Enron was one of the United States of America’s biggest energy companies which was established in 1985. The company was formed after a merger between Inter-North and Houston natural gas. The founder of the company was Kenneth lay. After it was founded, the company went through various challenges that not only led to its collapse but also the dissolution of Arthur Andersen. According to Manz, ‘‘Arthur Andersen was among the largest partnership in accountancy and audit in the world’’ (224).
It was dissolved to what was considered as failing to carry out proper audits for the books of accounts of Enron. There were a lot of issues that surrounded the financial reports of the company which gave a wrong reflection of the financial status. The chief financial officer and the board of directors managed to manipulate the auditors to give wrong information about the finances of the company (Manz, 234).
The company engaged in several projects that did not bear fruit which made it incur a lot of losses. The board of directors was ashamed of what was happening in the company and choose not to reveal the information. What became the next of the company has been a remembrance of a business entity that failed in its management procedures as they were not able to take care of their employees after the collapse of the company.
After years of giving false reports about the financial status of the company, it was officially announced in 2001 that the company was bankrupt. It reached a point when everything had to be made public as the company lacked the finances that could enable it to move on. It reached a time when the issues that were previously ignored could not be ignored anymore (Clarke, 72). The bankruptcy was made official when plans to sell the company failed. It was considered to be the most bankrupt company in the United States at that particular moment due to the debts that it had accumulated.
The auditor of the company was charged in court and found guilty of misrepresenting the financial reports of the company. The ruling was later overturned but there is nothing the company could do as it had lost most of its customers. The employees of the company managed to get limited returns through the lawsuits that were presented to the court. They had however lost a substantial amount of money in form of pensions and stock prices.
Despite the challenges that were later faced by the company, there were moments when the company was performing well in the market. The founder of the company helped in establishing policies that enabled the products of the company to perform well in the market. The high demand for natural gas made the prices go high and thus boosting the performance of Enron. There was stability in the prices of gas and electricity which made the company survive in the market. ‘‘In 1992, the company was considered as the largest distributor of natural gas in North America’’ (Ingram & Albright 74).
The sale of gas was the main trading activity of the company that made it experience such substantial growth. Due to the good income that was generated by the company, it sought to diversify its activities to maximize its earnings. Ingram & Albright (80) asserts that ‘‘Apart from the gas pipelines that are owned, it ventured into the production of pulp, paper, electricity plants, water plants and the sale of broadband assets.’’ As a result of the numerous inventions that were made to the company, it recorded an exemplary high income. It was considered the most innovative company in the United States as it recorded an exemplary high return.
The downfall of the company
It may have caught very many people by surprise that the company that was doing well in the market would all of a sudden be declared bankrupt. The main contributor to the downfall of the company was the wrong audit reports that were presented by the company. The auditor of the company did not give a clear account reflection of the company and changed the reports to show the opposite. The company was also engaged in very many complex business undertakings that made it difficult for the accounting officers to handle the records.
Numerous projects were being undertaken by the company that made it difficult to ascertain the exact source of its profits. It was also revealed that the scandal about the financial reports of the company started a long time and it was only a matter of time before the truth was revealed. The company had been giving reports of its financial audits to the public. What was being shown to the public in form of its financial reports was contrary to the performance of the company.
Even though the company collapsed in 2001, wrong financial reports were recorded in its books since late 1997. There was a habit in the company that was accumulated for a considerable amount of financial sessions. The chief finance manager may have noticed the defaults in the accounts but choose to ignore them. The failure of the management to suspect the flaws in their financial reports or simply ignoring them was a clear reflection of poor management skills.
The company may have been enjoying the publicity of its good performance and failing to take a critical look at why the growth was at such a high rate. There should have been a poor channel of communication in the leadership of the company that led to a lot of confusion. The management of the company mainly focused on launching development projects to generate income without taking a critical analysis of how the projects were performing. It may have been clear that some of the numerous projects that they had ventured into were liabilities rather than assets to the company. The management was fooled by the reports and failed to notice the abnormality in their profits.
The other thing that may have made the company run bankrupt was improper planning of its investment projects. The company was excited about making more money by engaging in many investment projects, this they did without employing a proper management plan that would have enabled them to handle the projects. The company was performing well in the energy industry, which was the area that it had specialized in. However, when the company decided to venture into other activities that it was not designed for, that is when the financial records of the company started raising questions. As the company ventured into other development projects, there is a probability that they did not involve the help of experts (Manz, 215).
The company needed to employ more workers that were skilled in the areas that they were venturing in. instead they made use of their original staff which made the work to be too overwhelming for them to handle. The financial accountants of the company may have realized that the work was too much for them but did not want to admit it to the board. When they realized the mistakes that had been made in the books of accounts, they did not report the matter because they feared for their career. It was also a time when the company was riding high in the market and any negative report at the moment would tarnish the reputation of the organization.
The financial controller and the auditor chose to suppress some of the information in the accounts with the hope of covering the company. They may have thought that as time goes by, the situation will turn out in favor of the company. It was a time when the company had just been credited among the best performing and also one that could engage in several activities and succeed. The praise that the company received from people who had no idea of the clear picture of the company may have made them suppress the information of the company. It was a secret that was known to the auditors of the company and its financial controllers.
The board of directors may have not had the skills to read through the financial records which would have made them suspect the poor records. This reflected a poor communication channel in the company as well as confusion among the leaders.
Profits of the company
The company generated income by selling its products wholesale to the agents who would distribute them to other customers. The agents that were taking over the distribution of the products would undertake all the risks that were realized in their operations. This was the main procedure that enabled the company to generate such a high amount of profits. The company was also using other unique procedures of reporting their revenues that granted a competitive advantage over the other companies. This made the companies adapt such measures with the hope that they will compete effectively with the company.
Danzon & Harrington assert that, ‘‘the merchants that are involved in the sell of the products are required to enter their products as the cost of goods sold while the agents provide the services to the final consumer.’’ Enron used the method of reporting inflated revenues that were also adapted by other companies. This was the method that made the company record exemplary growth as some revenues were added to their income. The revenue of the company recorded a 750% growth between 1996 and 2000. This extraordinary growth was related to its expansion rather than the faults in its accounting system.
The compensation scheme that was used to reward the employees of the company was aimed at expanded growth. The company was looking forward to experiencing high growth and hence aimed at rewarding their employees substantially. The compensation scheme was however done in favor of the top management. Accounting information was recorded immediately after the transaction occurred which made the company record higher revenue (Danzon & Harrington, 130).
It was also this move that made the managers receive good stock options and cash bonuses. The company was mainly focused on how the stocks moved. The stock ticker was seen at all strategic places of the company that made it keep a track of how it moved. The company employed any method that would guarantee them that the stock of the company will keep on moving. There was an earning strategy that was employed whereby people will be compensated just to ensure that the stock of the company was rising. It did not matter what the individual demanded to keep the stock high, it was usually granted as per their wish.
The fact that the company was focused on increasing its stock, meant that there was some unnecessary spending that was recorded in the company that was not being accounted for. The company seemed to lose its focus in its efforts to earn recognition in the market. The scheme that was used to compensate its top management created an expectation within them that there would be a high growth that would be experienced in the company. Other loopholes allowed the misuse of funds that were not accounted for. The expenses of the employees of the company were very high and the executives were paid almost double the price that other similar executives were earning.
This means that most of the funds that would have been used to effectively manage the activities of the company were used to pay workers what they did not deserve. They did not observe a specific compensation scheme that would have enabled them to be effective in their operations. The company believed in spending more to gain more, they did not have specific accounts that would help them know where and how their money was being spent. Such exorbitant expenditures without proper records of where the money was going must have been too much for the financial controller.
The financial controller and the auditors must have reached a point whereby they could not account for some of the expenses. Some of the money that had been used had not been recorded and hence making it difficult for the yearly records to be made. The good performance that was being experienced by the company made them resort to manipulating the accounts in whichever way possible.
This was to ensure that what was revealed in the accounts showed steady growth and improvement rather than deterioration. The role of a financial accountant is to ensure that all expenses and incomes are accounted for. This is usually done by collecting all the days and monthly records on the financial activities of the company and organizing them appropriately. They are usually required to enter the kind of transaction that was involved and the date on which the transaction occurred.
This will enhance the accountability of the company’s finances and hence reflecting on its performance. The work of an auditor is mainly to verify that the accounts that have been entered by the financial accountant are clear. There was no such clarity in the books of Enron accounts which made it complicated for both the auditor and accountant to ascertain. They may have been looking for a way to escape such accountability by using their skills to manipulate the accounts.
The company failed to employ a risk management plan that would have saved it from the scandal. The company needed to have such plans considering the numerous trading activities that they were involved in. The nature of their business establishment also exposed them to unknown circumstances which should have been predicted and taken care of. The company failed to foresee what would have befallen them for necessary action (Ingram & Albright, 83).
They were generally deceived by their rising stocks and recognition in the market and felt comfortable. The company also had a complex business plan that needed a risk management plan. The energy industry is usually faced with risks in price changes making it difficult to predict the performance of the industry in subsequent years. The company was also involved in other long-term commitments which needed a regular supply of finances to manage them. When making such investments, the company did it without a proper prediction of its financial position. Decisions were entered into by the company management without prior consultations from economic and financial experts.
The company exposed itself to a risk of bankruptcy by being too aggressive. The kind of business establishment that they engaged in required a substantial amount of operating capital. The company mainly entered into such operations with the hope of generating more income and failed to realize that the price they had to pay to reap such benefits. In making the investments, the company was not doing it with the aim of spending but rather the aim of gaining.
This made them squander the income that was generated from the establishments without considering their maintenance cost. It was also revealed that the board of directors was aware of the risks that the company was exposing itself to but failed to take appropriate action to correct the mess. It had reached a time when the company was not making any records of the transactions that they had engaged in. All this was known to the board of directors but they were not quick to correct the mess.
The cause of the slow action of the board to correct the mistake was because of the complex business plan that the company had entered into which interfered with a clear procedure of solving the problem. The matter was not only complex to the financial controllers but also to the board of directors who did not know where to start from.
Auditing of the firm’s records
The auditing firm of the company was Arthur Anderson. IT was the only firm that could have revealed the financial reports of the company and facilitates a corrective measure. The farm was however accused of also engaging in crafty measures to display that the company was performing well when it was heading into bankruptcy. The firm was in a good position to analyze the expenses and incomes of the company and hence being able to give a correct report. Arthur Anderson was earning a good amount from the company informed of consultation and audit fee. In 2000 alone, the company earned 27 million dollars as consultation fee and 25 million dollars as audit fee.
This accounted for only 27 percent of what the other auditors received. There is hence a possibility that the auditors were enticed by the good earnings they received from the company which made them manipulate the accounts (Markham, 123). The auditor did not act according to their professional requirements and chose to give a wrong report of Enron’s finances.
Before any financial reports of a company are published for the public to read, they are supposed to go through the hands of an auditor who is to verify that what has been indicated is a clear reflection of the financial activities of the company. What the auditing company does is verify all entries that have been made in the books of accounts by checking on the receipt records. The auditors are to seek verification from the controllers of the accounts of the firm in case they find that what has been reflected in the accounts book is not clear. It is after everything has been sorted out between the accountant and the auditor that the information will be published for public view.
There is so much trust that is invested in the auditors that nobody may want to challenge their performance. They are usually considered as the ultimate perfects of the books of accounts. Author Anderson was hence trusted that the verifications that they made to the audit accounts were clear.
This was the main reason why the company received a lot of credits from the economic experts who trusted in the report of the auditors. It caught everybody by surprise when it was announced that the company had become bankrupt. It was not normal for a company that had recorded an extraordinary growth in the previous year to be declared bankrupt. There was something wrong that had to be identified and sorted out.
The early signs of bankruptcy are usually depicted by a deteriorating performance of the company which makes people suspect that things were not right. However, the scandal at Enron was so much organized that it was difficult for anybody to suspect that it would run bankrupt. It was instead receiving a lot of compliments from the media as other similar entities admired their practices. Most of their business practices were adapted by their competitors with the hope of performing equally as the company was performing.
After the fall of the company, it was revealed that the company employed some of the experts in the accounts field to help them suppress the problem. They employed all the accounting techniques that would work to the advantage of the company. This means that the company had already noticed many loopholes in its accounting reports that it had to employ financial experts that would bail them out of the situation (Danzon & Harrington, 90).
The experts had to look for all possible means to seal the loopholes that were identified in the reports and ensure that they reflect growth. Even though the accountants managed to manipulate the accounts that went unnoticed, it was only a matter of time before the truth was revealed. The wrong presentation of the financial records did not change the fact that the company was performing badly. The poor performance of the company did not serve as a lesson for the company to change its ways. Probably it was too late for it to identify a measure that would handle the situation. The company was determined to show the public that they were performing well yet in the real sense they were hurting.
Other accounting issues of the company
There were also other accounting issues in the company that was taken for granted. For instance, the company continuously supplied money to projects that had been canceled by the company. The reason for such an action was mainly because the accounting department had not received a letter that indicated the cancellation of such projects. This hence meant that there was a substantial amount of money that was being disbanded to carry out projects that were not recognized by the company. This is a clear indication that there was no proper channel of communication in the company.
Everybody seemed to engage in their activities without knowing what was happening in other departments (Salter, 67). There was no accountability between different departments of the organization. Nobody also seemed to care much what their activities impacted the running of the organization and chose to mind their own business. This may have started with the top management.
They probably did not care much about what other departments were involved in rather than the income that was generated from such activities. There was no hard work that was being observed by the company, it was filled with a lot of pretenses simply to lure the public. Whenever there was a serious inspection that had to be carried out on the performance of the organization, the company would alert its employees on how they should behave. This was a deception whose time had to come to an end.
After the downfall
After the downfall of the company, what remained was to compensate its employees through their due salaries and pensions. Other shareholders were to be refunded for the investments that they made in the company. Four years before the bank was declared bankrupt, the shareholders had already lost 74 billion dollars. Out of the total amount that the company lost, it was discovered that 45 billion dollars were lost in the fraud. The total amount that the company owed its employees, creditors, and shareholders amounted to 67 billion dollars. There was no money for the company to carry out such payments and had to liquidize its assets.
The assets of the company which included pipes, artwork, photographs, and logo signs were auctioned to ensure that the company obtained funds to clear its creditors. Despite the efforts of the fallen company to clear off their employees, they did not manage to adequately grant them all their payments. In 2004, former employees of the company sued it for what they termed as un-cleared debts. The case was won and the company had to clear them of two billion dollars that they owed them in form of pension. The employees of the company received a total amount of 3, 100 dollars each for compensation. Other investors of the company were settled for about 2.4 million dollars from banks in the following year.
The company was also required to compensate other stakeholders that were involved in the running of the company. The payments were done in stages until when all the bills were settled (Clarke, 57). Many charges were presented against the company, the biggest of it being the one of fraud. All the fraudulent activities of the company were brought to light and exposed. There were no more secrets for the company as the main people that were involved in the activities spoke the truth before the court. It was a big shame to the management of the company as their dirty schemes to deceive the public was revealed.
The UC’s law firm received the highest amount of compensation from the company in fraud. This was a clear indication of the nature of fraud that the company was involved in. It was one of its kind; the highest that had ever been recorded in United States history. It was indeed a painful moment for not only the company but also its employees, clients, and stakeholders who depended highly on the activities of the company.
The mess that the company found itself in was avoidable, the management was only required to be real and engage in manageable activities. It had now become public that the company had been living a lie and could not be trusted anymore. The management may have thought that they are doing this to escape a temporal problem. They did not know that the issue they looked at with simplicity would lead to a serious problem in the future.
The management would have been doing this for personal reasons not realizing the wider community that they were serving. Even though a business is established by individuals for their interests, once it starts functioning, it ceases to be a personal affair. They have to be accountable for each activity that they engaged in. They had to recognize that the services that they are engaged in are for the interests of the public and hence doing all they can to ensure high productivity. This is the reason why the public had to be involved when the company went bankrupt.
Enron was a good example of a company that failed to employ correct management skills to earn profits. There was a lot of foolishness that was involved in the activities of the company that could not be contained for long. Even though they managed to fool the public concerning its performance, it was a matter of time before its folly returned to them. The management was over-ambitious about the growth of the company which was aimed at enriching their pockets. It was clear from such analysis that the numerous activities that the company was engaged in were not for public interests. They were mainly being done to earn a reputation in the US economy as well as fulfilling their interests.
There was no concern about how the employees were carrying out their activities (Markham, 187). All that the company was looking forward to was an extra coin in their pockets. When it reached a time when their secrets had to be revealed, they did all that they could including the engagement of experts. They were doing this at the expense of their clients and shareholders who trusted in their activities. The judgments that were taken against the key suspects in the scandal were done basing on how much they had fooled the public. It was to serve as an example to other business entities never to engage in similar fraudulent activities.
Clarke, Thomas. Theories of corporate governance: the philosophical foundations of corporate governance. London: Routledge, 2004.
Danzon, Patricia & Harrington, Munch. Rate regulation of workers’ compensation insurance: how price controls increase costs. New York: American Enterprise Institute, 1998.
Ingram, Robert & Albright, Thomas. Financial Accounting: Information for Decisions. London: Cengage Learning, 2006.
Manz, William. Corporate Fraud Responsibility: A Legislative History of the Sarbanes-Oxley Act of 2002. New York: William s Hein & Co, 2003.
Markham, Jerry. A financial history of modern U.S. corporate scandals: from Enron to reform. California: M.E. Sharpe, 2006.
Salter, Malcolm. Innovation corrupted: the origins and legacy of Enron’s collapse. Harvard: Harvard University Press, 2008.