Enron Acconting Practices Analysis

Case 4

Enron Collapse

1. Identify and briefly discuss 3 main reasons for Enron's collapse.

Certainly the Mark to Market accounting and pressure to put together deals with only the NPV of the deal and mark to profit having importance is a big reason for their collapse. This kind of accounting does not reflect the true health or long-term sustainability of an organization.

Its liquidity, partly due to accounting techniques, but also due to huge projects in places like the UK, India, and Brazil and broadband that failed, placed increasing pressure on the balance sheet. Analysts were starting to question how it was possible that Enron was posting profits and questions the value of its shares, which began to slide.

Enron's employee and officer financial involvement in SPEs was another reason for their collapse. Greed and seeking excessive remuneration, in whatever way possible really led to this company's demise. Clear ethical violations, with a complicit board of directors, and lack of any transparency in accounting and reporting lead to a company that collapse in surprising speed before most people knew what had happened.

2. Enron used Mark to Market accounting. What were the implications of this for Enron?

Mark to Market accounting is writing a profit as soon as a deal is signed in NPV of a long-term deal which is likely to be unprofitable, in Enron's cases, for some years into the future. Enron takes the profit immediately however, which does not reflect the true state of things within the company particularly with profits and debts. Implications here are that while it seemed Enron was very profitable, they were actually losing money and growing their liabilities and debt owed. Their research into the actual profit that would come from these deals down the line was often guessing and shoddy calculation, as there was significant pressure on to close deals quickly.

3. Enron used Special Purpose Entities (SPEs). What were the implications of this for Enron?

These were used to purchase from Enron certain assets and associated liabilities that the company did not want on its balance sheet. Enron could protect profits from "mark to market accounting" which were already on the books. It found a way, using SPEs run by its own Enron employees by allowing Enron to do a "put option" to require a subsidiary to buy the shares that produced the profit and that would then crystallize the profit. Third parties that put up the debt finance had their loans secured by options on Enron's shares.

The impact of deals like this is that these SPE partnerships made profit on every transaction, while enron "Earned"