In the late 1990s, Enron was one of the largest companies in the United States. It was an energy company with a high-flying stock price and a reputation for being innovative and forward-thinking.
In 2001, it all came crashing down. Enron was revealed to be a fraud. The company had been overstating its earnings and hiding its debt. When the truth came out, Enron’s stock price plummeted, and the company filed for bankruptcy.
The Enron Accounting Scandal
The Enron accounting scandal is one of the landmark cases involving accounting and auditing ethics practices. Enron collapsed after the irregularities and misrepresentations by the company, with the help of their auditors, Arthur Andersen, was revealed.
Shareholders and analysts were perplexed by Enron’s convoluted financial statements. In addition, the company’s sophisticated business strategy and illegal business practices necessitated the application of accounting constraints to misrepresent earnings and alter the balance sheet to reflect good performance. Additionally, some speculative business initiatives were unsuccessful.
The confluence of these flaws ultimately led to Enron’s bankruptcy, and most of them were sustained by the indirect knowledge or direct actions of Lay, Skilling, Andrew Fastow, Rebecca Mark, and other executives. Lay served as chairman of Enron during its latter years and approved of Skilling’s and Fastow’s conduct, although he did not always enquire about the specifics. Skilling consistently focused on achieving Wall Street’s expectations, promoted the use of mark-to-market accounting (accounting based on the then-inflated market value), and exerted pressure on Enron executives to discover new ways to conceal the company’s debt. Fastow and other executives “developed off-balance-sheet vehicles, sophisticated financing structures, and deals so incomprehensible that few individuals could comprehend them.
The Facts of the Enron Scandal
Enron’s Chief Accounting Officer, Jeff McMahon, started the accounting scandal. Enron’s Board of Directors were aware of some of the problems in the company’s accounting. A former board member, who has since been found guilty of perjury, told a grand jury that he had expressed concerns to then-CEO Kenneth Lay, and Lay had brushed him off.
The Enron scandal began with a series of questionable accounting practices that allowed the company to hide its mounting debt and inflate its profits. Enron’s auditor, Arthur Andersen, was complicit in these practices, and the two companies worked together to defraud investors. When the truth finally came to light, Enron’s stock price collapsed, and the company filed for bankruptcy. Thousands of employees lost their jobs and retirement savings, and shareholders were wiped out.
How the Enron financial scandal was revealed?
Sherron Watkin, the former Enron executive who secretly warned firm founder Kenneth Lay of approaching financial doom in the fall of 2001 had another crucial encounter with him on Wednesday, along with former CEO Jeffrey Skilling, a jury, and a phalanx of defence attorneys in their fraud and conspiracy trial.
Prior to joining the energy business in 1993, Watkins worked as an accountant for Enron’s previous external auditor, Arthur Andersen LLP. In the summer of 2001, she was supervised by Chief Financial Officer Andrew Fastow, for whom she had worked in several divisions.
Sherron Watkins, the eloquent former vice president who Congress designated as a whistleblower after the company’s demise, reiterated much of what she said at the time: Enron needed to come open about potentially devastating accounting techniques or face implosion.
The Enron scandal was the subject of several media reports. One of the most notorious events from this scandal was an interview given by Enron CEO Jeffrey Skilling on CNBC’s “Wall Street Week” program. This interview was broadcast on December 11, 2001. In this interview, Skilling stated to CNBC’s Maria Bartiromo that Enron could have made $43 billion in profit over the past year if only it had been allowed to continue using off-the-books accounting practices.
In 2001, several different news sources reported on Enron’s financial scandal. The New York Times was one of the first to break the story, reporting on September 26th that the company had been using creative accounting practices to hide its true financial situation. This article was quickly followed by others, including an investigation by the Wall Street Journal.
In January 2002, Enron filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code. The Enron scandal occurred during a period of rapid technological advancement and increased globalisation. The crisis started in the natural gas industry. Enron’s business model was predicated on selling natural gas as a commodity to utilities, trading it with its competitors, and then reselling that gas at higher prices. In 1996, Enron entered the electricity market by acquiring several power plants in California and Texas. In December 2001, Enron purchased Union Electric, a utility in New England with a $1.6 billion market capitalization. In 2002, Enron bought Dynegy, Inc.
Impact of the Enron Accounting Scandal on Investors
Since the news of the scandal broke, investors have been worried about the future of their investments. Many have lost trust in the company and feel that their money is no longer safe. Some have even decided to sell their shares and take their money elsewhere. This could lead to a decline in the company’s stock prices and a loss in investor confidence. If this continues, it could seriously impact the company’s ability to grow and succeed.
The Enron scandal discouraged many average Americans from investing. In any case, if a titan like Enron could fail, what investments could they rely on? A substantial number of Americans have chosen not to participate in the extraordinary stock market gains of the last two decades. In 2020, slightly more than fifty-five per cent (55%) of the population owned stocks directly or through savings vehicles such as 401Ks and IRAs. According to the Survey of Consumer Finances from the Federal Reserve, this is down from 60 percent in the year 2000.
Accounting Regulation Changes After the Enron Accounting Scandal
The Enron Accounting Scandal was a turning point in the history of corporate fraud. It led to new laws and regulations that increased transparency and accountability for public companies. It also caused many people to lose their life savings and destroyed the reputations of Enron’s top executives, who were convicted of criminal charges.
Many changes were made to the accounting regulations after the Enron accounting scandal. Some of these changes include more stringent requirements for financial reporting, greater transparency in financial statement disclosures, and more independent oversight of the accounting profession. These changes helped to restore public trust in the accounting profession and make it more accountable.
The Enron Accounting Scandal caused the government to implement some profound changes, as the damage caused by this scandal can last for a long time. The most significant change that was made in this matter is the restructuring of the accounting profession. This restructuring resulted in new accounting firms, which are more qualified and competent to tackle financial matters.
The second important change that was introduced was the creation of a new accounting firm. The establishment of this new accounting firm has led to an increase in the number of registered firms, which are now accountable for the activities of their employees. This is the biggest advantage of this restructuring of the accounting profession. This also helps to ensure that the accounting professionals are only involved in preparing and submitting financial statements.
The third change that was introduced was the introduction of the SOX act. The SOX act regulates the activities of all firms that deal with public sector finances. The law clearly states that each firm must be responsible for its activities, irrespective of whether they deal with financial matters or not. The law also dictates that the firm should also provide the clients with all the reports and information required by the clients.
The introduction of the SOX act has led to the consolidation of all the activities associated with the Big Four accounting firms. This consolidation led to the firm’s being called the Big Four. After this consolidation, the firm’s name changed from Enron to BCG. However, this firm still maintains the same level of expertise and competencies it has maintained in the past. This firm is still considered to be a premier firm that handles financial matters.
It has been established that the Enron accounting scandal caused huge financial losses to the firms associated with the financial matters. This resulted in the firm’s closing, a significant loss to the investors. However, after restructuring the accounting profession, this industry seems to be on its way back.
The restructuring of the accounting profession and the introduction of the SOX Act have helped in the regeneration of the Big Four accounting firms. These firms are more capable of handling the problems of financial matters and also provide better services to their clients. Therefore, it has become clear that the Enron accounting scandal did not only cause financial loss to the clients; the financial institutions and made the accounting industry stronger.
The Enron accounting scandal and its aftermath were a watershed in the accounting industry. This event also changed how companies communicate internally and externally with their regulators and investors.
Before this event, managers, analysts, and company shareholders were usually privy to company financial results but could not verify the accuracy of those results. For instance, one could claim that a good business generated a company’s reported earnings, but, in reality, that business was losing money. In such a case, managers would have been forced to choose between either cutting costs or failing to communicate externally and often choosing to cut costs.
This event would have been tolerated if it hadn’t ended in disaster. However, the Enron events caused the financial community to lose faith in a company’s ability to produce accurate financial reports. Since then, companies have been reexamining their internal accounting procedures to ensure that they do not, in any way, present an inaccurate picture of their financial health.