The Enron Scandal |
Enron Corporation was an American energy, commodities and services company based in Houston, Texas. From the 1990's until December 2001, Enron was famous throughout the business world and was named by Fortune as "America's Most Innovative Company" for six consecutive years. It grew wealthy due largely to marketing, promoting power, and its high stock price. Before its bankruptcy, Enron employed about 21,000 staff in forty countries and was one of the world's major electricity, natural gas, communications, and pulp and paper companies, which claimed revenues of $100.8 billion in 2000.
Enron gave the illusion that it was a steady company with ...view middle of the document...
Income from projects were recorded even though the incomes had not been received. This method which was introduced by Jeffery Skilling in 1999 when he was then president and Chief Operations Officer (COO), increased financial earnings on paper significantly.
However, in subsequent years, changes in profits or losses could not be included, so new and additional income had to be included from more projects and deals to sustain income levels and financial performance on paper. Investors and stakeholders were giving misleading information on the true state of the Enron’s performance.
An example of a deal that Enron recorded future profits was a 20-year contract with Blockbuster Video in July 2000. The deal with an estimated profits of more than $110 million was to introduce on-demand entertainment to various U.S. cities. After several pilot projects, Blockbuster withdrew from the contract. Although, the deal resulted in a loss, Enron continued to recognize future profits.
Special Purpose Entities
The mark-to-market practice led to schemes that were designed to hide the losses and make the company appear to be more profitable than it really was. The special purpose entities was created by the Chief Finance Officer (CFO), Andrew Fastow to achieve this. A special purpose entity is a legal entity that is created only to carry out a specific or temporary task. A sponsor creates the entity and is funded by investors. For financial reporting purposes, a chain of rules determine whether a special purpose entity is a separate entity from the sponsor.
Enron's special purpose entities were not only used to circumvent the traditional accounting conventions but also so they could hide debts of failed assets and keep them off its books. In return, Enron would issue to the investors of the special purpose entities, shares of Enron's stock, to compensate them for the losses. By 2001, Enron had used hundreds of these to underestimate losses and hide its debts.
Notable examples of special purpose entities that Enron employed were JEDI and Chewco. In 1993, Enron established a joint venture with California State Pension Fund (CalPERS) called the Joint Energy Development Investments (JEDI). Four years later, Enron initiated a move to take over CalPERS' stake in JEDI. However, Enron did not want to show any debt on its balance sheet from assuming CalPERS' stake. So, through Fastow, Enron developed the special purpose entity Chewco Investments which was used to acquire CalPERS's stake. By this, Enron succeeded in using Chewco to keep JEDI's losses off its balance sheet.
Trading Revenue Accounting
Merchants in the energy industry who engage in buying and selling are allowed to earned revenue on services such as wholesale trading, risk management as well as building and maintenance of power plants, gas pipelines, storage and processing facilities. They report the products' selling price as profits and the costs as cost of goods sold. In contrast, an agent who...