial statements, for instance, they had to declare the current market values of their assets,
the details of their assets and other relevant information (Ailon, 2015).
 Enron used to misuse the MTM and abuse it by two major practices. At the first step,
Enron used to develop fake and opaque numbers to show the actual worth of the energy
contract. It is to be kept in mind that natural gas and the prices of the futures can only be
accessed through NYMEX for a certain period of years for its use in the future. Enron
would just speculate a value and develop it as a legitimate value. This would increase the
company’s outlook and the performance of the company based on the profitability (Li
2010).
 In the second step, Enron recorded the total lifetime worth or value of any given contract
or on its Balance Sheet but did not put the value in that particular quarter. This practice
emerged Enron to be more valuable than it was. But in the end, the Enron issue had a
positive impact on improving the MTM methods and making it more transparent and
trustworthy for future use (Prebble, 2016).
 Enron Hailed for its Innovation
Enron created the Enron Online (EOL) in October 1999. It was an electronic trading website
that embodied on commodities. The counterpart of Eol on every transaction was Enron. It was
either the seller or the buyer. To entice the trading partners and the participants, Enron had
offered all its credit, reputation as well as expertise in the sector of the energy. Everyone praised
Enron for its expertise and expansions of its ambitious projects. It also received the title of
"America's Most Innovative Company" by Fortune from the year 1996 to 2001. Throughout this
period, Enron ruled the world (Vinokurova, 2019).

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 Enron's Energy Origins
The company of Enron was formed in 1985. Later two of the companies were incorporated-
Houston Natural Gas Company and Omaha based Internorth. The change followed this merger in
the CEO and the chairman of the company. Kenneth Lay, who was the Chief executive officer
the company named Houston Natural Gas became the chairman and the CEO of Enron. Enron
was rebranded and reframed as a supplier and energy trader. The deregulation of the markets of
energy allowed several trading firms as well as companies to place and set up bets on the prices
of the future. Enron took advantage of this situation. Enron Finance Corporation was created in
1990. Skilling joined the company at this important juncture of the company. It was an era of
minimal regulatory that helped Enron to flourish its business and maintain a high position in the
market. Throughout the period of the 1990s, the company flourished a lot, and the Nasdaq hit the
score of 5,000. The company had a great position in the stock market. This was subsequently
followed by more number of investors and creditors of the company (Kumar & Aldous, 2015).
 The Joint Venture
The joint venture is the most common and the basic form of SPE that is available in the
market. The joint venture is defined when two or more parties come together and engage
themselves in a common venture in expectations of returns and profits. The venture can occur
certain conduits known as SPE. The conduit can be of several types, namely corporation, trust,
partnership, LLC, and so on (Moon, 2017). The purpose of SPE is basically an entity purpose
and not a legal purpose. The nature of the project of SPE is isolated in nature. It creates attractive
conditions for investors. The company of Enron followed this principle and objective of SPE to
grab the attention of more number of investors and creditors in the company. These are some of

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the special purpose entities and how Enron’s management used them to fund contracts or achieve
financial reporting objectives.
Enron Corporation had a scheme that benefited the top management with high
compensation. This scheme was solely applied to the top management team and not the other
members of the company. There was an added benefit to the top management team, which is the
better stock options. In general, there are a numerous number of requirements for holding stocks
by a stockholder. In the case of Enron Corporation, there were a few requirements to be followed
for holding shares by the top management team. The company argued that the design of the high
compensation scheme was done to motivate the management team to make decisions that help in
short term stock performance. There was a need to establish the reasons behind the design of the
high-end remuneration or compensation scheme. Every company follows the agency theory
regarding corporation rules (Hasnas, 2016). The agency theory establishes four points for stating
the possible conflict between the board members of a company. The theory further stated that in
a conflict between the management bodies, the executive is to prioritize the shareholders over the
other members of the board (LAU, 2010). The agency theory gives an understanding of the
strategic decisions made by the corporate officers involved in a company body. The agency
theory firstly points out the decision-making protocol of a corporate body. The decision-making
protocol throws light on the decision-making conditions and criteria of a company. It states that
owning a share in a company gives that shareholder voting right in decision making of the
company (Clarke, 2013). There will be an independent vote given to every single shareholder on
any decision making on behalf of the company. In the case of Enron Corporation, the stock
options are given to the top management body of the company. Hence, the decision making
power is highly partial on the part of the top management team only.

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The second point raised by the agency theory is the greedy executive. The greedy
executive theory explains that where someone is given the power to make decisions, often clears
his way to the benefits (Kim, Prescott & Kim, 2005). In the case of a company, the management
body is given the power to make decisions, and the shareholders have the power to vote in that
case (Buckley, 2012). In the case of Enron, the top management body is empowered with fewer
requirements for stock holding. Therefore, the management team is more responsible for
decision making those other members of the company. In this case, it can be assumed that the
decisions made regarding the high remuneration and compensation were doe their own benefit
than the benefit of the company. The compensation and remuneration and the stock options as
been provided to the top management team only, it is clear that the benefit is solely related to
them only. The decisions made in the Enron Corporation was initiated by the management team
of the company. It is of no surprise that the members would look for their benefit than the benefit
of others while making the decision. Because of the circumstances might affect the entire
company in the long term. As explained in the last point for the agency theory, the long term and
short term interest get highly influenced by the company decisions. It has been examined and
analyzed that it is more beneficiary to invest in the long term returns than the short term returns.
Investing in the short term returns is less beneficiary than the long term investments.
In the case of Enron Corporation, the top management team has been gaining high-end
remunerations as well as compensation. This return was based on the outcome in the short term
investments of the company. The company did not focus on investing in the long term
investment neither planned for the long term investment. This decision regarding the design of
high-end remuneration was based on the outcome of the short term investments. The company
solely focused on giving the decision making power to the top management body. This

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eventually led the management team in making decisions concerning their benefit and not
otherwise. The Enron Corporation did not focus following the agency theory accurately neither
maintained the balance of power between the management team and the other officers. The
company believed in the strategy that providing the management team a high amount of
remuneration will motivate them. The motivation will be regarding taking decisions with a better
outcome of the company revenue.
The accountants and auditors of a company play a vital role in the financial decision
making of the company (Petrick & Scherer, 2003). The Enron Corporation had an expert team of
auditors in its audit team. There are several numbers of meetings held by the audit committee of
a company. In the case of Enron, the audit committee called for many short meetings that
covered a large number of grounds. The accountant team is responsible for following over the
financial matters of the company. The financial condition of the company is guided by the
decisions taken by the accountants. Any mistake done by the account team might affect the
financial condition of the company in the long or short term (Schwartz, 2003). The audit
committee includes both internal audit team and external audit members. The meetings called by
the audit teams cover many important issues regarding documentation and decisions of the
company. The audit committee covered all the necessary issues to be discussed in the meeting
successfully. The fund managers of the company as the account team did not follow the
professional ethics and hence failed to cope up with the duties. It was found that at some point
Enron was tagged an overpriced firm. This statement portrays the financial condition of the
company. Any kind of breakdown in the finance structure of the company raises a question
against the duties of the finance team. The accountants of the company were unable to recognize

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the upcoming possible risks of the company. In this case, it can be said that the account team did
not follow the professional code of ethics properly.
Ethics is a significant factor in intensifying the social value of an organization. With the
rapid growth of the competition in the entire market, the organizations are continually innovate
the organizational value, social value, and so on (World Health Organization, 2016). The
expansion development in corporate ethics leads the organization to enhance competitive
advantages. In addition to the active ethical principles improve the organizational standard and
aid to fulfill the various desires of the employees. Each and every regulatory staff desired to have
the ethical practices in a regulatory context (Kangas et al. 2017). The essential principles
comprised of accountability, autonomy, justice, integration, fairness. Enron Finance
Organization is mentioned in the case scenario, which had been established in 1990. Hence the
ethical principles had been considered as the predominant element to increase the value of the
Enron Finance organization. In the modern era, the minimization of regulation is the vital factor
that assisted the Enron finance organization to get flourished in the market. Apart from that, the
ethical principles also had to formulate in organizational context to evolve the social value of the
Enron Finance organization. The creativity in ethical formulation attracts various investors to
make a profound investment in the Enron Finance Organization. The auditors had certified the
accounting principles. Subsequently, the coherent application of accounting principles leads to
demonstrate the ethical value in Enron Finance organization. Moreover, the hierarchical
management of the Enron Finance Organization also aids to pledge adequate information about
the organizational financial condition (Feudtner, Schall, Nathanson & Berry, 2018). The
incorporation of adequate information towards the investors can be included as the ethical
activity in the context of the Enron Finance Organization. Initially, the organization also

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concerned about technological changes and product innovation. The appreciation of fundamental
principles such as the integration, honesty assists to influence the organizational activity (Galli,
Arteaga, Caprio & Kennedy, 2016). Moreover, the collaboration of the competent, ethical
principles aid to prevail in productivity and lead the organization to achieve technological and
product innovation.
Additionally, the emerging creativity in ethical formulation leads Enron Finance
Organization to inspire the mangers, auditors, investment community. The accomplishment of
ethical rules enables the political establishment and standard of the Enron Finance organization.
Hence there are intensive negotiation had been termed as the most prominent factor as it tends to
detail the inflexibility in the context of Enron Financial organization. Subsequently, the
apprehensive inclusion of integration, accountability, honestly leads tho prospers the ethical
value in Enron finance organization. Additionally, it also leads to demonstrate the organizational
context by prevailed the flexibility in the workplace. As an example, the various principles of
ethics included integration, prosperity, honesty, lead to demonstrate the ethical evolution in an
organizational context. Moreover, the accumulation of ethical intervention leads to inspiring
investors, consumers as well. Hence it motivates the employee activity and replicates the
technological innovation, product innovation in an organizational context. In addition to the
effective, ethical principles enhance the regulatory standard and aid to fulfill the various desires
of the employees.