De La Salle Lipa

BATANGAS

A COMPILATION OF INDIVIDUAL REPORT

Final Project for Midterm

Conceptual Framework and Standards

Presented to Ms. Elsa Glinda G. Altar

In Partial Fulfillment
Of the Requirements for the Degree
Bachelor of Science in Accountancy

Submitted by:

Dheine Louise L. Maderazo

S.Y. 2018 - 2019 1st Semester

 Table of Contents

Enron Corporation Page

I. Company Background 3

II. Conceptual Framework - Qualitative Characteristics 7

III. Financial Statements 9

IV. Financial Reporting Analysis 13

V. Application and Recommendation 15

VI. Rubric 16
Company Background

Enron Corporation

The story of Enron Corporation is a legend of a once successful business which was
doing wrong practices, faced its own consequence—its major downfall.

Enron Corporation was formed in 1985 when InterNorth purchased Houston Natural
Gas to create the country's longest natural-gas pipeline network. The company
transformed and evolved from a gas-pipeline business into a natural-gas and electricity
trading giant in the 1990s. By 2000 it was the seventh largest U.S. corporation with $70
billion. Despite the company’s growing success, of course it still has its major flaws, and
according to Bethany Mclean, author of “The Smartest Guys in the Room”, Enron’s
major flaws were about pride, arrogance, intolerance and most of all, greed.

The company was continuously achieving progress up to the point that they rose to
the top of their game. Earning millions up to billions of dollars, Enron owners could be
considered as crazy rich people. Investors also chose to invest in this company and buy
stocks from it due to how high the prices of their stocks were. Unfortunately, their
success came to an end and the company collapsed quickly, with it having all the
makings of a gigantic scandal. This resulted to 20,000 employees losing their jobs and
about $1.2 – 2 billion funds for retirement and pensions disappeared, which obviously
affected Enron’s employees greatly.

Enron adopted deceptive accounting practices in order to hide its financial losses,
and even their gains, thus, resulting to an unfaithfully represented financial statements,
reports and documents. The techniques of these well-structured financial transactions
were designed to evade the risks involved in business activities. These were used to
enrich some of Enron's corporate officers and hide the firm's financial losses. Enron
created independent partnerships wherein Enron sold assets to, which enabled Enron to
convert loans and assets burdened with debt obligations into income. However, the
contracts with the partnerships contained guarantees and risky buy-back conditions that
were really disastrous and dangerous for Enron. Enron also recorded projected long-
term income from trading contracts upon the signing of the deal, but having the income
projected overly optimistic and inflated. Although the Enron scandal involved a lot of
numbers, money and value, for Bethany Mclean, this story is not about such things—but
about people… a human tragedy.

Without the people behind the progress of Enron, the company would be nothing, but
they were, at the same time the reason it went from being “The Enron”, the best and the
largest company, to nothing but a bankrupt one. Here are the significant people behind
the greatest corporate crime of the history, and the important events that happened as
well.

Kenneth “Kenny Boy” Lay

Kenneth Lay, popularly known as Kenneth Lay, was the former chairman of Enron
Corporation. He lived a humble life before, and as a vision, he envisioned to make
wealth for himself. Thus, doing his best in order to be successful and rich, and this
explains his active career when he started working. Kenneth Lay joined the Florida Gas
Company, and served as president of its successor company, Continental Resources
Company in 1974 but eventually, he left Continental to join Transco Energy Company in
 Houston, Texas in 1981. After three years, Lay joined Houston Natural Gas Co. not just
as a regular employee, but as its chairman and CEO. During the 1985, the company
decided to merge with InterNorth which was later in 1986 was renamed Enron Corp. It
was also in this year when Kenneth Lay was appointed as the chairman and chief
executive officer of Enron. He helped transformed it from a relatively small pipeline
business into a giant energy trader worth $68 billion by 2000. As a chairman of the said
company, he has a huge responsibility for the fraudulent acts that were done, but
according to him, he isn’t—he is not responsible for something he didn’t do and know.
This is where he becomes suspicious since according to the documentary entitled
“Enron: The Smartest Guys in the Room” directed by Alex Gibney, Lay was actually
knowledgeable about the issues about Enron, especially the one about the company’s
two traders who falsified records and diverted profits to their personal accounts. Lay
even told them to keep making the company millions and convinced them to gamble
more. Despite the other employees raising this concern to him, he didn’t fire the traders
and told everyone that he did not know about it.

Jeffrey Skilling

Lay needed a man with big ideas or with the biggest idea, and he found it—it was
Jeffrey Skilling. He is a genius, and in fact, as what people say, was a nerd. Skilling
joined the staff of the energy company Enron in 1990 and was promoted to president
and chief operating officer in 1997. Given this capacity, he pushed an aggressive
investment strategy, helping make Enron the biggest wholesaler of gas and electricity,
with $27 billion traded in a quarter. It was his idea to transform energy into finance
markets, saying that it make them the largest buyer and seller of natural gas. He asked
for one condition as he entered the Enron Corporation, which is that they should use the
mark-to-market technique, which allowed them to book potential future profits upon the
deal no matter how little the cash actually came. This practice was one of the reasons
why their financial statements reflected steady high profits, because by using this
technique, from the outside world, people would see Enron’s profits the way Enron said
they were. He called it having Hypothetical Future Value, recording anticipated future
profits as actual gains in order to inflate its stock price. But, this is where their wrong
practices start because; they could put random values of their revenues, how much they
want it to appear. This act was the reason why Enron reached the top, and under
Skilling’s leadership, Enron soon dominated the market for natural-gas contracts, and
the company started to generate huge profits on its trades.

Lou Pai

Lou Pai, a person who is also behind the Enron scandal, is its real mystery man. In
both the company and during the trial, he was kind of “invisible”; his existence in the
office was rarely noticed, by his co-workers and during the trial for the case of Enron
Corporation, he wasn’t even called as a witness. This mystery man despite being silent
left the company with more money than Lay and Skilling. He was someone who was
only motivated by money and strippers, and for him, it’s all about numbers. Of course
Pai was also a part of the whole scandal-- One of the things that Lou Pai and his group
did was forecast future energy prices saying, “even though this deal is based on prices
10-15 years out, we’re going to value this deal with one big number right now. And we're
going to pay our bonuses right now. And we're going to post Enron's earnings right now.
We're going to manipulate the markets right now.” He left Enron with a lot of money and

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 after the filing of his divorce with his wife, to be with his exotic dancer girlfriend, who he
got pregnant.

Andrew Fastow

Andrew Fastow was the chief financial officer for Enron until he was expelled by the
company shortly before it declared bankruptcy. He was part—a huge part— of the major
figures behind the company’s “web of off-balance-sheet special purpose entities.” By
illegally maintaining individual stakes in these independent ghost-entities, Fastow
defrauded tens of millions of dollars out of the company. He also had partnerships which
were enormous guarantees of Enron’s stocks. Fastow gambled the company’s future on
the hope that its stock would never fall. After finding out that Fastow earned $45 million
from his LJM partnership, he was fired.

Kal-ee-‘for-nyah

Enron traders were very determined to look for and grasp new opportunities that will
help the company earn higher profits and in order to achieve success. Not all of the
traders who were working for Enron were like this. But those who were very eager to
achieve success reached the point where they did awful things and as said in the
documentary, they lost their morality. As an explanation to this, Gibney—the director of
the documentary—used the Milgram experiment to describe the situation of the Enron
traders that time. A factor of why they came to the point of committing fraud is the
pressure of the culture of the company, and because they idolize their superiors which
resulted to their complete obedience to them.

The committed fraud by the traders affected many lives and businesses in California,
which experienced blackouts, as a result of Enron’s manipulation. The blackouts left
more than 100,000 businesses and residential customers in the dark for about two days.
People were trapped in elevators and offices of high-tech companies such as Cisco
Systems and Apple Computer, were shut down, as well as chip-making plants, costing a
loss of millions-worth revenues. According to the traders, they were pushed by Skilling to
“trade aggressively” in California and to do whatever was necessary to take advantage
of the state's wholesale market to boost the price of Enron's stock; which they did… as
they were told. The traders also said that Enron used the fear created by the blackouts
to push large California businesses into more than $1 billion in long-term energy
contracts. As a result of this situation, California Governor Gray Davis was really pissed
and even said in an interview that Enron should be prosecuted for its actions, and
according to him, "purposely putting people's lives in jeopardy in the name of greed is
inexcusable."

Jeffrey has Left the Building

August 14, 2001—it was when Enron president decided to leave the company—a
decision that took everyone by surprise in the company. In the documentary, it was said
that CEOs don’t just resign out of the blue without a well-orchestrated campaign
beforehand so that there will be no questions. Skilling’s decision was something no one
expected, it was sudden. According to Mimi Swartz, executive editor of Texas Monthly
Magazine, Skilling was smart enough to leave the company that early, while it was still in
good shape. Swartz added that this is done so Skilling won’t be blamed if after a year or
a year and a half. When he stepped down as CEO and left, Kenny Lay took over.

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 Aftershock

The day after Skilling’s resignation, Sherron Watkins, ex-Vice President of Enron
Corporation, wrote a letter to Lay, since she was alarmed about all the information that
she got from a former employee of the company, Cliff Baxter, who after the collapse of
the company took his own life. Watkins also stated how the company’s financial
statements didn’t make sense and it didn’t add up thus, revealing the fraudulent acts
made within the company during the operations.

Investigations were done by the SEC. Investors began to worry that the billions of
dollars in the mark-to-market were actually losses. But, Ken Lay held a talk, and as part
of saving the image of the company, he assured the employees and even the investors
that Enron doesn’t have any irregular actions that are happening, financially and
operationally. Meanwhile, as he was conducting this, Enron’s accounting firm, Arthur
Andersen began destroying their Enron files and by October 23, they have shredded
about one ton of paper.

Andrew Fastow was fired for his supposed betrayal, but others believed or have a
theory that he was set-up so he would be the bad guy and take the fall.

Months after, Enron collapsed and was exposed of its wrongdoings. On December 2,
2001, Kenny Lay filed for and declared bankruptcy. This was a huge loss especially for
the employees.

I. Conceptual Framework - Qualitative Characteristics

The qualitative characteristics of the conceptual framework are classified into two,
mainly the fundamental qualitative characteristics and the enhancing qualitative

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 characteristics. These two have their own subgroups, which are the specific
characteristics the financial statements of a business should portray. In this part, the
qualitative characteristics will be related to Enron Corporation’s financial statements
whether they possess these characteristics or not.

Fundamental Qualitative Characteristics

1. Relevance – it is the capacity of the information to influence a decision and with this,
Enron Corporation’s financial statements could be considered relevant since it is
obvious how easy it was for the investors to decide to invest in this company and for
the people to buy stocks from it. Due to the high profits and high prices of stocks that
the company shows to its users, a lot of people became interested in investing in it,
which is a win-win situation because the users and the company will both benefit
from it.

2. Faithful Representation – from the word “faithful” it can be easily identified that this
characteristic means that financial reports represent economic phenomena or
transactions in words and in numbers. Descriptions and figures should match what
really existed and happened. From this, it can be derived that Enron Corporation did
not portray this characteristic, which can be clearly observed from its fraudulent acts
and putting random values in their financial statement to hide their losses (or could
be their gains). A concrete example would be their mark-to-market technique
wherein they record or book their potential or future revenue, which could inflate their
income. Thus, resulting to incorrect information which doesn’t match the transaction.

Enhancing Qualitative Characteristics

1. Understandability -- this is a very important characteristic that a financial statement

should possess, because not all users of the financial statements are knowledgeable
about financial statements, thus, the need for these statements to be very easy to
understand. This can be related to relevance because if a financial statement can
influence the user’s decision, it means that they understood it. With this, Enron
Corporation’s financial reports are also considered understandable.

2. Comparability -- this enables users to identify and understand similarities and

dissimilarities among items. It can also be comparable when accounting standards
and policies are applied consistently from one period to another and from one region
to another. In the case of Enron Corporation, it can be concluded that their financial
statements do not possess comparability since they were just inputting random
values, thus, showing that standards that were applied weren’t consistent and at
times, there may be no standards applied.

3. Verifiability – information is verifiable when it is supported by evidence so that an

accountant that would look into the same evidence would arrive at the same decision
or conclusion. This explains how the financial reports and statements of Enron
Corporation are unverifiable—and it can be supported by the evidence that Arthur
Andersen, its auditing firm, destroyed all their files involving Enron. With this, it can
be difficult to know if the information in those statements is true because the ones
that approved these reports shredded the evidence that they were approved and
signed.

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 4. Timeliness – this refers to the need for accounting information to be presented to the
users in time to fulfill their decision making needs. Enron Corporation, being one of
the largest companies, and the company whose stocks are being awaited, feels the
need to provide the financial information to people, just in time and with enough time
for them to make economic decisions. It can also be shown on their reports which
are reported using an interim period, quarterly to be specific.

II. Financial Statements

This part shows the financial statements of Enron Corporation wherein some
financial statements show the reports from the years 1998 to 2000, while some only

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 show results from the years 1999 and 2000. The financial statements shown in this part
are the company’s Statement of Financial Position or the Balance Sheet, Statement of
Financial Performance or the Income Statement and Statement of Cash Flow.

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 III. Financial Reporting Analysis

Financial Analysis (Horizontal Analysis)

For the interpretation of the Statement of Financial Position, it can be seen that
compared to the previous year of operation (1999), almost all of the accounts included in
this statement increased which can be interpreted as an improvement in the position or
status of the company. If we would look at the total assets and compare it to the total
liabilities, the assets have greater amount than the liability. This means that the company
has the capacity to pay its obligations and debts when asked to pay for it using its assets.

When it comes to the Statement of Financial Performance, what we’re looking at is the
net income, and using the horizontal analysis, if we compare the net income from the year
1998 up to 2000, the company’s profit went higher as the year progresses. The changes
were also massive. It can be concluded that the hike of the profit of Enron corporation is a
result of its good and improved position or status. But, a more accurate interpretation of it is
that it is a result of greater amount of revenue and a less or reduced costs or expenses.

The Statement of Cash Flow, of course shows the movement or the flow of cash all
throughout the operation of the business. With its results, we can find out how much cash
were collected and received (inflow) and how much were disbursed (outflow). Looking at the
Statement of Cash Flow of Enron Corporation, it was only in year 2000 did they have a
positive result as a total—it means that there are more cash that entered the business
compared to the cash that was spent. The two previous garnered a total with a negative
result, which means that during those years, more cash came out from the business than
cash received.

Objective of General Purpose of Financial Accounting

 The position adopted in this Statement is that the objective of general purpose financial
reporting is to provide information to users that are useful for making and evaluating
decisions about the allocation of scarce resources.

 When the objectives of general purpose financial reports are met, they will also be the
means by which managements and governing bodies discharge their accountability to
the users of the reports. An important function of the process of general purpose
financial reporting, particularly in relation to public sector entities and non-business
entities in the private sector is the provision of information for accountability purposes
is. However, the rendering of accountability made by the reporting entities through this
is encompassed by the broader objective of providing information useful for making and
evaluating decisions in the scarce resources allotments and portions, since the users
are the ones who will ultimately require the information for resource allocation
decisions.

Law and Standard for Financial Reporting

Accountants are strictly required to follow the accounting rules that are stated in the
Generally Accepted Accounting Principles (GAAP). If an accountant failed to operate
according to GAAP, it may result in sanctions for the accountant as well as liability in a civil
lawsuit. Usually, it first must be proven that violations were really made before filing an
accounting malpractice lawsuit.

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 Falsifying information regarding securities such as company stocks and bonds by
company accountants can also hold them liable. These are usually punishable under federal
laws and some of them are classified as felonies.

If the company accountant or the company itself is found guilty of accounting fraud,
penalties and consequences can include monetary fines and jail or prison time. Fines and
jail sentences will become more severe the more serious the violations become. Repetition
of such acts (e.g. violations) can also result to being given heavier consequences.

Enron Corporation’s Case

Enron's financial statements did not conform to existing accounting standards,

suggesting that the standards themselves were not at fault. While the recent focus on
financial reporting requirements may bring about needed changes and improvements in the
quality of financial information provided to investors, current standards should not be blamed
for Enron's failure.

Enron functioned business and capital markets far beyond financial reporting standards
and accountants' responsibilities which is a suggested reason of the collapse of Enron. In
particular, it raises questions regarding: (1) the oversight responsibilities of Enron's board of
directors, (2) the financial advisers that assisted the company in structuring its SPEs, (3) the
banks and other lenders that provided "off balance sheet" financing and (4) the brokers,
analysts and other investment advisers that ignored the warning signs of trouble apparent in
Enron's financial reports. All of these parties actively assisted and helped Enron's
management in its efforts to fake the documents that show the company's financial
condition.

IV. Application and Recommendation

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 Application

As an accountancy student, a CPA-in-the-making, I am pretty knowledgeable about

financial statements, how important they are to a business and its users, and most
importantly, about how accountants play a vital role in accomplishing these. Of course I still
have a lot to learn and to watch out for, but the documentary entitled “Enron: The Smartest
Guys in the Room” opened my eyes to the reality of being an accountant—that lots of
people will push you to do bad things that involves your profession. I learned how bad the
consequences are if such things are done. I don’t have any plans on doing fraudulent acts
and getting lost in bribery once I become an accountant, but upon watching the video, I
realized that I also need to be careful, because there really are bad people in the corporate
world.

Upon watching the documentary, the desire to study well and do my best in my journey
towards being an accountant sparked a flame, changing from just a desire to a burning
desire. I realized that I should study hard so I can be aware of all the standards to be
followed so that I know when companies are committing fraud. In line with this, I would pay
attention in my classes especially those that involve accounting, such as this course,
Conceptual Frameworks and Accounting Standards, Financial Accounting and Reporting
and other courses to come. With this simple act, I can learn so much and it will surely help
me to not just become an accountant, but become a competent accountant with morals and
values.

Aside from being a future accountant, I am also a person who seeks to earn besides the
profession that I will be taking—thus, I am a potential stock buyer and seller as well. From
the Enron Corporation scandal, I witnessed that businesses could really be fooling us
without us knowing, where in the end, we are the losers who lost everything that we invest. I
don’t want it to happen to me, which is why I will make sure that I will first research about the
business whose stocks I want to buy, before actually buying. That way, I will be familiar with
everything I need to know about their business. Before watching the documentary, I might
think that it’s silly and it’ll take a lot of time, but since I learned from the video, I realized that
there’s no harm in that and it is really important.

Recommendation

Assessing all the learning and lessons I got from the documentary directed by Alex
Gibney, I can say that the most important thing that I should keep in mind, and share with
other people as well is the one embarked in the last part of the video—“ask why”. I would
like to share this to every person, not only those in the corporate world because I personally
think that plays an important role before doing something you’re told—ask why. This is to
avoid being involved and engaged in wrong doings, because the business world is dirty,
there are a lot of deceptions, cheating and the likes. As a recommendation, I would also tell
them to learn how to say no to illegal activities and to stand up for what is right. It is better to
leave a job than to stay in it but what you’re doing is wrong and something that is against
your beliefs and morals. Lastly, I would recommend each person to watch the documentary
because it really is an eye-opener to the reality that money or the desire for money could
really lead people to do evil things.

V. Rubric

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 Rubrics for Grading Case Study
Student Name: Dheine Louise L. Maderazo

Year and Section: 1st Year—A1C

Date of Submission: October 21, 2018

Case Study Number: No. 1

Case Study Title: Enron: The Smartest Guys in the Room

Source: https://www.youtube.com/watch?v=H2f7FunDuTU&t=5710s
https://www.infoplease.com/encyclopedia/social-sciences-and-the-
law/economics-business-and-labor/businesses-and-occupations/enron
corporation
https://www.cbc.ca/news/business/the-rise-and-fall-of-enron-a-brief-
history-1.591559
https://www.britannica.com/biography/Kenneth-Lay
https://www.biography.com/people/jeffrey-skilling-235386
https://www.britannica.com/event/Enron-scandal#ref1254070
https://www.npr.org/templates/story/story.php?storyId=5411422
https://www.thefamouspeople.com/profiles/andrew-fastow-30070.php
https://www.biography.com/people/andrew-fastow-234605
https://www.marketwatch.com/story/enron-caused-california-blackouts
traders-say
http://picker.uchicago.edu/Enron/EnronAnnualReport2000.pdf
https://www.legalmatch.com/law-library/article/accounting-fraud-
lawyers.html
https://www.biography.com/people/kenneth-lay-234611

Number of Pages: 17 pages

Film Review

Maximum 21-25 21-25 21-25 21-25

Score
100

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 Title, author and Title, author and Title, author and Title, author and
source are stated. All source are not well source are incomplete. source are not
mechanical elements stated. Some Numerous errors or stated at all. There
(length, format, mechanical elements deficiencies in are serious deficiencies
spelling, etc.) are have minor errors or mechanical in
acceptable. are not completed elements. mechanical
properly. elements.
Summary shows that Summary shows that Summary is Summary is too
you clearly grasp the you grasp some of somewhat vague or short, vague,
essence of the manager’s the manager’s main unfocused. misrepresented or
position. points. missing.
Reaction explores Reaction explores Reaction merely Reaction indicates
content with clear content with some restates the author’s Article was not read
Analysis. critical analysis. ideas and words. With care.
Application shows Application shows Application shows Application shows
interpretation and partial interpretation partial interpretation little interpretation
extension of MAS and extension of or extension of MAS and/or extension of
learning to classroom/ MAS learning to learning to MAS learning to
everyday life classroom/ everyday classroom/ everyday classroom/
experience. life experience. life experience. everyday life
experience.
Total Score

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