3.4 Accounting Scandals 1: The Fall-out From Enron (What to look out for…)

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Из курса от партнера The University of Melbourne

The Language and Tools of Financial Analysis

725 оценки

The University of Melbourne

The Language and Tools of Financial Analysis

725 оценки

Курс 1 из 5 — Specialization Essentials of Corporate Finance

In this course, participants will learn the foundations of accounting principles and financial analysis, develop an understanding of the links between these, and the measurement of value creation at the firm level. This is the first course in a four-course Specialization on the Essentials of Corporate Financial Analysis and Decision-Making, created in partnership between the University of Melbourne and Bank of New York Mellon (BNY Mellon). View the MOOC promotional video here: http://tinyurl.com/jeoa83t

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The Links Between Accounting Principles and Financial Decision-making

Having established initial basic financial analyst's toolset in the first two weeks of this course, some caution is warranted as we turn our attention to some of the pitfalls associated with uncritical use of financial statements by analysts. Specifically, we highlight how the use of historical cost and accrual-based accounting might lead to sub-optimal corporate financial decision-making. We then discuss how the agency relationship between management and the owners of a company may also lead to poor corporate decision-making. We conclude with a cautionary tale of misleading accounting practices and the regulator's response to these cases.

3.0 Accounting Principles and Financial Decision-Making (Trust in numbers)5:31

3.1 Limitations 1: Historical Cost And Market Value (The market is always right...)7:37

3.2 Limitations 2: Accrual versus Cash Accounting (Money in the bank)5:31

3.3 Limitations 3: Profit versus Wealth Creation (Raising the bar)3:47

3.4 Accounting Scandals 1: The Fall-out From Enron (What to look out for…)5:32

3.5 Accounting Scandals 2: Earnings Management (Smoke and mirrors)9:07

Познакомьтесь с преподавателями

Paul Kofman
Dean, Faculty of Business and Economics
Sidney Myer Chair of Commerce
Sean Pinder
Associate Professor
Faculty of Business and Economics

As we saw in the introduction, the public's perception of the accounting

profession took a bit of a beating in the early 2000s.

One of the prime causes of that drop in public's perception of integrity and

honesty is undoubtedly the Enron Corporation example.

So what was so special about Enron?

After all it was just one of many, too many accounting

scandals that plagued the corporate sector in the USA in the early 2000s.

What was so special about Enron,

was that this particular demise caught the attention of the government.

Not only that, it lead to a significant review of accounting practices and

sparked Sarbanes-Oxley, of which we will talk a little later.

So what happened with Enron, and what caused this government interest?

Well, the Enron case is a prime example of investor deception by numbers.

The corporation was originally a relatively small, yet

important, natural gas transmission and distribution business.

Enron over time transformed itself into much more than that.

It became an energy giant, trading in commodities and

services throughout the 1990s.

In the mid 1990s, financial analysts criticized Enron on its debt level.

The debt levels probably reflected the significant investments that Enron made

in transforming itself to the energy giant it then became.

Enron management pursued those critics relentlessly,

aggressively as they did with accountants, lawyers, financial media,

that they'd ask questions of Enron's business operations.

Enron's growth, meanwhile, sparked its sharemarket success.

So the company went from strength to strength.

Shareholders, relying on analysts' forecasts, and

those analysts' forecasts were invariably ‘buy’ recommendations,

which only turned to neutral recommendations in 2001.

And if we take a closer look at the share price graph,

we see that,

that happened at a time when the share price was already very much in decline.

So how did this happen?

Well at the same time as analysts were recommending buys to the shareholders,

assets and profits, in fact, were inflated or even nonexistent.

Selling assets at inflated prices with a buy back promise at the same time

to buy back at higher prices.

Only recording the revenue, not the buy back that would occur in the future.

Meanwhile, debts and losses were parked in offshore entities,

and those offshore entities didn't appear in the financial statements.

So what financial analysts saw was only a very partial picture of the truth

of the accounting statements of Enron.

So how did the auditors miss it?

Well there's a variety of possible reasons here.

Could it be the bullying by Enron's executives?

Remember that Enron had just aggressively retaliated to

the financial analyst who dared question the debt levels on Enron in the mid 90s.

Could it be the culture at Enron?

An aggressive business culture focused on growth,

growth by borrowing significant amounts of money?

Could it be accounting loopholes that allowed Enron to park those losses in

those offshore entities it owned, without revealing the existence of those losses.

Could it be sophisticated fraud from the top down?

Again, an entrenched culture in the corporation

that also captured the internal auditors.

Conspiracy by executive management, perhaps, from the top down.

Or could it be that the share market itself didn't quite

invest the time and due diligence necessary to scrutinize

the business operations of Enron, probably captured by the irrational

exuberance plaguing the share markets in the late 1990s and early 2000s.

Perhaps a final point worth noting here is that the external auditor of

Enron was also providing Enron's internal auditing services,

potentially a compromise of the independence of the external audit.

So how was accounting involved in this context of Enron?

One of the then Big Five accounting firms and Enron auditor,

Arthur Andersen's performance was significantly scrutinized in the aftermath

of the Enron demise, by the media, by the regulators, and by government.

And despite being cleared of any legal wrong doing,

the impact of the scandal ultimately destroyed the firm.

So that Arthur Andersen decided to surrender its CPA licenses and

its right to practice in 2002.

That in itself then turned the spotlight on the audits that Arthur Andersen did for

a variety of other problematic companies, including Sunbeam and WorldCom.

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