The Enron story is a very well known story in the business world. Its story has been made into a movie. its scandal has conjured the fear that many other similar scandals have been discovered in the past, at present and in the future. the infamous company mislead everyone and violated many accounting standards set up in the United States. This fear of swindling the public of their hard earned money is coupled by the connivance of one of the top five auditing firms in the United States, Arthur Andersen.
The following paragraphs explain in detail the Enron Scandal in the realm of accounting and auditing parlance. BODY What Went Wrong? It had been discovered that Enron prepared its financial statements to mislead its readers. Basically, Enron’s assets were window -dressed. Further, Enron’s liabilities were also window – dressed. Also, its stockholders’ equity was also window -dressed. Finally, its income statement was window dressed. Enron’s assets were window -dressed. Window dressing is described as presenting a more beautiful picture of the company than what is the real picture should be.
This situation is best described as a store displaying on its windows the best selling products of the company in order to entice the store passers -by to enter the store and buy the displayed products. usually, the window -displayed products are the low -priced ones. Upon entering, the customers will be see the other displayed products that were not displayed in the store window. This is what happened to Enron. Enron’s balance sheet presented its assets to be more than what they actually are (Hake, 2005).
This enticed the wall street prospective and current investors of Enron to invest more of their hard -earned money on this fraudulent company. The window dressing occurred because Enron recorded sales in its books even though there were no actual sales that had taken place. The recording of sales transaction would require a debit to cash or receivables account titles. A sales transaction would give us a credit to revenues or sales. Thus, the assets were inflated from the debits to an asset account for sales that did not actually happen.
This is in complete violation of United States generally accepted accounting principles that asset like cash and receivables should be recorded only if an exchange transaction has taken place. Evidently, Enron’s assets were window -dressed (Fusaro & Miller, 2002, p. 21). Further, Enron’s liabilities were also window – dressed. Enron violated generally accepted accounting principles established in the United States. Enron’s window -dressing occurred in this category when the company presented its liabilities in the balance sheet at a lower amount than what the actual liabilities figures should be.
The company recorded many of its liabilities as the liabilities of its off -shore businesses outside the United States. This non – recording of its real payable amounts gave a false impression that its obligations to outside parties were lower than what the actual figures should be. As a result, this presented a better picture of the company than what the actual accounting figures should be. Clearly, Enron’s liabilities were also window – dressed (Fox, 2003, p. 59). Also, its stockholders’ equity was also window -dressed.
Window dressing occurred because the company had presented a higher stockholders’ equity than that real figures should be. This is in complete violation of United States generally accepted accounting principles that journal entries should be based on original source documents. source documents include official receipts given to customers for paying cash in in sales transactions. Likewise, official receipts are given for cash payments actually paid to the suppliers of Enron. A Sales invoice or statement of account received by the customers proves that an actual sales on account had taken place.
The stockholders’ equity is arrived at by the formula: Total Assets less Total Liabilities. An overstatement of the assets would result to an overstatement of stockholders’ equity. In like manner, an understatement or presenting the assets at a lesser amount than the actual figures would result to an understatement of stockholder’s equity. Naturally, an understatement of the liabilities would result to an overstatement of stockholders’ equity. An overstatement of liabilities would give us an understatement of stockholders’ equity. Unquestionably, its stockholders’ equity was also window -dressed (Geisst, 2004, p.
214). Finally, its income statement was window dressed. The company had recorded sales transactions which never took place. consequently, this fraudulent transaction would translate to higher sales. higher sales would give a higher net income. a higher net income would give us a higher net assets. a higher sales would generate a higher stockholders’ equity. In addition, the company did not record some of its losses. It window -dressed by presenting these Enron losses as losses of its off -shore companies. as a result, the unrecorded losses resulted to a net income that is higher than what the real net income should be.
Convincingly, its income statement was window dressed (Chandra, Ettredge & Stone, 2006). How Did It Go Wrong? Based on the prior paragraphs, the connivance between some of the officers and employees of Enron and its external auditor, Arthur Andersen, was the cause of the company’s downfall. The senior management officers and accounting officers of Enron had prepared the fraud -laden financial statement in complete violation generally accepted accounting principles that is the minimum requirement of business and other types of organizations established and doing business in the United States.
Then, these officers connived with the external auditors. It is standard accounting procedure that external auditors must be hired to give an opinion on the fairness of the presentation of financial statements. The stockholders and interested parties of Enron will give more credence to a financial statement that had been externally audited. The Enron officers diabolically succeeded in persuading the external auditors to give an audit opinion that the financial statements which included the balance sheet, income statement and statement of cash flows were fairly presented.
As a consequence of this scandal, Arthur Andersen was literally dragged out of the big five auditing firms in the United States. Arthur Andersen finally folded up or closed shop because of this big scandal. This incident shows that the life of the external auditor as well as the companies presenting the financial statements, like Enron, is built on trust. Undoubtedly, the connivance between some of the officers and employees of Enron and its external auditors was the cause of the company’s downfall (Madrick, 2002). Could It Have Been Prevented? Internal control and other measures will prevent another Enron scandal.
It could be prevented by hiring external auditors of impeccable character. The public knows that it is inherent on the business organization to present a better picture of itself to the different parties enumerated above. The users of the financial statements will then rely to the external auditors to give fairness or credence to the financial statements. The external auditors will then advise management on how to set up the internal control environment. Internal control environment decreases to a large extent or even prevents the occurrence of fraud in an organization.
One such internal control environment is the establishment of an audit committee under the leadership of the one or more members of the board of directors. Definitely, internal control and other measures will prevent another Enron scandal (Barefoot, 2002). Further, the auditor can set up an internal control environment to eliminate future frauds. Internal control entails that there is separation of three major duties of recording of business transactions (accounting), approving (of sales discounts, write off of doubtful accounts, etc.
) and handling of assets (cashier receives cash). However, the most difficult fraud that the auditors can detect or prevent is when management colludes or connives with its employees to present fraudulent financial statements (Kinney, 2000, p. 83). Management can completely override any internal control environment suggested and /or implemented by the external auditors. Lastly, external auditors should be changed regularly to prevent the closeness or collusion between the client and the auditors.
A peer review by auditors in the same auditing firm can act as a check a balance to decrease or even eliminate the occurrence that happened in the historic Enron business scandal. The Sabarney Oxley Act imposes the compulsory auditing of external auditors to prevent accounting scandals like Enron (Ettredge, Li & Sun, 2006). Surely, the auditor can set up an internal control environment to eliminate future frauds (Rittenberg, Martens & Landes, 2007). What Was the Final Outcome? The final outcome was that both Enron and its external auditing firm finally closed shop .
All the officers of Enron in the accounting and top management positions were charged in court. Arthur Andersen, as discussed above, dropped out of the auditing scene after this debacle. For, they had lost the trust and confidence of the general also known as the users of the financial statements to give a TRULY fair opinion on the financial statements of any other company after their fall from the Enron scandal. Naturally, the final outcome was that both Enron and its external auditing firm finally closed shop (Thomas, 2002).
CONCLUSION Evidently, Enron’s financial statements were window -dressed. Enron’s assets were window -dressed. Clearly, Enron’s liabilities were also window – dressed. Unquestionably, its stockholders’ equity was also window -dressed. Convincingly, its income statement was window dressed. Undoubtedly, the connivance between some of the officers and employees of Enron and its external auditors was the cause of the company’s downfall. Definitely, internal control and other measures will prevent another Enron scandal
Surely, the auditor can set up an internal control environment to eliminate future frauds. Naturally, the final outcome was that both Enron and its external auditing firm finally closed shop. Conclusively, Enron’s financial statements were window -dressed.
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