Matakuliah
Tahun
: F0122 – Seminar Akuntansi
: 2009
Accounting Scandals:
What we have learned from Enron and World
Com Debacle?
Pertemuan 04
Accounting Scandals:
What we have learned from
Enron and World Com Debacle?
Accounting Seminar
Week 9
Prepared by:
Gatot Soepriyanto SE. Ak., M.Buss (Acc)
The Recent Scandals
• The obvious corporate greed—is it more
widespread than in earlier periods?
• Earnings manipulation is part of (and usually
central to) most of the scandals
• Prominent industries included energy companies
and telecommunications (+ accommodations by
investment banks)—importance of deregulations
• Scale: these were big firms involved
Enron
• Stogy gas transmission company started with
massive debt
• Formed a gas trading company, expanded into
electricity, risk mgt. & telecom; expanded
internationally
• Based on economic reality, many of these were
failures
• Based on earnings magic, all were successful
Enron 2
• Gas trading: deregulated & volatile, need for spot market
purchases & related derivatives, volatility increased
trading profits
• Problem of massive & potential junk bond ratings
• Use of special purpose entities (SPEs) to reduce
perception of too much debt
Enron 3
• Importance of meeting quarterly earnings, initially
through cost savings, then increasingly more gimmicks
• Scheme 1: revalue physical assets using “fair value”
models (SFAS 125, designed for financial assets)—frontloading profits
• Scheme 2: using SPEs in virtually any complex context
to record earnings
Enron 4
• SPEs were mishandled
• CFO Andy Fastow manipulated these for his own
enrichment + independence problem
• Particularly shady SPEs approved by auditor Arthur
Andersen, attorneys, & board of directors;
accommodated by investment banks & no obvious
oversight by SEC
Enron 5
• Some operations were successful, others were
major blunders; the net effect was to
dramatically increase financial risk, & Enron’s
unwillingness to disclose real losses as they
occurred
• Mid-2001: stock price dropped, executives
bailed out of stock options, bond ratings back to
junk status
• Enron restated earnings in 3rd quarter 2001
• With no credibility, Enron declared bankruptcy in
December 2001, the biggest bankruptcy until …
WorldCom
• Bernie Ebbers started long-distance telecom
company in 1983 (name changed to WorldCom
in 1995)
• Growth through merger strategy (note earnings
magic of business combinations)
• WorldCom “looked” solid, with total assets of
$104 billion & debt-to-equity of 79.3%, but half
the assets were goodwill & other intangibles
• In 2002 internal audit found operating expenses
capitalized
WorldCom 2
• New auditor KPMG reviewed the books, old auditor
Arthur Andersen was fired; Ebbers resigned in April
• In June 2002 WorldCom announced $3.8 billion in
accounting errors, mainly by capitalizing “line costs”
(fees to other telecom companies for network access
rights—these are operating expenses)
WorldCom 3
• WorldCom restated earnings, CFO was fired
• Actual capitalization misstatements totaled over $11
billion
• WorldCom filed for bankruptcy in July 2002, replacing
Enron as the largest bankruptcy in US history
What do Enron & WorldCom Have in
Common?
• Deception on a massive scale—manipulation at
the highest levels of the companies
• Growth through acquisitions plus related
Business combination accounting abuse
• Importance of meeting quarterly earnings targets
at all costs—related enrichment of senior
executives
• Accommodating auditors, attorneys & boards of
directors
• All two restated earnings
What Happened at Arthur Andersen?
• One of original Big 8, founded in 1913, stressing
integrity & consistency
• Especially since the 1980s, AA had a history of
“aggressive auditing,” clients became too
valuable to defy (Toffler)
• Associated with many of the big scandals:
Sunbeam, Waste Management, Enron,
WorldCom & Global Crossing
• Found guilty of obstruction of justice in Enron
case
The Lessons of History
•
•
•
•
•
•
•
•
It’s the incentives, stupid
Irrational exuberance
Corporate culture
Regulation follows the business environment
Regulations are not fool-proof
The political environment
Financial, operating and credit risks
The economy is global
Assignments:
• Discuss and present your answer related to the
WORLDCOM CASE STUDY.
• You may use external sources other than those provided
in this teaching materials.