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ENRON CORPORATION AND ANDERSON: ANALYZING THE FALL OF TWO GIANTS

Grant, Kadeon -0601750Taylor, Mario -0801489Marston, Nicholai -0802001

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Introduction

Enron Corporation was an American company based in Houston, Texas that specialized in electricity, natural gas, communications and pulp and paper.

It reported revenues of nearly $101 billion in 2000 yet went bankrupt in December 2001, as a result of one the largest cases of accounting fraud in recent history.

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Cont’d

Andersen LLP, was one of the “Big Five” accounting firms, and one of their largest clients was Enron.

They were found responsible of bad auditing and accounting practices after they approved Enron’s financial reports even though they knew they were inaccurate.

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Business Risks

Using SPEs buried under dense legal language to keep a massive amount of company debt off the balance sheet.

Guaranteeing Whitewing investors full compensation if stocks were sold at a loss. This decision was unknown to Enron’s stakeholders.

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Cont’d

Expansion under their “new economy” line of reasoning severely impacted the company as the growth required large initial capital investments.

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Responsibilities of the board of directors

Keeps the organization’s mission, values, and vision out front.

Long range Strategic planning for the organization.

Monitors fiscal management and maintains

accountability to funders and donors.

Review and approves the annual budget, major program plans, and organizational policies.

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Cont’d

Ensure the adequate resources are available to the organization.

Evaluates the organizational effectiveness.

Represents public need and interest within the organization.

Represents the organization to the public, especially to sources of financial support

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How BOD could have prevented collapse

Failure to report to shareholders of the state

of the company

High-risk Accounting

Conflicts of Interest

Extensive off-the-books activity

Excessive Compensation

Lack of Independence

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Enron & SPEs

A financing technique in which a company

decreases its risk by creating separate

partnerships, rather than subsidiaries, for

certain holdings and solicits outside investors

to take on the risk. (financial-dictionary.com)

Enron entered into several business

transactions involving hundreds of SPEs.

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Cont’d

Enron used these entities to hide large

amounts of debt from its stakeholders

Borrowed funds through them were made to

appear as revenue

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What is Auditor Independence?

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Auditing Related Issues

The issues include:

Magnitude of income to be generated by the accounting firm from the client

Inability of the accounting firm to remain unmoved if the clients produce adjustment propositions deemed illegal or not in accordance with Generally accepted accounting principles

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Cont’d

Retaining the same auditing company for long periods of time.

Audit company partners accepting employment by client.

Audit Committee members often not independent of senior management.

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For…

Possible arguments in support of an auditor being allowed to provide these services for the same client include: Consolidation of services may reduce expenses for the

client

Provision of these services enhances the auditor’s knowledge of the client thus increasing the auditor’s objectivity and independence.

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Against…

Possible arguments against an auditor being allowed to provide these services for the same client include:

Possible violation of the underlying principle of auditing – integrity.

Reports may reflect what company executives want it to reflect and not what is.

The line between auditor and client may become blurred as the form of payment may vary and include shares in the client’s organization

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Accounting Principles

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Accounting Principles cont’d

Principle Advantage Disadvantage

Rule-based Increase accuracy and reduce the ambiguity .

•Precise requirements may cause management to manipulate statements to match what is compulsory.

•Strict rules can cause unnecessary complexity in the preparation of financial statements.

.

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Accounting Principles cont’d

Principle Advantage Disadvantage

Principle-based It offers general guidelines that could be used in a variety of circumstances.

•Absence of rigid guidelines can produce unreliable and inconsistent information.

.

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Cont’d

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Dangers Of Removing “bright-line”

“bright-line” is favoured because in the absence of these industry regulatory rules an organization maybe be brought to court if their judgement of financial statements were incorrect or inconsistent.

When there are strict accounting rules being adhered to the possibility of lawsuits is greatly minimized.

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Cont’d

Decreased accuracy in the preparation of statements.

Increased ambiguity by management.

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“run on the bank”

Occurs when a large number of depositors,

fearing that their bank will be unable to

repay their deposits in full or on time,

simultaneously try to withdraw their funds

immediately (Kaufan, 2001).

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Cont’d

The “run on the bank” analogy is valid for

both firms; however, it is important to note

that this is not the primary reason why these

organizations failed.

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“run on the bank”-Enron

The internal break down of Enron led to scepticism and scrutiny over company operations.

As a result of the corporate scrutiny, the public (customers) and trading partners of Enron began to lose confidence and therefore; this led to them withdrawing themselves from these industry brand Enron.

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“run on the bank”-Anderson

The collapse of Enron adversely affected Anderson’s reputation as a consultation and auditing firm.

Criminal charge against Anderson was listed as obstruction of justice for destroying important documents after the federal investigation had begun into the Enron case.

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cont’d

This formal charge and the nature of it led to

a “run on the bank” situation for Anderson as

most of its clients withdrew themselves. This

also included high-profile clients with which

Anderson had enjoyed long relationships.

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Personal Application of Principles

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Involvement in unethical or illegal activities or appearance of such -- EFFECTS

Loss of Job

Loss of Respect from Colleagues

Possible Jail time

Questions may be raised about the validity of previous work

Blacklisted and prevented from being rehired

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Integrity – Being Questioned and Preservation

Consequences when Integrity is ??

Preservation of Reputation

Loss of Trust Do not associate with questionable activities

Loss of Job Ensure confidentiality becomes another body part

Loss of Family Support Commit to being a teamplayer

Diminished Friendships

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Auditor, Client Relationship

Audit partners struggle with making tough accounting decisions that may be contrary to their client’s position on the issue due to fees received by the auditor from the client.

Auditors tend to praise their clients because of the large amounts of money being paid out to them by their client.

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Cont’d

Some changes the profession could make to eliminate these obstacles are:

Transparency: Make all phases and progress of audit accessible to not only internal stakeholders but external ones.

Establishing a committee independent of the auditing team to ensure that auditors are following industry regulations and are making neutral and un-biased decisions.

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Recommendations

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Recommendations cont’d

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ENRON CORPORATION AND ANDERSON: ANALYZING THE FALL OF TWO GIANTS

Grant, Kadeon -0601750Taylor, Mario -0801489Marston, Nicholai -0802001