Accounting and Auditing Loopholes in Enron’s Case, Dissertation – Literature Example
Words: 3280Dissertation - Literature
Unfortunately the last decade the economy has been the witness of the most incredible financial frauds which have not only heart the economy but also the society at large. According to Chad and Conan (2008), financial frauds can be defined by the method of deception, confidence and trickery in order to obtain some kind of benefit, usually financial from another person or persons. The most financial statements frauds have several features in common and almost every fraud is committed by using the following schemes, by income fraud, in management of inventory and cost of goods sold, by understatement of liabilities or overstatement of assets, by insufficient disclosure and with improper use of off balance sheet arrangements. Fraud can be divided into two categories. The first type of fraud is that which is committed against an organization and often this fraud is performed by employees, vendors or costumes. The second type of fraud is well known as fraudulent financial reporting or management fraud. Business managers, board members or individuals in positions of authority typically perpetrate management fraud which is committed on behalf of a business. (Chad and Conan, 2008)
The Scandal of Enron was revealed in the year 2001 which eventually led to the bankruptcy of Enron Corporation. Enron was an American Company and an energy giant, headquarters is based in Houston, Texas. The concerning fact was that the financials of the company were audited by Arthur Anderson, which was one of the biggest accountancy and auditing partnership firms globally. Moreover, the scandal of Enron is the largest bankruptcy case seen in the American history of organization. The biggest loophole was of the audit failure which leads to the demise of Enron (Hussey & Wolfe, 1998). The corporation was established in the year 1985 by Lay Kenneth after the merging of the Natural Gas Company of Houston and Inter North. After many years, Jeffrey Skilling was hired and he trained the executive staff related to the special purpose entities, poor financial reporting and the use of accounting loopholes. In this way, these executives were able to hide billions of dollars from failed projects and deeds in debt (Tomasic, 1992). The CEO of Enron, ‘Andrew Fastow’ and the other executives not only misguided the Board of Directors of Enron but also put the committee of audit on high-rick accounting practices (Hansen et al., 1992).
In 1999, the Committee of Sponsoring Organizations of the Tread way Commission published a study on the financial statements that covered then years researched between 1987 until 1997. Despite the fact the many years have passed from this study, the most financial statement fraud problems are still relevant until nowadays. During this study, more than 200 organizations reported fraudulent financial statements difficulties (Chad and Conan,2008). According to Rasha and Andrew (2012), after the fraud scandals in big organizations such as Enron, WorldCom and Xerox, financial reporting has increased dramatically. The bankruptcy of Enron has exposed some significant flaws in the organization of the US financial market and financial reporting requirements for companies. The presence of such defects provides the ability to abuse their position of top management of the company and retrieve financial institutions with large incomes by deception shareholders and the state, while respecting the existing legislation (Larson, 2006). The Company has been involved in various types of operations, many of which have yet to be adequately investigated. A special place in the affairs of the company occupies about 3,500 specially created its businesses, mainly in the form of a partnership, the total managed by the CFO, E. Fastow. Operations of these companies are reflected on off-balance sheet accounts of the company and have no effect on its earnings. These partnerships have been used as structures to conceal the company’s debt and profit from financial transactions (Larson, 2006). The deterioration in the financial position of Enron partnership used to transfer unprofitable assets for the balance of the company. Enron thus used a loophole in accounting standards FASB, which allows not considering the balance sheet of the company engaging in partnerships where the external investor had a share of more than 3% (Ronen, 2014). The result was the collapse of the company, which served as a detonator for the disclosure of the three-sponsored firms. On December 2, 2001 the company appealed to the court in New York on the basis of Act 11 of the Bankruptcy Act (Chad and Conan, 2008). The Act specified that the amount of assets submitted by the company to protect is 24.7 billion dollars and the amount officially announced liabilities are 13.1 billion dollars. The year before, the company’s capitalization exceeded $ 90 billion and two months before bankrupt company’s assets were estimated at $ 38 billion. The shares of Enron which at the beginning of 2001 sold for $80 for the entire year were down in price and in October have already cost about $30 and then rapidly fell finally after declaring bankruptcy impaired the company (Chad and Conan, 2008).
The collapse of energy giant Enron has forced the world to think seriously about issues related to corporate ethics and auditing standards. In addition, two were seriously compromised unconditional values ??that hold the debt of the economy is the confidence of investors and current financial instruments hedging investment risks (Ronen, 2014). However, while the investigative commission looking malice in bankruptcy Enron and the authorities are trying to prevent a repetition of the story with the help of new laws, analysts say directly in the global financial system, where reforms are really ripe, yet nothing will change. The risk of new bankruptcies is still great. After the reduction of state intervention in the financial sector (in America in the late 1970s, and in Europe in the 1980s) private debt growth accelerated considerably (Kassem & Higson, 2012). By the 1990s, the official volume of debt of US individuals and companies was on par with the amount of their income. To a large extent this was due to the emergence of a more efficient financial system, new financial instruments, increasing the timing of payments on loans and a more competitive market for the sale of mortgage loan made to individuals and companies business readily available (Kassem & Higson, 2012). However, the euphoria of earnings growth due to the development of modern financial instruments did not last long. In 2001 was passed by the absolute maximum number of defaults. According to the agency Standard & Poor’s, 211 companies in the world have announced in the past year about the impossibility to pay back the bonds or loans (Chad and Conan, 2008). A year earlier the figure was almost half and 132 cases of non-payment. The total volume of overdue liabilities in 2001 was $ 115.4 billion against $ 42.3 billion a year earlier. Almost 4% of the companies said about the impossibility to pay its creditors and only two hundredths of one percent did not have this indicator to block a sad record in 1991 to be 4.01% (Kassem & Higson, 2012).
Enron bankruptcy questioned the imposed around the world the principles and values ??of corporate America. It is known that the main cause of almost all the crises of the past two decades, beginning with Mexico and Japan and ending with Southeast Asia and Russia, was overreliance on borrowing by companies and citizens or governments. Last year proved to be fruitful for investors to negative events (Fox, 2003). Between these two points are an avalanche of bankruptcies and a wave of defaults on its own obligations in the corporate sector. However, only a collapse in early 2002, the energy giant Enron, recently was considered the seventh largest US company, made the corporate world to overestimate the financial risks debt of the economy (Fox, 2003). For investor confidence and modern financial hedging. These two absolute value on which rests the debt economy, it is the bankruptcy of Enron has been seriously compromised. One of the reasons that the bankruptcy of Enron was so unexpected was extremely low transparency reporting this energy giant (Ronen, 2014). Manipulating statements, the company actively used subsidiaries formally considered independent. According to The Economist, at the end of last year, Enron announced its intention to review all financial statements from 1997 to 2000, which led to a decrease in the cumulative income of $ 591 million and increased debt by $ 628 million (Lipson & Kolb, 2010). Obviously, the partnership with related Companies and complex off-balance sheet transactions Enron served one purpose to draw the balance. As it now appears, this was particularly interested in top management generously stimulated option schemes (Ronen, 2014).
It is known that hedging strategies, such as those used by Enron, usually justified with the growth of the market but are ineffective in the event of a fall. The situation is further complicated by the fact that the machinations of reporting the business world the US are quite tolerant (Mohamed, 2013). As it turned out during the investigation of the Securities Commission of the United States, the largest representatives of corporate America were directly involved in the strategy Enron. It is documented that in late January were published in the online magazine SmartMoney.com. According to the documents off-balance sheet transactions Enron conducted through the fund LJM2 (Ronen, 2014). This structure, whose assets are estimated at $ 394 million, was established in 1999 with the aim of hedging Enron. All operations fund was intended to reduce the risk of changes in value of the investment portfolio at the expense of Enron transactions with derivatives on own shares of the company (Mohamed, 2013). LJM2 was intended for the acquisition of assets owned by Enron, and ensure profitability to them at a rate of 30% per annum for a limited number of investors. The documents explained: if some of these assets have been reflected on the balance sheet Enron, this would lead to a reduction in paper profits, which in the future could adversely affect the company’s credit rating. Thus, Enron was interested in deconsolidation of these assets. For third-party fund participants has become the most attractive investment opportunity in the derivatives of Enron which were not available to outside investors (Mohamed, 2013). This, in particular, the largest US insurance company American International Group (AIG), Citigroup, Credit Suisse First Boston, Dresdner Bank, JP Morgan Chase, Lehman Brothers, Morgan Stanley, Merrill Lynch and others. In addition to the largest financial institutions in the operation with the Foundation has been involved General Electric and small institutional investors including pension and private foundations (Perino, 2012). The largest creditors LJM2 were Chase Manhattan Bank and Dresdner Bank. With the expansion of financial transactions Enron Company is more like a normal investment bank is not much different from the inhabitants of Wall Street. Up to 90% of the company brought its electronic trading system Enron online stopped work (Perino, 2012). According to experts who have studied the causes of insolvency (bankruptcy official version yet), at a certain stage, the company lost its usual caution in conducting the financial operations of pursuing risky scam and incurring substantial financial losses (Perino, 2012).
Initiating the establishment of a single global mechanism for financial reporting, audit leaders of the world want to restore the confidence of investors. It seems that the consequences of the collapse of Enron will appear for a long time and in many directions. Above all, they will affect the audit standards of business and accounting (Ronen, 2014). A special committee of the US Congress set up to investigate the circumstances of the collapse of Enron has concluded that the auditors of the firm Arthur Andersen not only knew about the existence of fraud in reporting but also advising how best to carry out financial transactions. In addition, experts have warned that auditors should prepare for large-scale testing in connection with an increase in the number of bankruptcies, and in connection with the practice of overstating revenues, which became their catalyst (Romero, 2010). Due to the recent bankruptcy of Global Crossing Telecommunications Corporation to attract the attention of the federal bodies of the USA can the same Arthur Andersen. As it turned out, Global Crossing overstated their income and not included in the statements of some of their costs. Now the firm Arthur Andersen will have to give explanations as to why she did not notice. In addition, according to the newspaper The Washington Post is one of the leading audit companies in the world Ernst & Young was at the center of a scandal involving the bankruptcy of the Chicago Bank Superior, which cost the Corporation Deposit Guarantee US $ 350 million. The investigation revealed that the bursting of the summer of 2001 Bank also overestimated their income (Mohamed, 2013).
The question of the impartiality of the auditors rose repeatedly and its relevance is further increased after the company’s auditors turned into a huge international structure, offers its clients a comprehensive service, from consulting and legal services and ending with the selection of personnel and tax planning. However, the blame for what happened doesn’t goes to auditors only. Until recently, the US legislation which has many kinds of loopholes that encourage this approach to accounting when it becomes important is not the meaning of operations and compliance with its letter of the law (Sarra, 2012). In an effort to restore confidence in themselves and their clients, they responded quite quickly. The President of the American Institute of Certified Public Accountants (American Institute of Certified Public Accountants – AICPA), Barry C. Mel ancon on January 31 said, ‘the magazine BusinessWeek Online about the readiness of his organization to work together with the Congress and the Commission on Securities and Exchange Commission (Securities & Exchange Commission – SEC) to prevent future disasters such as bankruptcy Enron.’ (Mohamed, 2013) In other words, now AICPA will not prevent the adoption of laws prohibiting audit companies provide their clients with additional consulting services. On February 1, 2010 Price water house Coopers and KPMG representatives also expressed support for the initiative of the American authorities on the division of consulting and auditing business (Dooley, 2002). Meanwhile, the AICPA not give decisive conflict of interest auditors and consultants. Experts look at the probability of creating a world system of financial security is pessimistic.
The history bankruptcy Enron and other high-profile bankruptcies in America and Europe, once again reminded about the absence of a mechanism of society insurance companies from the wreck, leading unfair financial policies. Corporate debt both in America and in Europe, reached the critical level comparable with the volume of national GDP. A large proportion of loans of US firms have been used to buy shares or invest in projects that led to the creation of an overcapacity (Baxt & Baxt, 2005). The sharp rise in debt in Europe although he had other reasons (was associated with the acquisition of telecoms licenses for the production of mobile phones third generation) but it has also been unproductive loans. As a result, the balance sheets in the private sector no longer reflect the real state of affairs in corporate business and being on the verge of a foul (Baird & Zailin, 2008). The Economist in a January issue of notes concern that even the global recession has not weakened the tendency to exceed the amount of borrowing over the amount of the borrower’s income, as happened in the past. A number of experts, in particular, Wynne Godley of Judge Institute of Management at Cambridge and Bill Martin of Phillips & Drew in London said that, ‘what is happening now with Enron and similar companies is the result of the so called debt lawlessness.’ (Akpom & Dimkpah, 2013) It used to be that in order to maintain investor confidence about the safe level of debt in these borrowers information about the real lending rate and the expected future income growth is sufficient. But it turns out; you now need to formalize fraud and corruption, opened during the collapse of Enron (Albrecht et al., 2008).
In America itself, the bankrupt Enron acquired pronounced political overtones, since the scandal first became involved in the US officials. It is natural because of its history; Enron has made repeated attempts to influence the energy policy of the United States. In 1998 and 2000, the company successfully lobbied the Senate (Denteh , 2011). Senate Banking Committee approved a series of laws which conducted operations of the oil giant out of control authorities. In addition, Enron got the right to take into account the revaluation of the contracts ‘market value’, which is an illiquid market, large long-term fuel contracts led to a precedent. Investigation into the bankruptcy has prompted the US Congress to amend the law on the financing of election campaigns (Enron and here shown exceptional ingenuity, understating expenditure data) (Dickins & O’Reilly , 2009). The next step is the amendment to the law on auditing business and accounting (Crawford & Weirich, 2011). Perhaps to accelerate the reform of pension schemes and options that is used for material incentives for top managers.
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