CIA 2001
ADVANCED FINANCIAL ACCOUNTING AND REPORTING
SEMESTER 1 SESSION 2020/2021
GROUP ASSIGNMENT
LECTURER: DR. DALILAWATI ZAINAL
PREPARED BY:
GROUP 2 (TUTORIAL SLOT: WEDNESDAY 1PM-3PM)
NO.
NAME
MATRIC NUMBER
(OLD)
MATRIC NUMBER
(NEW)
1.
HAFEEZA BINTI
KAMALUDEEN
CIA190033
17204549/1
2.
MUHAMMAD ZULHILMI BIN
ZAINAL
CIA190078
17205717/1
3.
NUR AFIFAH BINTI ABD
GHANI
CIA190084
17204953/1
4.
NURUL LIYANA BINTI
MOHD KHAIDIR
CIA190100
17202382/1
5.
SHAMMITA RAM A/P
RAMALINGAM
CIA190119
17206821/1
Table of Contents
NO
TITLE
PAGE
1.
Introduction
1
2.
Ethical Issues Involved
1-2
3.
Causes of the Scandal
2
4.
List of Parties Involved and How They Involved
2-3
5.
How Did the Company Solve the Problem?
3-4
6.
How Ethical Issues Affect the Quality of Financial
Reporting and Implication to the Company? Any
Implication to the Company?
4-5
7.
How to Overcome the Problem?
6
8.
References
7
1.0 Introduction
American’s energy, commodities and service company named Enron was
formed by Kenneth Lay in 1985 with the merging of Houston Natural Gas and
InterNorth Inc. and located in Houston, Texas. Enron was once the 7th largest
company in America and the largest buyer and seller of natural gas and
electricity. With market capitalization exceeding $60 billion and its stocks
priced at $83.13 by December 2000, Enron Corporation was awarded
“America’s most innovative company” for six consecutive years.
2.0 Ethical Issues Involved
2.1 Mark-to-market accounting which brought to overstating of
revenues
Initially, Skilling contributed to transforming Enron’s accounting
practices by changing conventional historical cost accounting approach to the
accounting method of mark-to-market (MTM) after it got its official approval
from SEC in 1992. He used MTM accounting by saying it shows how the real
economy is but it is actually used to inflate their revenue.
For instance, Enron dealt with customers to estimate oil and gas prices by
using derivative trading and long-term contracting in 10 years. They
recognized the total profit over the estimated lifetime immediately before any
work has been performed or expenses incurred to execute the contract. In
other words, the present value of future cash flow is the profit. To summarize,
they did a fraudulent timing difference in reporting by using MTM to quickly
recognize long-term contract revenue.
2.2 Usage of Special Purpose Entities (SPEs) to hide losses
SPEs are off-balance-sheet structures that isolate financial risk of a
firm. Its legal status enables parent companies to secure their assets that sold
to investors with the cash turns back to the parent company. With this being
applied, Enron buries their debt while increasing short-term cash flow.
One thing without doubt is that Enron had used hundreds of their
off-balance-sheet SPEs to suppress their debt, causing their liabilities to look
dubiously lesser compared to their assets in their financial statements. A solid
and questionable example was LJM Cayman LP, who invested in one of
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Enron’s SPE called Raptor vehicles and exchanging issued common stock
with a $1.2 billion worth of note receivable as part of the capitalization of
Raptor entities. But, Enron increased shareholders’ equity and notes
receivable for this transaction. To conclude, Enron violated the Generally
Accepted Accounting Principles (GAAP) because of failing to consolidate
those SPEs into the financial statements when they should have been done
otherwise.
3.0 Causes of Enron Scandal
1. Competitive environment
Enron’s high competitive environment actually lead to a deception society.
They focused only on how to make their results look good because their
workers were worried about losing their jobs. They ignored the ethical norms
and concentrated on achieving their financial target. After a few employees
decided to cheat on their jobs, others began to cheat more. No individuals
were afraid of cheating because they had no other options as all of their
co-workers were cheating around them as well.
2. Emphasized too much on the financial goals.
Too much focus was put on financial targets by Enron. The hero of the
company will be the one who can meet the budget estimates. Both managers
and workers focused on making false gains by producing good financial figures
instead of improving the company’s economic value. For example, we can take
an immoral leader, Jeff Skilling where he introduced mark-to-market
accounting method to hide the company’s financial losses in order to make
Enron as to be the biggest wholesaler in the gas and electricity sector.
4.0 List the parties involved and how they were involved
1. Kenneth Lee Lay
From 1985 to 23 January 2002, he held the position of Chief Executive Officer
(CEO) of Enron Corporation. However, Jeffrey Skilling took over the position
for a few months in 2001. Kenneth Lay was charged for making false
statements, involved in fraud and money conspiracy in 65-page indictment
2
documents. On 25 May 2006, Kenneth Lay was found guilty for cheating and
making false statements.
2. Jeffrey Keith Skilling
Jeff Skilling was the ex-CEO of Enron Corporation. He enabled Enron to be the
greatest wholesaler in the electricity and gas industry by promoting aggressive
investment strategies. He also introduced the mark-to-market accounting
method where each agreement’s expected future profit is recorded at current
market value, not at future value or historical value.. In 2006, he was convicted
for making false statements, conspiracy, fraud of share certificates and insider
trading (based on unpublished or confidential information, the offence of
buying or selling shares).
3. Andrew Stuart Fastow
Fastow was the Chief Financial Officer (CFO) of Enron Corporation. He
developed a company website that does not exist at all. The said company
then made a fake transaction with Enron to raise the money of the company.
The intention was also to hide losses accumulated from its quarterly Balance
Sheet to make it seems like Enron was a debt-free company.
4. Arthur Andersen
Arthur Andersen is one of the 5 large accounting firms known as The Big Five.
Arthur Andersen was found guilty of obstructing justice by destroying
thousands of documents and removing emails and files that were needed for
auditing purposes.
5.0 The way company solve/ deal with the problem
In December 2001, the world was shocked by the news of the Enron
bankruptcy. It happened when the media started to question whether Enron
was overvalued or not. It put pressure on the stock price of Enron which was
as high as 90 dollars a share before. Less than two years later, Enron credit
rating was downgraded by the credit rating agency. They started selling lots of
shares and prices continued to decline until they ended up at below $1. Then,
Enron’s bankruptcy was filed with over 20,000 workers and $2 billion in a
long-term retirement of employees.
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Enron did not give up easily and they tried its luck to save the company
from bankrupting and merged with their rival, Dynergy. Unfortunately, Dynergy
did not accept it because Enron’s credit rating was extremely low. On the 2nd
of December 2001, Enron was desperately looking for bankruptcy protection
under Chapter 11 (Bankruptcy Code). Generally, this code allows for
reorganization. The new Enron Board of Directors changed its name to Enron
Creditors Recovery Corporation (ECRC) after the U.S Bankruptcy Court
approved the Restructuring Plan. The company’s mission was restructuring
and liquidating some of the 'pre-bankruptcy' activities and assets of Enron for
the benefit of creditors. Investors lost billions of dollars in the Enron case. The
company paid more than $21.7 billion from 2004 to 2011 to its creditors.
Many Enron executives were convicted with a variety of charges. In
2004, Lay was convicted by a grand jury on 11 charges and he was
surrendered to the FBI. Skilling was convicted for fraud on several counts and
was sentenced to prison in 2006. Andy Fastow, the financial officer of Enron
was sentenced in 2006 to six years in prison. Skilling was sentenced to a
prison term of 24 years by Judge Lakes and imposed a fine of $45 million; later,
the sentences were reduced to 14 years. This bankruptcy was such the largest
filing in U.S. history. Enron’s reputation has become synonymous with
business greed and corruption.
6.0 How do unethical issues affect the quality of financial reporting
Financial reporting should have decision-usefulness when the financial
report is relevance and faithful representation. However, those two qualities
are not fully applied in the Enron financial statement in recognizing revenue
and misused Special Purpose Entities. For instance, in July 2000, 20 year
agreement about establishing on-demand entertainment to different U.S. cities
by year's end has been signed by Enron and Blockbuster Video. Despite the
fact that the technical viability and market demand of the service are
questionable by analyst, Enron claimed estimated profits of more than $110
million from a few pilot projects that they have signed. Blockbuster drew out
from the contract when the network failed to work. Enron proceed to declare
future profits although the deal caused a loss. This shows that Enron financial
4
statements are not free from error (faithful representation) and does not
provide relevant information. All this matter lead to inaccurate ratio
computation by stakeholders then make wrong decision. For example, the
investors did not want to sell their stocks due to good profit.
6.1 Implication to the company
a. Going concern issues
It is vital to demonstrate the stability of the entity. In the case of Enron,
inflating profit to become higher affects the stock price of the business. The
stock prices kept increasing and more investors bought the stocks due to
misinterpreted company performance. Consequently, when Enron reviewed its
financial statements for the previous five years, they actually had posted $586
million in losses instead of profit, its stock value began to decline. Enron faced
bankruptcy and the investors lost approximately $11 billion dollars when
Enron’s share prices declined to less than $1 by the end of November 2001. If
Enron discloses the accurate financial statements, a negative trend like
declining sales, increasing costs, recurring losses will be referenced to
manager and shareholders to make the right decision.
b. Impact to employees
Financial statements used by employees to analyze the performance of an
entity or company that they work for. Therefore, they can make a prediction
whether the company is able to sustain for a long time or there are possibilities
for them to get fired. The scandal has caused thousands of employees to lose
their jobs and face retirements without a nest egg. Some of the employees that
have shares in Enron’s stock were unable to sell their stock when the firm was
crashing because of Kenneth Lay’s advice. Kenneth Lay encouraged them to
keep their stock but he and his executives were immediately selling their
shares to avoid loss. As a result, the employees lost some of the savings,
retirement funds and had to find new work. They also have difficulties in getting
a new job because their reputation is also affected by Enron’s scandal.
5
7.0 Suggestions on how to overcome the problem.
To prevent another scandal like Enron from happening, there are many
regularities and enforcement of accounting ethics that should be made. I have
a few suggestions for companies in today's business world.
1. Empowerment to Audit Committee
Firstly, the key way to avert future Enron is by specializing the authority
that is assigned to the audit committee and how it determines the qualification
of membership on this committee. According to Sarbanes-Oxley Act (SOX),
auditors are given a specific and detailed responsibilities such as regulatory
and legal compliance, integrity of the financial statement of a corporation and
also the evaluation of independent auditors. SOX also stated there must be at
least 3 'independent' people as the audit committee members. Such act should
be strongly adhered to avoid the conflict of interest between auditors and the
organisation so that incident like when 'Arthur Anderson handled the external
auditing, internal auditing and consulting service of Enron that resulted in them
covering up the accounting malpractice for 5 years' from happening again in
the future.
2. Restructure corporate culture
Secondly, organisation should think carefully about their corporate culture
because the culture of business, when confronted with ethical dilemmas, they
can influence the decisions of both employees and employers. Enron had a
competitive atmosphere and stringent requirements for performance appraisal.
The work culture of Enron brought many negative outcomes and led to its
fraud and bankruptcy. Enron's focus was solely on financial goals and profits
that he neglected the welfare of his employees. If Enron offered their
employees more job protection, there would be less cheating on the job. This
is so that they will be confident to voice out if there is any misconduct or
misuse of the accounting ethics. Therefore, companies should structure their
corporate culture in a way that it is conducive and healthy for their employees
and stakeholders to work in.
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REFERENCE
Bondarenko, P. (2016, February 05). Enron scandal. Retrieved October 30,
2020, from https://www.britannica.com/event/Enron-scandal
Cameron, S. (2019, April 29). The Enron Scandal & Ethics. Retrieved October
30, 2020, from
https://bizfluent.com/info-7747847-enron-scandal-ethics.html
Di Stefano, T. (2007, February 2). Enron: Could It Happen Again? Retrieved
October 30, 2020, from
https://www.ecommercetimes.com/story/55489.html
Enron Scandal - Overview, Role of MTM, Agency Conflicts. (2020, May 12).
Retrieved October 30, 2020, from
https://corporatefinanceinstitute.com/resources/knowledge/other/enron-s
candal/
Impact on Impact of the Enron Scandal on Accounting Standards. (2017-2018)
Retrieved October 30, 2020, from shorturl.at/rvyES
Linder, D. (n.d.). The Enron Trial: A Chronology. Retrieved October 30, 2020,
from https://www.famous-trials.com/enron/1789-chronology
Segal, T. (2020, September 22). Enron Scandal: The Fall of a Wall Street
Darling. Retrieved October 30, 2020, from
https://www.investopedia.com/updates/enron-scandal-summary/
Thomas, C. (2002, April 01). The Rise and Fall of Enron. Retrieved October 30,
2020, from
https://www.journalofaccountancy.com/issues/2002/apr/theriseandfallofe
nron.html
Wang, X. (2012, April 29). The Fall of Enron-An Analysis of Ethical Issues
[Web log post]. Retrieved October 30, 2020, from
https://blogs.bgsu.edu/wxiaom/author/wxiaom/
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