Question

In Enron's bankruptcy, "Revenue Recognition" was one of the major issues. First, summarize the revenue recognition issue in Enron Bankruptcy. Second, as an auditor, what type of evidence would you want to examine to determine whether Enron was inappropriately recording revenue from the Sithe Energies contract?

Answer 1

Question - Summarize the revenue recognition issue in Enron bankrupsy. Answer - The Enron scandal was an accounting scandal of Enron Corporation, an American energy company based in Houston, Texas. ... The deal failed, and on December 2, 2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code.

Summary and definition: The Enron Scandal surfaced in October 2001 when it was revealed that America's seventh largest company was involved in corporate corruption and accounting fraud. ... ENRON shareholders lost $74 billion leading up to its bankruptcy, and its employees lost their jobs and billions in pension benefits

The Enron scandal was an accounting scandal of Enron Corporation, an American energy company based in Houston, Texas. . In addition to being the largest bankruptcy reorganization in American history at that time, Enron was cited as the biggest audit failure.Enron was formed in 1985 by Kenneth Lay after merging Houston Natural Gas and InterNorth. Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that – by the use of accounting loopholes, special purpose entities, and poor financial reporting – were able to hide billions of dollars in debt from failed deals and projects. Enron was formed in 1985 by Kenneth Lay after merging Houston Natural Gas and InterNorth. Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that – by the use of accounting loopholes, special purpose entities, and poor financial reporting – were able to hide billions of dollars in debt from failed deals and projects. As a consequence of the scandal, new regulations and legislation were enacted to expand the accuracy of financial reporting for public companies.

Question -As an auditor what type of evidence would you want to examine to determind whether enron was inappropriately recording revenue from the sithe energies contract.

Answer - In my opinion, the main critical factor in the case of Enron is manipulative accounting practices. Enron and Arthur Anderson both manipulated the financial statements, over reported income and under reported expenses to make Enron seem like a profitable and secure company, when in fact that was not the case. They achieved this by way of the contributing factors of misrepresented SPEs, Mark to Market Accounting, and Arthur Andersens poor judgment, and lack of independence in the success or failure of Enron.

SPEs or Special Purpose Entities, are traditionally used to limit an investors risk to a single venture of a company, and to prevent their exposure to the risk of the rest of the companys practices or ventures.1Case page 180

Enron began using SPEs to hide it's dirty laundry.2Case page 187

. The debt and assets purchased from Enron as well as the losses reported by the SPE, no longer needed to be reported or disclosed on Enrons financial reports. Although questions were raised in Andersens risk assessment meetings regarding Enron's use of SPEs, the lead partner for Anderson at on Enron assured them that everything was good,3Case page 187

The Mark to Market method of Accounting allows for a long-term contract to be signed, and at that time the present value of expected future payments can be recorded now as revenue, and the present value of the cost to fulfill the contract can be recorded now as expenses.4Case page 183

This appropriatness of this method of accounting under any circumstances is hotly debated. Enron began using MTM in 1991. The difference between the estimated value of their contract and the amount Enron estimated it would pay to fulfill it's part of the deal was regarded as profit by Enron when in fact, they might not ever supply anything. There is little doubt that the projections of the long-term income were optimistic and inflated. For example, in the deal with Blockbuster, Enron recorded estimated profits of more than $110 Million, based on expected future revenue. Less than a year later the deal was canceled with zero in revenue actually being earned.5Case Pages 183, 184

Arthur Andersens actions at Enron defied some of the fundamental principals of GAAS. However at the time GAAS did not exist. Public accounting was self regulated by the AICPA. Although the AICPA did issue Statements on Auditing Standards to provide guidance on audit conduct, there were no consequences for deviating from these standards and no consequences for bad behavior.6Textbook, page 36

The Anderson Audit team managed to seemingly ignore them. They were not independent. In addition to Independent Audit services Arthur Andersen provided, consulting services tax services, and 40 personnel left Enron to work at Anderson on their internal audit services for Enron. That is the exact opposite of independence. Anderson's team also failed to act with due professional care and professional judgment. The Anderson staff were well aware of the questionable use of SPEs and inflations made by the use of Mark to Market accounting and chose to allow it to continue, and knowingly allowed the misrepresentation the financial statements. Why wouldnt they? They had a vested interest in Enron doing, and appearing to do well financially. Anderson billed Enron for 50 Million dollars in 2001just before the collapse, more than half of that was from nonaudit services.7Case page 184

Could it happen today?

In my opinion, no. As a direct result of the fraud and scandal at Enron, as well as other well publicized frauds, the United States Government passed the Sarbanes-Oxley Act in 2002. SARBOX established the PCAOB to provide oversight to public accounting firms. It also established standards for auditor independence, financial disclosures, and conflicts of interest. But most importantly SARBOX enacted criminal penalties and therefore consequences for breaking the rules they set forth. Had theses rules been in place at the time, I don't believe Enron or Arthur Andersen employees could have run so freely amuck. That's not to say they would have been ethical, or even honest, but the chances of them pulling off such a wide spread, all encompassing fraud without being detected would have been far smaller.