Background Of Enron And Its Case Accounting Essay

Category: Accounting

Enron Corp was one of the largest energy, commodity and service providers. They sold electricity, natural gas, energy and other physical goods, along with financial and risk management services to global customers. Enron was formed in July 1985 by the merger of Houston Natural gas and InterNorth, based in Houston, Texas. Initially the company sold natural gas, and as it grew, they started brokering energy and delivering it. The company started advertising electricity in 1994 and entered the European energy market in 1995. Enron also expanded into non-energy resource businesses such as global metals trading and water resources and were recognized as a leading innovator and employer. Enron's market capital increased from $ 2 billion (in mid 1980s) to $ 70 billion in early 2001 (CBC News, 2006). Enron advertised most of its products on their website by providing the facility to trade commodities online. It became famous and was the largest business site in the world. About 90% of Enron's income came from trade over the internet. Enron reported consolidated income / revenue of $101 Billion in the year 2000. It was recognized as the seventh largest company on the fortune 500 and the sixth largest energy company in the world (CBC News, 2006). Enron had approximately 58,920 shareholders of its common stocks (Ordinary Shareholders) and its market share price peaked to $ 90 (CBC News, 2006) per share before the bankruptcy case.

Enron Case:

Enron was reported as the largest corporate bankruptcy case in US when Jeffery Skilling (CEO of Enron) restored his post of CEO. In October 2001, Enron reported a loss of approximately $ 618 million to its shareholders (CBC News, 2006). This was the first quarterly loss the company reported in the last four years. The CFO Andrew Fastow was replaced after the incident and the U.S securities exchange commission launched an investigation to dig out the main source of such a massive loss. The concern area was the investments partnerships which were led by the former CFO (CBC News, 2006). In the investigation it was found that Enron incorporated "mark-to-market accounting" for the energy trading business in the mid-1990s and used it on an exceptional scale for its business. Under mark-to-market rules, whenever companies had outstanding energy-related or other derivative contracts on their balance sheets at the end of a particular quarter, they had to adjust entries according to fair market value, to avoid booking unrealized gains or losses in the income statement of that particular period.

Difficulty with the application of these rules, for long-term futures contracts in commodities such as gas is that there are often no quoted prices upon which valuations are based. Companies having these types of derivative instruments are free to develop and use discretionary valuation models based on their own assumptions and methods (C. William Thomas, 'the Rise & Fall of Enron', 2002). This was adapted to hide Enron debts by showing fake investments. After the revelation of the traumatic news the share price fell down to $ 1 US (CBC News, 2006). Investors had lost billions in it. The audit firm 'Arthur Andersen' lost its reputation and goodwill in the market and were among the Big Five audit firms of the world before the biggest fraud scandal in America.

After its demise the world was left with the Big Four firms. Roughly 5,600 Enron employees subsequently lost their jobs. (The Fall of A Wall Street Darling, 2011)

After a month of Enron filing for bankruptcy protection in US, the US justice department opened a criminal case against Enron's management (CBC News, 2006). The CEO, Ken Lay left his post as chairman and CEO. Numerous charges were filed against him. It was found that nineteen (19) former executives were found guilty and have been convicted for the largest white collar crime in America History. Key lay (CEO) and Jeffery (CFO) were both found guilty. The CEO was sentenced for twenty four (24) years; where as CFO along with its associates were given six (6) years of sentence (CBC News, 2006).

Role of Arthur Andersen:

As an audit firm, it was Arthur Andersen's duty, to address its audit reports to the shareholders after finding out about the Window dressing of Enron's debts. Unfortunately, it was found that Andersen had aliened forces with Enron's management on the founded fraudulent activity. A major issue enlightened by the case of Enron was "Conflict of Interest" of Andersen. Andersen was playing dual roles in Enron; auditor and consultation. Andersen was accused of overlooking the huge amount of money kept off Enron's books because of the sum of money paid to them in terms of audit fee which was $100 million ( Andersen was also accused of destruction of thousands of pages of documents of its clients including Enron. The documents were destroyed and remained a mystery, raising a question in mind, were the files and documents destroyed to be kept away from the government and law enforcing securities? (

Corporate Governance:

Issue of Corporate Governance in Enron:

Corporate governance is a system through which organizations are directed and controlled, deal with the finance to corporations and assure themselves of getting a return on their investment (Cadbury, 2002). Good corporate governance is achieved through transparency and integrity of financial statements to its stakeholders and shareholders, providing maximum independency to external auditors, accurate and timely disclosures of material matters of the company to its shareholders. This can be done by protecting the rights of all minority and majority shareholders for effective monitoring of management by the board and creating board accountability to its shareholders (Shleifer & Vishyny, 1997).

If Enron had practiced good corporate governance then its stakeholders would not have suffered. One can easily identify the following Corporate Governance problems in Enron's case:

Vague and belated disclosures of Accounts

Inappropriate and ineffective monitoring of management by the board (independence of board)

Conflict of interest of Management

Jeopardized the independence of External Auditor

Argument about increasing Independence of the Board:

Yes! One will agree if independence of the board is established, such frauds or scandals can be alleviated to some extent. As a result, management and board members will have to share their meeting minutes with shareholders and respect every shareholder both minors and majors. Taking Non - Executive directors on board can assist in increasing the independence of the board.

A question is raised, how can board independence be increased? The answer is straight, by adopting good Corporate Governance practices. As discussed earlier corporate governance is a set of relationship between company's directors, its shareholders and other stakeholders. It also provides the structure through which the objectives of the company are set, the means of achieving those objectives and monitoring performance.

There are a number of elements of corporate governance which will assist organizations in mitigating the risk like Enron brought on its investors. Following are some elements of good corporate governance that can be incorporated:


Fairness in Corporate Governance means that director's and other stakeholder's legitimate interest should be accounted and shareholders should be treated equally and should have protection of their rights (Dooley, 1991). If the board of Enron was able to protect shareholder's rights and treat everyone with the same fairness, the news would have disclosed sooner or we can say that no one in the finance department and other higher management would ever have exercised the window dressing of accounts.


Transparency means accurate and complete corporate disclosure to stakeholders. Disclosure not just includes financial statements and notes to the accounts but also narrative statements such as the director reports and the operating and financial review. There should be voluntary disclosures as well to show integrity of the management and gain trust of stakeholders. Voluntary disclosure includes management forecast, presentation and press releases (Mallin, 2003). In the Enron case transparency was jeopardized. Share price of the company was increasing on speculations rather than actual facts and figures. The last share price before the bankruptcy disclosure was $ 90 per share which was speculated as Enron did not have any investments and had crossed its gearing limits four years before December 02, 2001.


According to Agrawal ET. El, (2005), independency is a vital concept related to directors of the company. Corporate Governance reports have increasingly stressed the importance of independent non executive directors (NED). The reason behind taking NEDs on board is to monitor board performance and management without having conflict of interest in the company that is their finance and other related decisions are not affected by the performance of the company.

They are free from pressure that could hinder their activities. They will be in a better position to comment and compliment board and to promote the interests of shareholders and other stakeholders.

External Auditors should be independent and not influenced by the management of the company because they are there to examine what company's management is doing with the company. External Auditor fee or remuneration should not exceed sufficiently from the previous year (Agrawal et. el; 2005). External Auditors responsibility is not to identify fraud, they evaluate company's financials critically and if they come across with any reservations, management and shareholders are to be reported.

In the Enron case, Arthur Andersen's independence was laid down due to which it overlooked and concealed matters from companies' stakeholders and didn't qualify their audit reports on time. Therefore, one needs to develop a mechanism to balance both Management and External Auditors working to avoid any material conflicts. Corporate Governance suggested that there should be an 'Audit Committee' to work as a bridge between management and external auditors. In the Enron case, if an Audit committee was in place, Andersen would have had a very low chance of developing interest in the company. Andersen would have qualified the Audit report and protected shareholder interest.

Responsibility & Accountability

The main motto of responsibility and accountability is to make management responsible for their actions. In management terms, it's often said "Greater Responsibility brings increased Accountability" (Ribstein, 2005).The board of directors, have a responsibility towards company shareholders, of protecting their rights and ensuring they work towards maximizing the wealth of shareholders. Management is responsible to both major and minor shareholders. Directors owe fiduciary duty to the company to exercise their powers bona fide in what they honestly consider to be in the best interest of the company.

Corporate accountability means whether organization and its directors are answerable in some ways for the consequences of their actions (Ribstein, 2005). In Enron case the CFO and CEO had acted in personal interest and ignored the fact that investors might have had life savings and pension money on Enron stocks. The stock price went to $ 1 from $ 90 US per share (The Fall of A Wall Street Darling, 2011). They did not exercise their power in the best interest of the company which resulted in the most renowned scandal of the world.

Reputation and Judgment

Organization reputation depends on how likely other risks are to crystallize. In the same way directors concern for an organization's reputation will be demonstrated by the extent to which they fulfill the other principles of corporate governance. These are purely the commercial reasons for promoting the organizations reputation. The price of the share and the goodwill or we can say the consideration which might be obtained on selling the company totally depends upon the organizations reputation of distributing profits or dividend, investing in other business, meeting company's liabilities and reserving more assets and handling their stakeholders.

Reputation also depends upon how they react to sustainability of the environment. Banks and other financial institutions can extend the period of repayment of organization loans and withdraw their loans from organizations on the basis of their reputation in the market. This is what happened to Enron too. Key management showed the act of selfishness and did not analyze the risks of distorting the organizations reputation in the market by their actions. Due to which Enron's share price went from $ 90 to $ 1 (CBC, 2006)

Good judgment means the board making decisions that enhance the prosperity of the organization. This means that board members must acquire a broad enough knowledge of the business and its environment to be able to provide meaningful direction to it. This has implications not only for the attention directors have to give the organization's affairs, but also the way the directors are recruited and trained (Rhodes, 1996). The complexities of senior management means that the directors have to bring multiple conceptual skills to management that aim to maximize long-term returns. As a result, corporate governance composes competing people on board which evaluate positively and critically the decision made by management in the benefit of company's stakeholders.

Judgment should not be biased it should be based on facts and figures and in the benefit of stakeholders. It's therefore suggested by corporate governance to have NEDs on board so they can critically, indecently and with integrity view management plans and actions and decisions for the company. Due to the absence of mixed director's skills and due to lack of independency of directors the company was shade to pieces. If NEDs were involved in the board, the decision of fake investment would have never been passed and if an Audit committee was made for handling and liaising between internal and external auditors, Enron shareholders would have never suffered the huge losses in their investments. Enron management did not have the clear expertise of doing right for the right people. They had just acted right to avoid the bad news (BPP learning Media Ltd, 'Professional Accountant', 2007).


Companies having corporate governance have following advantages over others:

Their shareholders will be timely informed of any material matters of the company through sharing of meeting minutes of 'Annual General Meeting' (AGM).

Code of best practice will be followed in providing guidance and controlling the company, such as the Framework laid by OECD for disclosure and transparency of directors or board responsibilities.

Audit Committee (especially for list companies) will be placed for effective and efficient liaison between External Auditors and internal Auditors and other financial management.

Every Shareholders right will be protected through legitimate procedures. All shareholders will be treated equally.

Board will maintain a sound system of monitoring and controlling management activities. Internal Controls will be developed and best practices of the industry will be followed by the management regardless of the post and power the management personnel possess.

With the above final words we believe that corporate governance has a very vital role in providing best practice guidelines to manage and control a company. The existence of it, especially in a list company, is very crucial and fruitful for all stakeholders. Independence of board can be managed and increased effectively and efficiently through it.


Following people attended and took part in the brainstorming and learning session:

1. Jasdeep Giller 10003667

2. Mandeep Chaggar 10005979

3. Amreen Asghar 08029296

4. Hardill Aziz 08027754

5. Ferheen Khan 10008508

6. Sharjeel Jelani 09008000

13/02/13: First meeting, got familiar with the group members, reviewed the assignment, and task was set to carry out research on what each person thinks that needs to come under each section.

18/02/13: Brought all notes together and discussed the points and came up with a draft plan of the assignment layout, which then led to equally distributing certain parts of the assignment to members.

27/02/13: Had a rough draft of the individual parts that were assigned, sent one another email of everyone's work that had been completed so far, so could write up ideas of what needs improving.

04/03/13: Improved on previous notes that were said and continued completing each section.

08/03/13: Put the overall assignment together, read through the assignment together to correct any grammar and spellings, complete the referencing and write up the cover page and conclusion of the overall assignment.

16/03/13: Last meeting to bring up any concerns that anyone had, printed the assignment out.

Attendance at all meetings was excellent, as all members were present.

1. 10003667: 100%

2. 10005979: 100%

3. 08029296: 100%

4. 08027754: 100%

5. 10008508: 100%

6. 09008000: 100%