Enron and Andersen Scandal

Synopsis

Enron was formed through 1985 merging of Houston Natural Gas and InterNorth -a Nebraska based gas pipeline company. In 1989, Enron started trading natural gas commodities and eventually became the world’s largest buyer and seller of natural gas. In the early 1990s, Enron became the nation’s premier electricity marketer and established the development of trading in such commodities as weather derivatives, bandwidth, pulp, paper, and plastics. However, despite of its growing success Enron suddenly fell and collapsed due to some mismanagement and fraud. For instance, Enron scandal has the most controversial scandal that really affects the accounting profession.

Enron scandal involves complicated accounting issues. Some of its suspicious accounting scheme are Reducing Enron`s tax payments, inflating its income and profits, inflating its stock price and credit rating, hiding losses in off-balance -sheet subsidiaries and fraudulently misinterpreting financial condition in public reports of Enron. It started in the merging causes large amount of debt to Enron company . And to find the best solution to the company`s problem, CEO Ken Lay hired Jefrrey Skilling as a consultant and finally had its solution, to create "a gas bank"- buying gas from its suppliers and sell it to the consumers. Enron then became a trading business with its product, energy derivative. The company also engaged into "mark to market" in which whenever the companies have outstanding energy-related or derivative on the balance sheet, they must adjust them to fair market value. But the Enron`s financial analysis rating is still lower than what they desired, the debt is still visible that led them to issue SPE( special purpose entities). However these SPEs did not result to transparent financial statement. But then, regardless of these transactions Arthur Andersen, company`s auditing firm and at the same time the one who did consulting to Enron, issued an unqualified opinion. Under investigation, it was found that Andersen is negligent at best and at worst that creates false earnings reports by hiding huge amounts of debts and artificially inflate stock prices intentionally. It was also determined that the firm had either directed or personally destroyed many documents that showed the true extent of Enron`s financial problems. And so bankruptcy arouses causing for Enron company to collapse.

Code of Ethics` Violation

Almost of the basic principles of the code of ethics was violated. Above all independence was not performed .The people in Enron as well as the auditing firm did not act professionally based on the outcome of the scandal. The decisions were not being evaluated and decided properly. Here are some of the situations that would prove that they had violated the Code of Ethics:

Integrity

The company`s personnel itself is not honest in their service. The chairman of the board, Ken Lay and the CEO Skilling, allowed the CFO to build private institution secretly and illegally. Arthur Andersen hides huge amounts of debts and misinterpreted the financial statement of the company.

Objectivity

Andersen is being biased that influenced his professional judgment. Also the company has its conflict of interest that also affects the judgment of the auditor. He has failure in disclosing in audit papers.

Professional due care

Andersen`s global engagement partner, David Duncan failed to exercise professional due care and skepticism. He failed to notify the Enron Audit Committee of the management`s rejection of audit recommendations. He as reckless in not knowing that the Enron`s financial statements were not performed according to GAAS and that its financial statement did not present Enron`s financial position. This is just one of the example situation of violating professional competence and due care.

Professional Behavior

Acting professionally complies with relevant laws and regulations and avoids any actions that may discredit to the profession. But what Andersen did - misstating the financial position and issuing unqualified opinion regardless of the violations done by the management of the company is an opposite of this. Andersen involved into fraudulent actions that he should avoid.

Threats

Self- interest - It is said that having conflict of interest contributed a lot in the firm`s collapse. Based on the reports and hearings, Enron kept accounting documents hidden and well manipulated with the complicity of its auditing company. This is due to some unethical practices (a) off-balance sheet used to hide the companies deteriorating fiancés (b) revenue from long=term contracts being spread for a several years (c) financial reports being falsified to inflate executive bonuses and incentives9d)manipulation of electricity market. The staff of Andersen failed to follow auditing procedures that issues unqualified opinion. On the part of the management, the board of directors were irresponsible of detecting the company`s mess. They were more interested in incentives and satisfied profits. Managers and Andersen chose to betray the shareholders to maximize their self-interest.

Self-review - Andersen offers two services- auditing and consulting. The two roles of Arthur Andersen, as auditor and as consultant, this might jeopardized their reputation and independence. As a result of providing non audit service, the audit firm is associated with aspects of the preparation of the financial statements and may be unable to give an objective view of relevant aspects of those financial statements.

Familiarity- there is an intimate relationship between the auditor and the client. The auditor is not independent. Andersen tends to develop over-familiarity in the internal control and surroundings of the company because of the long involvement in the company. Andersen have been an internal and

external auditor as well as consulting for Enron for a several years since it was established in 1983 that`s why there is stronger relationship as years pass by.

Intimidation threat- Auditor is being fee dependent in their client. And so this may affect its judgment because they are afraid they might be replace by another auditor the next year.

Safeguards

1. Having a good culture in the company is a good safeguard. How? By having own Code of Conduct is a good way of implementing good culture in the company. Posting in the bulletin or having at the paper documents of the Code of Conduct is not enough. It should be that the boards and executives should set as an example of the conduct that they want to expect from others.

2. The company should conduct code ethical trainings for the people in the company annually or every other year to develop and enhance the ethics of its people.

3. It should be that auditing and consulting must be separated. Hiring Andersen`s employees as Enron employees made a real ethical conflict of interest. To avoid conflict of interest, this two services must be separated. Firm should not accept two services at the same time and at the same client and client must not have same auditing and consulting firm.

4. There must be a rotation of audit firms. This is to avoid from being familiar to the client`s business flow.

5. Implementing bigger fines or sanctions to those who violates any of the code of conduct of the firm or the code of ethics.

Effect in the accounting profession

Enron scandal leaves marks to the accounting profession not just in America but also in other place including Philippines. After this phenomenon, a lot of things changed in the accounting profession. The scandal led to one of the most significant pieces of legislation associated with the oversight of corporate ethics- The Sarbanes/Oxley Act which sets guidelines and requirements for Accounting, financial disclosure and the ethical behavior of corporations. With this legislation in place, the promise exists for the elimination, if not total eradication of corporate fraud as was so transparently practiced by the Enron team. It also discouraged the double role of auditors. After the collapsed of Enron, a lot of comparisons were drawn between the principles based approach which exists in the UK and the US rules-based approach. This incident also led to mandatory rotation of audit firms with a maximum of 7 years of service.

Philippines follows same standards of accounting profession from US. And so we could say that our country is also affected from the Enron scandal. Our country is becoming strict to avoid fraudulent

and unethical actions that might happen. Today, if you passed the board exam you cannot easily sign financial statements without recognition and registration from the PICPA even though you are already a CPA. You still need to comply the requirements before doing some engagement. Also, a Filipino accountant cannot easily work abroad as an accountant because of accounting profession abroad is restricted. You must first register to their organization and comply everything the requirements in order to practice your profession outside the Philippines. The Enron scandal shows that America can no longer take the pre-eminence of its accounting for granted. That is a far bigger concern than any number of congressional investigations.

References:

http://www.slideshare.net/joelnshisso/enron-s-wnalysis

http://voices.yahoo.com/the-enron-scandal-crime-scandal-tragedy-controversy-136695.html

GR7_TobiasPavel_Myleneencontro_ENRON.pdf

http://mpra.ub.uni-muenchen.de/1147/1/MPRA_paper_1147.pdf

http://www.economist.com/node/940091

Worldcom

Synopsis

Worldcom is the Nation’s second largest long distance telecommunications company. It grew rapidly through acquisitions and from increased demand for telecom. But in 1998, the telecommunications industry began to slow down and WorldCom's stock was declining. CEO Bernard Ebbers came under increasing pressure from banks to cover margin calls on his WorldCom stock that was used to finance his other businesses endeavors (timber, yachting, etc.). The company's profitability took another hit when it was forced to abandon its proposed merger with Sprint in late 2000. During 2001, Ebbers persuaded WorldCom's board of directors to provide him corporate loans and guarantees totaling more than $400 million. Ebbers wanted to cover the margin calls, but this strategy ultimately failed and Ebbers was ousted as CEO in April 2002.Beginning in 1999 and continuing through May 2002, WorldCom (under the direction of Scott Sullivan (CFO), David Myers (Controller) and Buford Yates (Director of General Accounting)) used shady accounting methods to mask its declining financial condition by falsely professing financial growth and profitability to increase the price of WorldCom's stock.

The nature of accounting fraud in Worldcom occurred in two main ways: a) understatement of operating expenses of $7B through improper release of accruals and through improper capitalization of operating expenses and b) Overstatement of revenues of 41B.s

http://voices.yahoo.com/worldcom-scandal-look-back-one-biggest-225686.html?cat=3