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Analysis of Hp monetary Statement EssayKenneth Lay organize Enron in 1985, when InterNorth acquired Houston Natural Gas. It was once the seventh largest telephoner the United States of America. Enron branched into many non-energy-related fields oer the next some(prenominal) years, including such atomic number 18as as Internet bandwidth, risk charge, and weather derivatives (a type of weather am terminals for seasonal logical argumentes). Although their core business remained in the transmission and distribution of power, their phenomenal growth was occurring through their another(prenominal) interests. Fortune Magazine selected Enron as Americas most innovative companion for vi straight years from 1996 to 2001. whence came the investigations into their complex network of offshore partnerships and accounting system practices.The Enron s messdal was revealed in October 2001 that eventually led to the nonstarter of the Enron tum and the de facto dissolution of Arthur Andersen, which was one of the five largest scrutinise and accountancy partnerships in the world. In addition to being the largest bankruptcy reorganization in American history at that time, Enron was attributed as the biggest scrutinise stroke. Several years subsequently it inception when, in 1992, Jeffrey Skilling was hired as the President of the attach to, he developed a staff of executives that, by the phthisis of accounting loopholes, special intent entities, and poor pecuniary cut throughing, were able to hide billions of dollars in debt from failed deals and projects. main(prenominal) Financial Officer Andrew Fastow and other executives not solely misled Enrons board of directors and canvass committee on unfit accounting practices, but also pressured Andersen to ignore the issues.From the early 1990s until 1998, the computer memory bells of Enron rose by 311%, yet slightly higher than the rate of growth in the Standard Poors 500. But, after which the stocks crap-shooter up. They increased by 56% in 1999 and another 87% in 2000, comp ard to a 20 per centum increase and a 10 percent decline for the index during the same years. As on celestial latitude 31, 2000, Enrons stock was priced at $83.13, with market capitalization exceeded $60 billion, that was 70 times earnings and sixsome times book value, an indication of the stock markets high expectations well-nigh its future prospects. Enron was rated the most innovative large company in America in Fortune magazines comply of Most Admired Companies. Despite of which within a year, Enrons image was in tatters and its stock price had tanked nearly to zero.The Enron Scandal was a legend of document shredding, restatements of earnings, regulatory investigations, an unsuccessful merger and Enron filling for bankruptcy. all the same an elaborate corporate governance network, Enron was able to magnetize large sums of capital to source a turn over business model, masking its actual performan ce through a serial publication of accounting and financing ploys, and change magnitude its stock prices to unmaintainable levels.Shareholders lost nearly $11 billion when Enrons stock price plummeted to less than $1 per share, by the end of November 2001, from a high of US$90 per share during mid-2000. As the Securities and Exchange Commission (SEC) initiated an investigation, oppose Houston competitor Dynegy bid to purchase the company at a very low price. The deal failed, and on celestial latitude 2, 2001, Enron filed for bankruptcy, with $63.4 billion in assets do it the largest corporate bankruptcy in U.S. history.How it happened?Enron had a rather mingled business model, stretching across many products, incorporating physical assets and trading operations, and crossing national borders. This element stretched the limits of accounting. Enron took sufficient advantage of accounting limitations in managing its earnings and balance sheet to portray a rosy vulnerability of it s performance.The trading business of Enron involved complex long-term contracts. The accounting rules thence, apply the present value good example to record these transactions, requiring management to make forecasts of future earnings. This approach, known as mark-to-market accounting, was square to Enrons income recognition and resulted in its management making forecasts of energy prices and interest rates well into the future.Enron relied expansively on structured pay transactions that involved setting up special purpose entities. These transactions shared ownership of particular(prenominal) cash flows and risks with outside investors and lenders. Traditional accounting that focuses on arms-length transactions between independent entities faces gainsays in dealing with such transactions. Unconscious resolutions were used to record these transactions, creating a discrepancy between economic realities and accounting numbers. (Healy Palepu, 2003)Financial Reporting IssuesTra ding Business and Mark to commercializeingDefinitions* A measure of the fair value of accounts that can change over time, such as assets and liabilities. Mark to market aims to provide a realistic idea of an institutions or companys current financial situation. (Investopedia) * The accounting act of recording the price or value of a security, portfolio or account to reflect its current market value rather than its book value. (Investopedia)In Enrons original natural gas business, the accounting had been fairly straightforward in each time period, the company listed actual costs of supplying the gas and actual revenues received from selling it. However, Enrons trading business adopted mark-to-market accounting, which meant that once a long-term contract was signed, the present value of the stream of future in flows under the contract was recognized as revenues and the present value of the expected costs of fulfilling the contract were expensed. unfulfilled gains and goinges in the market value of long-term contracts (that were not hedged) were then required to be inform later as part of yearbook earnings when they occurred. Enrons primary challenge in victimization mark-to-market accounting was estimating the market value of the contracts, which in some cases ran as long as 20 years.Income was estimated as the present value of net future cash flows, even though in some cases on that point were serious questions about the viability of these contracts and their associated costs. Mark to market was a plan that Jeffrey Skilling and Andrew Fastow proposed to pump the stock price, cover the loss and attract more enthronisation. But it is impossible to gain in a long-term operation in this way, and so it is clearly immoral and illegal. However, it was reported that the then US Security and Exchange Commission allowed them to use mark to market accounting method. The ignorance of the drawbacks of this accounting method by SEC also caused the final scandal. Thus, an accounting system, which can disclose more financial discipline, should be created as soon as possible.Reporting Issues for supererogatory Purpose EntitiesThe accounting rule, then, allowed a company to exclude a special purpose entity (SPE) from its own financial statements if an independent party has control of the SPE, and if this independent party owns at least 3% of the SPE. Enron need to keep an eye on a way to hide the debt since high debt levels would lower the investment grade and trigger banks to recall money. exploitation the Enrons stock as collateral, the SPE, which was headed by the CFO, Fastow, borrowed large sums of money.And this money was used to balance Enrons overvalued contracts. Thus, the SPE alter the Enron to convert loans and assets burdened with debt obligations into income. In addition, the taking over by the SPE made Enron transferred more stock to SPE. However, the debt and assets purchased by the SPE, which was actually burdened with large amou nt of debts, were not reported on Enrons financial report. The shareholders were then misled that debt was not increasing and the revenue was even increasing. (Li, 2010) Enron had used hundreds of special purpose entities by 2001. Many of these were used to fund the purchase of forward contracts with gas producers to supply gas to utilities under long-term fixed contracts. opposite Accounting ProblemsEnrons accounting problems in late 2001 were compounded by its recognition that several stark naked businesses were not performing as well as expected. In October 2001, the company announced a series of asset write-downs, including after tax charges of $287 million for Azurix, the water business acquired in 1998, $180 million for broadband investments and $544 million for other investments.Enrons gas trading idea was probably a reasonable solution to the opportunities arising out of deregulation. Conversely, extensions of this idea into other markets and international expansion were unsuccessful. Accounting games allowed the company to hide this reality for several years. The capital markets largely ignored red flags associated with Enrons spectacular reported performance and aided the companys pursuit of a flawed expansion strategy by providing capital at a remarkably low cost. Investors seemed forgeting to assume that Enrons reported growth and profitability would be bear on far into future, despite little economic basis for such a projection.Governance and Intermediation Failures at EnronMost of the blame for failing to recognize Enrons problems has been assigned to the firms auditors, Arthur Andersen, and to the analysts who work for brokerage, investment banking and research firms, and sell or make their research available to retail and professional investors. region of prime attention CompensationAs in most other U.S. companies, Enrons management was heavily paying(a) using stock options. Heavy use of stock option awards linked to short-term stock pr ice may explain the focus of Enrons management on creating expectations of rapid growth and its efforts to puff up reported earnings to meet Wall Streets expectations.Role of Audit CommitteesCorporate audit committees usually meet just a few times during the year, and their members typically pay all a modest background in accounting and finance. As outside directors, they rely extensively on information from management as well as internal and external auditors. If management is fraudulent or the auditors fail, the audit committee probably wont be able to detect the problem fast enough. Enrons audit committee had more expertise than many.But Enrons audit committee seemed to share the special K pattern of a few short meetings that covered huge amounts of ground. Enrons Audit Committee was in no position to second-guess the auditors on technical accounting questions related to the special purpose entities. Nor was it in a position to second-guess the validity of top management repre sentations. However, the Audit Committee did not challenge several important transactions that were primarily motivated by accounting goals, was not skeptical about potential conflicts in related party transactions and did not require full disclosure of these transactions. (Healy Palepu, 2003)Role of External AuditorsEnrons auditor, Arthur Andersen, had been accused of applying lax standards in their audits because of a conflict of interest over the significant consulting fees generated by Enron. In 2000, Arthur Andersen earned $25 million in audit fees and $27 million in consulting fees. It is difficult to determine whether Andersens audit problems at Enron arose from the financial incentives to retain the company as a consulting client, as an audit client or both. However, the size of the audit fee alone is likely to have had an important impact on local partners in their negotiations with Enrons management. Enrons audit fees accounted for roughly 27% of the audit fees of public clients for Arthur Andersens Houston office.When the credit risks at the special purpose entities became clear, the auditors apparently succumbed to pressure from Enrons management and permitted the company to defer recognizing the charges. Two major changes in the 1970s in the legal system, created meaty pressure for audit firms to cut costs and seek alternative revenue sources. In response to the changes, the audit firms lobbied for mechanical accounting and auditing standards and developed standard operating procedures to reduce the variability in audits. This approach bring down the cost of audits and provided a defense in the case of litigation. But it also meant that auditors were more likely to watch out their job narrowly, rather than as matters of broader business judgment. Furthermore, while mechanical standards make auditing easier, they do not needs increase corporate transparency.Role of Fund ManagersInvestment fund managers failed to recognize or act on Enrons risk s because they had only modest incentives to demand and act on high-quality, long-term company analysis. These managers are typically rewarded on the basis of their relative performance. Flows into and out of a fund each quarter are goaded by its performance relative to comparable funds or indices. If the manager reduces the funds holdings of Enron and the stock falls in the next quarter, the fund provide show superior relative portfolio performance and will attract crude capital. However, if Enron continues to perform well in the next few quarters, the fund manager will underperform the benchmark and capital will flow to other funds. In contrast, a risk-averse manager who just follows the crowd will not be rewarded for foreseeing the problems at Enron, but neither will this manager be blamed for a poor investment decision when the stock ultimately crashes, since other funds made the same mistake.Role of Accounting RegulationsMany U.S. accounting standards tend to be mechanical a nd in flexible. decipherable rules have some advantages, but the downside is that this approach motivates financial engineering designed specifically to circumvent these cutting edge rules, as is well understood in the tax literature. In accounting for some of its special purpose entities, Enron was able to design transactions that satisfied the letter of the law, but violated its intent such that the companys balance sheet did not reflect its financial risks.The Sarbanes Oxley ActIn 2002, President scrubbing passed the Sarbanes-Oxley Act into law to re-establish investor confidence in the integrity of corporate disclosures and financial reporting. The act was brought in as a result of the large number of corporate financial fraud cases (such as those of Enron, WorldCom, Tyco, Adelphia, AOL, and others) and by the end of the boom years for the stock market. The Act requires all public companies to submit both quarterly and annual assessments of the effectiveness of their internal financial auditing controls to the Securities and Exchange Commission.Each companys external auditors must also audit and report on the internal control reports of management and any other areas that may affect internal controls. The companys wind executive officer and principal financial officer must personally certify that the financial reports are true and that everything has been disclosed. Many of the Acts provisions apply to all companies, United States and foreign. However, some provisions apply only to companies that have equity securities listed on an exchange or NASDAQ. While refocusing public company management on shareholder interests was the central purpose of the Sarbanes-Oxley corporate governance reform law, years later in that respect are sharp disagreements on both sides as to whether the effort has been a success.Did it help?Considering foreign firms that listed on either New York or London exchanges in addition to their home markets between 1990 and 2006, the researchers found that those firms were six percent less likely to choose New York over London after Sarbanes-Oxley was implemented. This suggests that foreign executives, wonted(a) to laxer regulatory environments at home, were convinced that the acts deterrents against self-dealing and fraudulent accounting were serious. Those who criticize the Act direct that the Act is unnecessary and too expensive to implement. The most ardent criticizers of the bill claim that not only has Sarbanes Oxley failed in its mission to ensure honest financial recordkeeping and disclosure but that it has also stifled new business development in the United States.Some criticizers point to the Madoff scandal as an example of the failure of the Sarbanes Oxley Act. Yet, not all analysts share in this type of criticism. Many analysts believe that more precise financial statements are now being prepared for public companies and that shareholders have greater confidence in their investments as a result o f Sarbanes Oxley. In order for these benefits to be realized, however, the S.E.C. must ensure that all of the requirements of the Act are carefully and universally followed and that exceptions, such as those for certain accounting firms, are not permitted.Bibliography* Wikipedia. (2012, December 18). Enron Scandal. Retrieved December 26, 2012, from Wikipedia http//en.wikipedia.org/wiki/Enron_scandal * Obringer, L. A. (n.d.). How cooking the books works? Retrieved December 26, 2012, from How Stuff Works? http//money.howstuffworks.com/cooking-books7.htm * Healy, P. M., Palepu, K. G. (2003). The Fall Of Enron. Journal Of Economic Persepectives , 9. * Investopedia. (n.d.). Mark to Market MTM. Retrieved December 26, 2012, from Investopedia http//www.investopedia.com/terms/m/marktomarket.aspaxzz2G9qt6COE * Li, Y. (2010). The Case Analysis of the Scandal of Enron. International Journal of Business and Management , 37-41.