Enron Accounting Scandal Analysis

Financial statements are useful tools in the evaluation of a company’s financial performance and position. It provides stakeholders with an understanding of the multiple factors driving the business. This includes strategic, financial and economic aspects which collectively portray a representation of the company which stakeholders can use to assist their decision-making. In order for financial statements to be useful in decision-making, it must incorporate the qualitative characteristics of relevance, reliability, comparability and understandability through the employment of the Generally Accepted Accounting Principles (GAAP). However in certain instances, entities don’t conform to the GAAP and fraudulently manipulate their financial reports

The downfall of these entities highlighted ethical issues that could have been solved though proficient corporate governance and internal controls. Analysis of these cases also provides lessons to accountants on due diligence and suggestions on avoiding accounting scandals.

The Enron accounting scandal revealed in October 2001, led to the bankruptcy of the Enron Corporation; an American energy and commodities trading company. At its peak, the company operated on annual revenues in excess of $100 billion and was the source of employment for more than 20,000 people. Enron’s collapse was primarily rooted in poor management and its negligence in sound accounting practises.

Enron was a solely profit-driven company that disregarded other business indicators as a result of poor corporate governance and internal controls. In pursuit of appeasing shareholders, Enron created a consistent profiting situation by abstaining from the historical cost principle. The historical cost principle states that all financial transactions of an entity must be recorded at historical cost. Since accounting is concerned with consistency and comparability, this principle provides a conservative approach by eliminating market volatility and thus

By decentralizing its operations into numerous subsidiaries, Enron was able to hide huge liabilities and derivative losses of their financial statements. However as these started to accumulate, creditors and investors demanded their money back but Enron was unable to meet their requirements with a negative cash flow, thus going bankrupt. Moreover, Enron’s finances were an impenetrable maze of carefully crafted imaginary transactions between the subsidiaries and itself, which masked its true financial state and therefore could not seek help when needed.

The importance of internal controls in a business’ corporate culture is established through the beliefs and values of upper management. Enron focused on maintaining the appearance of value rather than creating it, thus fostering a competitive and risk-tasking environment that promoted the use of unethical accounting practises. To further exacerbate the situation, employees that raised concerns over Enron’s management were demoted or fired hence creating a workplace full of distrust and paranoia, with no clear