Course Title: Audit

Course ID: ACN403

Section: 02

Assignment on:

The Enron Collapse

Submitted to:
Ms. Susmita mandal
Lecturer,
Dept. of Accounting
Independent University, Bangladesh.
Submitted by:

Name ID
Israt Jahan 1621160
Jihan Mubtasim Tamim 1621484
Tasrif ahmed 1721733
Mohammed Sayed Hossain 1722017
Monirul Islam 1530246
 Letter of Transmittal

31th March, 2019

Ms. Susmita Mandal

Lecturer, Independent University, Bangladesh

Bashundhara R/A, Dhaka.

Subject: Application for the acceptance of the submission of the Assignment on Enron.

Dear Miss,

This is to inform you that we are the student of your ACN403 section-02. It gives us pleasure
that we have completed the Assignment on The Enron Collapse successfully. We tried our
best to utilize and use the knowledge that we got through yourself and this course.

We hope that our assignment will be able to meet the expectation that you want from us. And
if there any errors and mistakes are found, we wish it will be considered with sympathy.

Therefore, we would like to request you to accept my report and oblige there by.

Sincerely your student,

Israt Jahan
Jihan Mubtasim Tamim
Tasrif Ahmed
Monirul Islam
Mohammed Sayed Hossain

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 Acknowledgement

At the very beginning we would like to express our sincere gratitude to Almighty God for
giving us patience & courage to finish the task within the scheduled time. We are feeling very
thankful and therefore special thanks to our honorable teacher Ms. Susmita Mandal who gave
us the opportunity to use our knowledge & skill practically so that we can use it in future.

We tried our best to imply our knowledge and skill that we learnt from our teachers, study
materials, internets, etc. Mainly Google were always been there for us. At the last but not the
least we are thankful to all our friends and well-wishers who have been always helping and
encouraging us throughout this whole assignment.

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Table of Contents
Executive Summary...........................................................................................................................1
Introduction.......................................................................................................................................2
What were the main reasons for Enron’s collapse?..........................................................................3
Could it have survived?......................................................................................................................6
Reference..........................................................................................................................................8

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 Executive Summary

The sudden and unexpected collapse of Enron Corp. was the first in a series of major
corporate accounting scandals that has shaken confidence in corporate governance and the
stock market. Only months before Enron’s bankruptcy filing in December 2001, the firm was
widely regarded as one of the most innovative, fastest growing, and best managed businesses
in the United States. With the swift collapse, shareholders, including thousands of Enron
workers who held company stock in their 401(k)retirement accounts, lost tens of billions of
dollars. It now appears that Enron was in terrible financial shape as early as 2000, burdened
with debt and money losing businesses, but manipulated its accounting statements to hide
these problems. This report briefly examines the accounting system that failed to provide a
clear picture of the firm’s true condition, the independent auditors and board members who
were unwilling to challenge Enron’s management, the Wall Street stock analysts and bond
raters who failed to warn investors of the trouble ahead, the rules governing employer stock
in company pension plans, and the unregulated energy derivatives trading that was the core of
Enron’s business. The Enron scandal eventually led to the bankruptcy of the corporation
together with and the dissolution of the auditing company Arthur Andersen. ENRON
shareholders lost $74 billion leading up to its bankruptcy, and its employees lost their jobs
and billions in pension benefits. Enron CEO Jeff Skilling was sentenced to 24 years, former
CEO Kenneth Lay died before serving time.

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 Introduction

Enron was formed in 1985, following a merger between Houston Natural Gas Co. and
Omaha-based InterNorth Inc. Following the merger, Kenneth Lay, who had been the chief
executive officer (CEO) of Houston Natural Gas, became Enron's CEO and chairman and
quickly rebranded Enron into an energy trader and supplier. Deregulation of the energy
markets allowed companies to place bets on future prices, and Enron was poised to take
advantage. In 1990, Lay created the Enron Finance Corp. To head it, he appointed Jeffrey
Skilling, whose work as a McKinsey consultant had impressed Lay. Skilling was at the time
one of the youngest partners at McKinsey.

Skilling joined Enron at an auspicious time. The era's regulatory environment allowed Enron
to flourish. At the end of the 1990s, the dot-com bubble was in full swing, and the Nasdaq hit
5,000. Revolutionary internet stocks were being valued at preposterous levels and
consequently, most investors and regulators simply accepted spiking share prices as the new
normal.

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 What were the main reasons for Enron’s
collapse?

The sudden and unexpected collapse of Enron Corp. was the first in a series of major
corporate accounting scandals that has shaken confidence in corporate governance and the
stock market. From Enron case we tried to find out what could be the possible cause’s for
Enron collapse. The reasons we find out are given below:

Management Issue: The Enron fiasco did not happen by accident. It was facilitated by a
corporate culture that encouraged greed and fraud, as exemplified by the energy traders who
extorted California energy consumers. Rather than focus on creating real value,
management's only goal was in maintaining the appearance of value, and therefore a rising
stock price. This was exacerbated by a fiercely competitive corporate culture that rewarded
results at any cost. Some divisions of Enron replaced as much as 15 percent of its work force
annually, leaving employees to scramble for any advantage they could find to justify their
continued employment.

Fallout from Fraud: Taken at its word, this rosy scenario made the company the darling of
Wall Street, and it was able to borrow almost endlessly and expand into e-commerce and
other questionable ventures. Its stock literally soared, which made employee compensation
and pensions in the form of stock options seem very attractive. But what were already
considered accounting practices on the edge of acceptable standards were eventually revealed
to be outright fraudulent. The disgrace drove so much business away from and created such
liability for accounting firm Arthur Anderson that it was itself forced out of business. By this
time, though, the true value of the company had been revealed and the stock price collapsed,
leaving employees with worthless options and pension packages. Of course, executives that
understood the real picture sold their shares in advance of the collapsed and waltzed away
with billions.

Auditing and Accounting Issues: Federal securities law requires that the accounting
statements of publicly traded corporations be certified by an independent auditor. Enron’s
auditor, Arthur Andersen, not only turned a blind eye to improper accounting practices but
was actively involved in devising complex financial 9 structures and transactions that
facilitated deception. An auditor’s certification indicates that the financial statements under

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review have been prepared in accordance with generally-accepted accounting principles
(GAAP). In Enron’s case, the question is not only whether GAAP were violated, but whether
current accounting standards permit corporations to play “numbers games,” and whether
investors are exposed to excessive risk by financial statements that lack clarity and
consistency. The conventional wisdom is that it was "innovative" accounting practices and
their consequences that started the tide of losses that brought the energy giant down. Enron
collapsed not so much because it had gotten too big, but because it was perceived to be much
bigger than it really was in the first place. By decentralizing its operations into numerous
subsidiaries and shell corporations, Enron was able to hide huge derivative losses that would
have halted its growth much sooner if widely understood. Publicly traded corporations are
required to make their financial statements public, but Enron's finances were an impenetrable
maze of carefully crafted imaginary transactions between itself and its subsidiaries that
masked its true financial state. In other words, losses were held off the book by subsidiary
companies, while assets were stated.

External Auditing Issue: Enron`s internal corporate governance structure, Enron`s external
auditor, Arthur Andersen, also played a key role in contributing to the Enron fiasco. The role
of the auditor, generally, is to provide reasonable assurance that audited financial reporting is
free from material misstatement, as well as truthfully and fairly presented by management. In
doing so, the external auditor is required to be impartial and free from any financial interest
in the audit client. With Enron, the external auditor acquiesced in Enron`s financial reporting
and so deliberately withheld information about the difficulties. Firstly, this could have
resulted from the economic bond, as discussed earlier. It is a fact that Arthur Andersen was
paid $27 million for non-audit services and $25 million for audit work from Enron and this
firm was attempting to raise 8 its revenue. Hence it is probable that the quality of Arthur
Andersen`s audit work for Enron was impaired by conflicts of interest between protecting its
professional reputation by fulfilling its professional responsibilities and being willing to risk
such a reputation as a means of keeping its largest client by acquiescing with Enron`s
management. Moreover, it is also argued that their acquiescence was caused by Arthur
Andersen`s lack of competence in detecting extremely complicated financial vehicles
designed by its client`s management. Regardless of the reasons, Arthur Andersen failed to
produce a quality audit report and the action of shredding tons of Enron`s documents reflect
its failures to fulfil its fiduciary duty.

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Internal Auditing Issue: One of the most important mechanisms in internal corporate
government is the internal audit. It is important to note that Enron`s internal auditors were
outsourced from Arthur Anderson for several years. The lack of a strong and capable internal
audit department also significantly contributed to Enron`s collapse because of the high
probability of undetected wrongdoing, unnoticed questionable transactions and dealings and
earnings management. Also, outsourced auditors may have influenced the effective ness of
the audit department as their reports were based on a limited understanding of the business.
Therefore, Enron should have established its own audit department so that the internal audit
could have made a greater contribution to enhance the integrity of corporate governance. In
doing so, internal auditors should achieve the following objectives: overseeing the
effectiveness of internal control, performing risk assessment and management processes,
ensuring procedural compliance including IT systems integrity, producing audit committee
briefs and getting involved in other corporate governance issues.

The role of directors: The contribution of Enron`s directors to the Company`s demise can be
briefly described as unfulfilled fiduciary duties. Generally, directors are wholly responsible
for governing and directing the company`s affairs in the best interests of the company and its
shareholders. All Enron`s Board members were aware of and supported Enron`s strategies,
which aimed at maintaining its investment-credit rating, increasing cash flows and reducing
its debt burden. The Board not only was well-informed but also authorized numerous hedging
transactions that were handled by Enron`s SPEs. Moreover, it was the Board that allowed
Andrew Fastow the CFO to establish and even worse to become the sole manager of the
private equity fund to do business with Enron, which apparently lacks economic substance.
He was also approved to become the general partner of some other partnerships that were
deliberately set up to make profits at Enron`s expense. The significant effects of these
breaches on Enron`s financial position was that debts were moved off Enron`s balance sheet
and earnings and cash flows were inflated. In addition, the Board also supported an asset light
strategy or syndicating the assets which allowed Enron to trans several billion dollars` worth
of its asset with a slow generating cash flow to its unconsolidated affiliates and record
exorbitant earnings. Further the Board was adequately informed of the increases in typical
examples of unsolved conflicts of interests that had long existed in Enron and enabled self-
interested managers to make huge profits at their company`s expense.

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 Could it have survived?

It is very important to know whether the collapse of Enron could have avoided. First of all,
the strong culture could have helped avoid the collapse. This kind of mishap would never
have happened in a culture with honesty, integrity and ethics as its major building blocks.

Ethical management on the part of Kenneth could have prevented the scandal. Managers and
CEO are the catalysts in the implementation of the ethics. If Kenneth Lay had developed a
strong organizational culture based on ethics and would have induced ethical values in each
and every employee of the company, then this dilemma could be avoided. There should have
been better ethical oversight and stronger management form the CEO.

Next, Skilling should have informed Kenneth Lay about the actual situation of the company.
Kenneth Lay depended on Skilling to manage details of the company’s partnerships, but
Skilling used to inflate profits and improperly hide debts. If the effective corporate code of
conduct were in place and were properly enforced, Enron could have saved itself from this
humiliation.

There should have been a mechanism in place to keep an eye on the activities of the
accounting firms like Arthur Andersen which approved Enron’s fraudulent partnerships
because of playing the dual role of the Auditor and Consultant to Enron. These two kinds of
business should not have been allowed to a same accounting firm as the conflicting interests
induce them to indulge in such kind of acts. If not, then there should have been a penalty or
fine on such financial institutions where the corporate clients and investors were exploited.

Proper disclosures, accountability and transparency and could have prevented the problem.
Enron should have been fair and honest to its partners and shareholders alike. If the
partnerships were taken away or removed from the financial statements, the shareholders
could have been informed in the notes accompanying the financial statements or by making
some memorandum entries of the partnerships. In addition, the Enron should have told their
partners about the exact figures of the earnings and profits instead of the inflated ones. Plus,
there should have been a mechanism or some regulations to make Market regulator aware of
the sophisticated accounting practices that firm could use to hide losses form investor and
report unrealized profits. And unethical accounting tricks that could keep the debt and such
practices unreported.

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Another important thing liked to Enron’s scandal is the Alignment of the employee’s goals
with that of the organization’s goals. This case is one of the biggest examples; how the
Enron’s employees valued and preferred their self-interest to that of the interest of the
stockholders and the stakeholders.

We think, Enron could have survived. If the management kept Enron’s books clean and
maintained good relationships with investors and customers alike, this plan would right the
ship and earn back the trust of investors.

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 Reference

Cuong, N. H. (2011). FACTORS CAUSING ENRON’S COLLAPSE. Retrieved from virtusinterpress:

http://www.virtusinterpress.org/IMG/pdf/10-22495cocv8i3c6p2.pdf

Enron Fast Facts. (2018, April 23). Retrieved from CNN:

https://edition.cnn.com/2013/07/02/us/enron-fast-facts/index.html

Nicholson, J. (2017, September 26). What Caused Enron to Collapse? Retrieved from bizfluent:
https://bizfluent.com/how-does-4911332-what-caused-enron-collapse.html

Why did Enron Fail? (2012, March 0). Retrieved from enotes:
https://www.enotes.com/homework-help/what-were-reasons-enron-
fail320449#answer400863

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