Question

Enron's demise. Briely discuss the following:

What did Enron use to hide its debt? What was the main thing that led directly to the downfall of Enron? What was the basic idea underlying Enron’s use of SPEs and why was this flawed?Could Raptor and the other SPEs have actually worked?  Tell briefly why or why not? What is a ‘Ponzi scheme’?  Say briefly how it works? What is the classic definition of ‘materiality’? What is the basic difference of responsibility between a company executive and that company’s auditor? Was Arthur Andersen aware of the use Enron was making of its SPE? Give two of the things that Arthur Andersen discussed during their “Enron Retention Meeting.” What is the difference between the appearance and the reality of independence?  Which is essential for an accounting professional? What is the relation of this difference to Arthur Andersen’s distinction between the level and nature of fees? What is one good reason why even the appearance of lacking independence should be avoided? What are the two kinds of objectivity? What is the basic relationship between rules and principles? Briefly explain what Ken Lay meant when he said that Enron had a ‘real time audit’ by Arthur Andersen all the time. Why is the concept of a ‘real time audit’ problematic? What is the basic relationship between ethics and legality? What are the ethical considerations that bear upon document destruction? What was the purpose of the SPE called RADR, which was controlled by William Dodson and, vicariously, Michael Kopper? In what way could Enron’s actions justify its corporate culture being call a ‘culture of greed’?

Answer 1

• Enron used Special Purpose Vehicles or Special purpose entities to hide its Debt. These are off balance sheet items. The aim of these is to hide the realities of accounting. These SPVs were capitalised with the stock of Enron due to which they could not be hedged for a better position.
• The innovative accounting practices by the CFO were not successful and brought a tide of losses. Enron was hiding its losses by decentralised operations. This later created liability for the company and led to downfall.
• Idea was that Enron would transfer its good performing stocks to SPVs for cash/note. SPVs would use stocks to hedge assets in balance sheet and there would be a guarantee from Enron to reduce counterparty risk by the value of SPVs. SPVs. Were capitalised entirely from Enron’s Stock. Due to this SPVs could not hedge if prices fell. Value of SPVs later on fell.
• SPVs are legal and can serve various purposes if used well. Many of the transactions are not shown on Parent company’s books. Companies who sponsor SPVs get cheaper financing and offer greater safety to their investors. Careful balance sheet analysis should have been done and then SPVs should have been considered.
• Ponzi scheme is a fraudulent activity that promises investors of high returns and lower risks. The Ponzi scheme generates returns for old investors by tapping new investors. This is the same as Debt Trap i.e. taking new Debt to clear older one.
• Materiality is a concept that any error in financial statement has an affect on the decision making of users.
• A company’s executive has a role of growing the business and taking such decisions that would help the business grow in near future.

Auditor has a role of checking and approving the financial statements of the company and verifying that the statements are correct to the best of his knowledge.

• Arthur Andersen was aware of the use Enron was making of its SPE.
• Discussion at Enron Retention Meeting:
• Corp.'s aggressive accounting practices and potential conflicts of interest

Enron executive who warned the company's chief executive that it was in danger of being swamped by accounting irregularities also voiced concerns to Andersen

• In appearance, third party see us as independent and in reality of independence we may or may not be independent to take decisions of invest funds.
• Reality of independence is essential.
• The fees that was paid was very high i.e. $25 million for year 2000 and this brought the issue on reality of independence.
• Appearance of lacking independence should be avoided so that thee investors or clients do not think that the decisions taken will be for selfish purposes.
• Rule is enforced and a principles is what guides to act in a way.
• She meant that Enron had a continuous audit by Arthur Anderson
• Public scrutiny can be there for disposal of documents.