Name: CEJALVO, Nery Rose L.

BS ACCOUNTANCY 2 STUBCODE: 123

SUMMARY ABOUT THE DOWNFALL OF ENRON IN 2000

Enron was born from the merger of Houston Natural Gas and Inter North, a Nebraska
pipeline company. In the process of the merger, Enron incurred massive debt and, as the result of
deregulation, no longer had exclusive rights to its pipelines. In order to survive, the company had
to come up with a new and innovative business strategy to generate profits and cash flow.
Kenneth Lay, CEO, hired McKinsey & Co. to assist in developing Enron’s business strategy. It
assigned a young consultant named Jeffrey Skilling to the engagement. Under Skilling’s
leadership, Enron Finance Corp. soon dominated the market for natural gas contracts, with more
contacts, more access to supplies and more customers than any of its competitors. With its
market power, Enron could predict future prices with great accuracy, thereby guaranteeing
superior profits.
As the boom years came to an end and as Enron faced increased competition in the
energy-trading business, the company’s profits shrank rapidly. Under pressure from
shareholders, company executives began to rely on dubious accounting practices, including a
technique known as “mark-to-market accounting,” to hide the troubles. Mark-to-market
accounting allowed the company to write unrealized future gains from some trading contracts
into current income statements, thus giving the illusion of higher current profits. The severity of
the situation began to become apparent in mid-2001 as a number of analysts began to dig into the
details of Enron’s publicly released financial statements. An internal investigation was initiated
following a memorandum from a company vice president, and soon the Securities and Exchange
Commission (SEC) was investigating the transactions between Enron and Fastow’s SPEs.

This includes unduly aggressive earnings targets and management bonus compensation
based on those targets, excessive interest by management in maintaining stock price or earnings
trend through the use of unusually aggressive accounting practices, management setting unduly
aggressive financial targets and expectations for operating personnel, inability to generate
sufficient cash flow from operations while reporting earnings and earnings growth, assets,
liabilities, revenues or expenses based on significant estimates that involve unusually subjective
judgments such as reliability of financial instruments, significant related party transactions.

These factors are common threads in the tapestry that is described of the environment
leading to fraud. They were incorporated into SAS no. 82 on the basis of research into fraud
cases of the 1970s and 1980s in the hope that auditors would learn from the past. Andersen will
have to explain when and how it identified these factors, as well as how it responded and how it
communicated with Enron’s board about them. The scandal resulted in a wave of new
regulations and legislation designed to increase the accuracy of financial reporting for publicly
traded companies. The most important of those measures, the Sarbanes-Oxley Act (2002),
imposed harsh penalties for destroying, altering, or fabricating financial records. The act also
prohibited auditing firms from doing any concurrent consulting business for the same clients.
Name: CEJALVO, Nery Rose L. BS ACCOUNTANCY 2 STUBCODE: 123

REACTION PAPER

ENRON was one of the biggest and most admired companies during the year of 1990’s
until the fall of 2000. Enron had built up a reputation for innovation that sent its stock price
soaring, but then all of the energy company's accomplishments came crashing down over just a
few months. Previously high-flying shares were suddenly worthless, and thousands of workers
lost not only their jobs but the value of their employee-owned stock holdings.
As I read the article about Enron’s fall, I think one of the reasons of their fall was their
strategies and their way of running the company. Among them are the conflict of interest
between Arthur Andersen, as auditor but also as consultant to Enron; the lack of attention shown
by members of the Enron board of directors to the off-books financial entities with which Enron
did business; and the lack of truthfulness by management about the health of the company and its
business operations. When some of their business and trading ventures began to perform poorly,
they tried to cover up their own failures. Bankruptcy was brought about greedy traders. I felt like
they wanted to monopolize the energy industry, they wanted power so they made everybody else
believe that they were indeed making so much money to acquire the other companies. Also one of
the reason of the fall is that Enron did not pay attention to its employee. They did not treat such as
a responsibility and was constantly focusing on its stock price. It recorded accounting results as
soon as possible just to keep up with company’s stock prices which had helped ensure deal makers
and executives for them to receive large cash bonuses and stock options. It was a mistake that
Enron continuously thinking about their company’s reputation and compensation although their
business began to perform poorly. Due to the fall of Enron, it became a factor in the creation of the
Sarbanes-Oxley Act of 2002 thus government regulations and rules need to be updated for the new
economy.
The lesson that I learned about this Enron’s fall is that in business, there shall be no room
for arrogance. Arrogance can infect all employees in a company with the silent destructiveness of
a computer virus. There is nothing at all wrong with being proud of your company and the work
you do. In fact, if you don’t take pride in your work, you are probably not doing the best job you
can do. But pride is not arrogance. Also, I learned that a corporation should establish a structure
of reasonable rules to guide their executive decision-making and their employee behavior,
reports accurately and adequately to its shareholders, its regulators, its suppliers, and its
communities, keeps its employees informed of developments that would affects its customers,
the marketability of its products and services, and the employees' own financial position and
lastly it develops and implements a practical code of ethics, including fair play in dealing with
customers, fair treatment and training of employees, and respect for human rights and dignity.