Analysis of Enron Scandal

EXECUTIVE SUMMARY

The report analyzes how the Enron Scandal took place and how the big energy giant was collapsed suddenly and eventually filed for bankruptcy. We have also analyzed it by giving an example of our own hypothetical company Group No.2corporation. The report covers the main false accounting practices that Enron used for manipulating its financial reports which include the use of mark to market accounting, special purpose entities, agent vs merchant model. Hence it aims at giving an overview of how Enron was able to pull off such a gigantic fraud which led to the biggest bankruptcy ever.

ACKNOWLEDGEMENTS

We are thankful to Allah Almighty for enabling us to complete this report. This report would not have been possible without the guidance of our course instructor; Ms. Sabina Asim. We express our gratitude to her for her readiness to assist throughout the course of our analysis. Our class mates have been a source of great help and moral support in times of stress and work overload. Their patience is commendable.

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1 Introduction

1.1 Introduction to the company

Enron was energy based American company. It used to have its headquarters located in Houston, Texas. Enron was formed in 1985 by Kenneth Lay. It came into existence because of a merger between Houston Natural Gas and InterNorth.

In 1997, Jeffrey Skilling was promoted to the post of president and chief financial officer (CFO) of Enron, while remaining the head of Enron Capital & Trade resources. It was Skilling who came up with the idea that the company didn't really need any assets, pushing the company's investment strategy. He made Enron the biggest gas and electricity wholesaler with a record of $27 billion traded in a quarter. Jeffrey Skilling appointed a staff of executives who used accounting loopholes, special purpose entities and poor financial reporting to prevent the disclosure of billions of debt amounted from failed deals and projects. These executives misled and misguided Enron's board of directors and Audit committees on the risky accounting practices used. Its audit firm, Arthur Andersen was pressurized by Enron's executives to overlook these issues.

Later in the mid of 2000, the company's stock price reached to its record high price of US $90 per share. Unfortunately, the executives of Enron could not hold on to this price for long and by November 2001, the share price crashed to less than $1 a share. The company declared bankruptcy in December 2001.

1.2 Rise of Enron

The rise was Enron started from the time when it got into the selling of electricity at market prices, followed by the deregulation of natural gas by the United States Congress. This provided companies like Enron with the opportunity of earning tremendous profits by selling energy at high prices. By 1992, Enron became the largest seller of gas in 1992, with a total gas trading contracts earned earnings before interest and tax of $122 million.

After this the company adopted a strategy of diversification, it acquired and operated a variety of assets including gas pipelines, electricity plants, pulp and paper plants, water plants and broadband services. As a result of these operations, Enron's stock price increased by more than 300% from 1990-1998. Than in 1999 and 2000 it increased by 56% and 87%, whereas in 1999 the index grew by 20% and in 200 it declined by 10%. By December 2000, its market capitalization exceeded $60 billion, which were 70 times earnings and six times the book value. Other than that, Enron was rated as the most innovative large company in USA in the Fortune's Most Admired Companies survey. This further increased the stock price of the firm and made the investors more confident in their investments of Enron.

2) Causes of Downfall

With the help of fabricated non-transparent financial statements, Enron did not reveal its operations and finances to its shareholders and analysts. In order to conceal its unethical practices it used accounting limitations to keep the income and cash flow high, showing the assets at inflated values and kept the liabilities off the book.

After some time, the fabrication of the accounting statements became tough and the closure of information became a tough task. It was then that facts started to