CORPORATE ACCOUNTING ANALYSIS OF THE ENRON COLLAPSE

Corporate Accounting Analysis of the Enron Collapse



Corporate Accounting Analysis of the Enron Collapse

Introduction

Formed in 1985 from a merger of Houston Natural Gas and Intermonth, Enron Corp. was the first nationwide natural gas pipeline network. Over time, the firm's business focus shifted from the regulated transportation of natural gas to unregulated energy trading markets. The guiding principle seems to have been that there was more money to be made in buying and selling financial contracts linked to the value of energy assets (and to other economic variables) than in actual ownership of physical assets.

Until late 2001, nearly all observers - including professional Wall Street analysts - regarded this transformation as an outstanding success. Enron's reported annual revenues grew from under $10 billion in the early 1990s to $101 billion in 2000, ranking it seventh on the Fortune 500.

The unraveling began in August 2001, when CEO Jeffrey Skilling resigned for undisclosed reasons. On October 16, Enron reported its first quarterly loss in 4 years, taking a charge against earnings of $1 billion for poorly performing businesses. The reported third quarter loss was $618 million, versus a $292 million profit a year earlier. (CNN 2006)

On November 8, the company announced in a Securities and Exchange Commission (SEC) filing that it was restating its earnings since 1997 - reducing them by $586 million. The coup-de-grace came on November 28, when the major bond rating agencies downgraded Enron's debt to below-investment-grade, or junk bond status. The company filed for Chapter 11 bankruptcy on December 2, 2001. (Murphy 2002)

Several committees in the House and Senate have held or plan to hold hearings related to Enron's fall. The Justice Department is conducting a criminal investigation.

The challenge for financial oversight, however, does not depend on findings of wrongdoing. Even if no one at Enron did anything improper, the swift and unanticipated collapse of such a large corporation suggests basic problems with the U.S. system of securities regulation, which is based on the full and accurate disclosure of all financial information that market participants need to make informed investment decisions. (bbc.co.uk)

Literature Review

The overarching financial issue raised by Enron is whether the quality of information available about public corporations needs to be improved. Several aspects of this central issue are briefly sketched below, with references to CRS products that discuss the issues in more detail.

Auditing Issues

Federal securities law requires that the accounting statements of publicly traded corporations be certified by an independent auditor. Enron's outside audits have received much attention. While external audits do not prevent corporations from making financial mistakes, let alone bankruptcy, problems with recent Enron audits may have contributed to both the rapid rise and the sharp fall in its stock price. Outside investors, including financial institutions may have been misled about the corporation's net income (which was subsequently restated) and contingent liabilities (which were far larger than generally known). The auditor, Arthur Andersen, has admitted some mistakes. Andersen fired the partner in charge of Enron audits on January 15, ...