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Enron Scandal: Historical Accounting Method

Enron started as an energy trading company but began losing money, so they manipulated their accounting practices to hide losses. Specifically, [1] they switched from historical cost accounting to mark-to-market accounting, allowing them to assign arbitrary values to assets; [2] they overvalued assets to inflate revenue and profits from 1996-2000; and [3] they created shell companies to hide debt and losses. When the SEC investigated in 2001, Enron had to report over $600 billion in losses, bankrupting the company and costing many employees their jobs due to the massive accounting fraud.

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Rudraksh Parey
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82 views2 pages

Enron Scandal: Historical Accounting Method

Enron started as an energy trading company but began losing money, so they manipulated their accounting practices to hide losses. Specifically, [1] they switched from historical cost accounting to mark-to-market accounting, allowing them to assign arbitrary values to assets; [2] they overvalued assets to inflate revenue and profits from 1996-2000; and [3] they created shell companies to hide debt and losses. When the SEC investigated in 2001, Enron had to report over $600 billion in losses, bankrupting the company and costing many employees their jobs due to the massive accounting fraud.

Uploaded by

Rudraksh Parey
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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ENRON SCANDAL

Enron was started by mergering Houston Natural Gas Company and Internoth Company. Enron was an
energy trading company. It traded electricity, natural gas etc. Enron was not performing well so it hired a
consultant from Mc Kinsey and Company namely Jeffrey Skilling as a consultant. After Jeffrey Skilling
was hired and became the COO of Enron. Jeffrey hired Andrew Fastor as Andrew was known for
complicating the skills of a company. After some time Andrew Fastor became the CEO of the company.

Now the company started facing loses and to avoid showing losses they started showing fake revenues.
They changed the accounting methods from Historical Cost Accounting Method to Mark -to Market
Accounting. They informed the US Capital Market Regulation that Enron will not be using the Historical
Cost Accounting Method. It will be using the Mark –to Market Accounting.

Historical Accounting Method:

Here the price at which the asset was bought, that particular price was shown in the balance sheet of the
company. The problem in this Accounting Method was that most of the assets value used to change in the
future but the value in the balance sheet would remain the same as it was in the past.

Mark – to Market Accounting:

Here the price at which the asset was bought, that particular price was not showed in the balance sheet
rather the prevailing price in the market was showed in the balance sheet. Now, it is very difficult to know
the real price prevailing in the market so what they did that they took estimates of the value.

So, Enron started taking estimates and showed bigger and higher value of their assets. Enron collaborated
with Sithe Energy Company and started showing the size of the deal even before the deal had actually
started.

So Enron started manipulating all its figures such as:

1996 – Revenue ($13 Billion) Profit ($584 Million)

1997 – Revenue ($20 Billion) Net Income ($105 Million)

1998 – Revenue ($31 Billion) Profit ($703 Million)

2000 – Revenue ($100 Billion) Profit ($979 Million)

They wanted Capital for their company but they neither had revenues nor did they have profits and they
had shown the world fake profits and revenues so they couldn’t ask for Capital from investors. So, they
thought of getting Capital from Special Purpose Vehicle (SPV). Enron transferred some assets to the SPV
and then took the loan given to SPV from Bank. Enron showed the assets transferred to SPV as sales in
their balance sheet and the loan as money received from SPV.

To boost the sales of the company it over valued non-performing power plants and showed the difference
between the book value and fraudulent market value as interest.
Then, at the end when Enron showed their Balance sheet it showed $618 Billion loss and then SEC
looked upon what had happened in the company and got to know that the company was a fraud due to
which many employees lost their job. The main culprits of this fraud were CEO Jeffrey Skilling and
Former CEO Ken Lay.

According to International Accounting Standard boards (IASB), International Financial Reporting


Standards (IFRS) and International Accounting Standards Committee (IASC) the accounting statements
or financial statements should be produced fully with transparency, efficiency, and it should be
accountable. But in the case of Enron they did not follow even one of the principal correctly. They did not
fully disclose their financial statements. They were not transparent with their financial statements neither
they were efficient nor they were accountable. They also stopped using the Historical Cost Accounting
Method and used the Mark – to Market Accounting in which they could show false value of the assets and
make the world believe that their company was efficient and accountable but in reality this was not the
case.

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