Question

Answer the following questions about the Enron scandal.

1. Explain mark-to-market accounting in your own words (1 Point). What role did mark-to-market accounting play in the Enron scandal (2 Points)?

2. Describe the culture and tone at the top at Enron using specific quotes from the book (3 Points). How did the tone at the top at Enron contribute to the downfall of the company (2 Points)?

3. How does the fraud diamond apply to Enron? Make sure to use specific examples from the book (4 Points).

4. In the legal system’s judgment of it’s role at Enron, Arthur Anderson was ultimately found not guilty. Do you believe that Arthur Anderson was innocent (1 Point)? Why or why not (2 Points)?

5. Who (or what) do you believe is the most responsible for the fall of Enron (1 Point)? Why (1 Point)?

Answer 1

ANS.1. Mark to Market Accounting: Mark to Market Accounting means recording the value of the balance sheet assets or liabilities at current market value with the aim to provide a fair appraisal of the company’s financials. The reason for marking to market certain securities is to give a true picture and the value is more relevant as compared to the historical value.

For Example: A held-for-trading asset is a financial security that can either be in the form of debt or equity and is purchased with the intention of selling the security within a short period of time, which is generally less than a year. Any gains and losses from fluctuations in the market value of assets classified as available for trading will be reported as unrealized gains or losses on the income statement.

Role Mark to market played in ERON Scandal

Understanding the scandal: The Enron scandal is likely the largest, most complicated, and most notorious accounting scandal of all time. Through deceiving accounting tricks, Enron Corporation – the US-based energy dealing in commodities, stated that commodities are another class of assets just like stocks and bonds. However, they are different in the sense that they are products that come from the earth, which include cotton, oil, gas, corn, wheat, oranges, gold, and uranium. Basically, commodities are the raw materials and services, Company was able to trick its investors into thinking that the firm was doing much better than it actually was. At Enron’s peak in mid-2001, the company’s shares were trading at an all-time high of $90.75. Then, as the scandal was uncovered, the shares plummeted over several months to an all-time low of $0.26 in November 2001.

Mark to Market Accounting (MTM) in the Enron Scandal

The principal method that was employed by Enron to “cook its books” was an accounting method known as mark-to-market (MTM) accounting. Under MTM accounting, assets can be recorded on a company’s balance sheet at their fair market value (as opposed to their book values). With MTM, companies can also list their profits as projections, rather than actual numbers.

Fair values are hard to determine, and even Enron CEO Jeff Skilling found it difficult to explain to financial reporters where all the numbers on the company’s financial statements came from. Skilling stated in an interview that the numbers provided to analysts were “black box” numbers that were difficult to pin down due to the wholesale nature of Enron, but assured the press that they could be trusted.

In the case of Enron, the actual cash flows that resulted from their assets was substantially less than the cash flows that they initially reported to the Securities and Exchange Commission (SEC)Securities and Exchange Commission (SEC)The US Securities and Exchange Commission, or SEC, is an independent agency of the US federal government that is responsible for implementing federal securities laws and proposing securities rules. It is also in charge of maintaining the securities industry and stock and options exchanges under the MTM method. In an attempt to hide the losses, Enron set up a number of special shell corporations known as Special Purpose Entities (SPEs).

The losses would be reported under more traditional cost accounting methods in the SPEs but were almost impossible to link back to Enron. The majority of the SPEs were private corporations that only existed on paper; thus, financial analysts and reporters simply did not know that they existed. Thus, Skilling and his team became determined to boost the stock price of Enron in hopes that their management incentives would translate in bigger compensation for them.

ANS.2.The culture and tone at the top at Enron:

Tone at the top refers to the ethical atmosphere that is created in the workplace by the organization's leadership. Tone at the top failed at Enron, as business procedures show that morale ethics can affect the whole organization. Business ethics were not evident in the company, regardless of position in hierarchy. Tone of the Top allows a business to have control over itself, the stronger the tone at the top, the more likely the business is to be successful, however it has been suggested that organizations who rely too much on tone at the top give businesses too much independence.

Tone at the Top at Enron Resulted in downfall of the company

The reason for Enron’s failure was due to the lack of tone at top, ethical values and morals also didn’t play a role in the decisions which were made at the expense of the business, employees and customers. This particular case of failure in business highlighted the fact that when tone at the top is not implemented into a business, employees often follow the decisions made even if they are ethically immoral, this can be down to personal circumstances and a need for the job. There are regulations in place that deter organizations and employees from committing this white collar crime and also the criminal law prosecution.

The Enron case highlights how an organization can quickly sink if they lack tone at the top, however the case failed to provide a message against ‘gaming the system’. Tone at the top is imperative in a business that wishes to be successful, as otherwise the company can be led astray by an individual who has no business morale and lead the company into committing fraud to make the company successful.

ANS.3. Fraud diamond apply to Enron in the following manner:

Fraud is more likely to occur when someone has an incentive to commit fraud, and the person can rationalize the fraudulent behavior by its capability to do so..This four-sided framework, commonly known as the fraud diamond, played an important role in Enron Scandal because the CEO had all the four elements to commit the fraud. The CEO’s positional authority to influence when contracts or deals take effect and affecting the timing of revenue or expenses recognition resulted in fraud.

ANS.4 In my opinion Arthur Anderson , was not innocent even if he was not found guilty under the legal system.

A. Arthur Andersen had improperly categorized hundreds of millions of dollars as increases in shareholder equity, thereby misrepresenting the true value of the corporation.

B. Arthur Andersen did not follow generally accepted accounting principles (GAAP) when it considered Enron's dealings with related partnerships. These dealings helped Enron to conceal some of its losses.

ANS.5 Most Responsible Person For the fall of Enron: The CEO was responsible as ultimately it was CEO Jeffrey Skilling that decided to fudge the numbers by keeping the extent of Enron's debt off the books. The CFO Andrew Fastow was clearly involved in the fraud as he doctored the books and mislead the Board of Directors and the auditors about the companies' liabilities and created an illegal scheme Chewco to hide Enron’s mounting debt.