Enron Accounting Fault Essay

Enron is frequently given as an example of creative accounting. It is also given as a good example of accounting fraud and insider trading. This is a good example of creative accounting taken too far – not many would disagree that it was accounting fraud, although some would say they were just unlucky to get caught. after all, the auditors were Arthur Anderson, at the time one of the most respected auditing firms. Creative Accounting – Example 1 – Creating multiple trading entities The creative accounting involved setting up other entities and then trading with these entities. This is a common practice; many businesses divide their operations into sectors that perform specialist functions and then trade is carried out between these various entities. However, normal applicable accounting standards (GAAP), would require that some sort of financial consolidation is performed and the full picture reported. However, there was a bias to record income, revenue, and profits from transactions with these entities; rather than costs, expenses, and losses. Creative Accounting – Example 2 – Moving business segments offshore Enron created these entities offshore. This is also a common practice in accounting and tax planning. Many businesses do this to reduce the amount of taxes they pay, this can be done legally (tax avoidance) and it can take illegal forms (tax evasion). Offshore entities usually enjoy an enhanced level of privacy, this can make it difficult for local governments and auditors to gain insights into what is going on. Enron appears to have manged to succeed for a long time in hiding what was going on from both auditors, investors, and potential whistle-blowers. If Enron was recording profits, and assuming not much else was happening in these other entities, then these offshore entities would be recording losses. These losses were conveniently recorded away from the financial statements and therefore investors and many staff never new about them. Creative Accounting and Insider Trading The executives didn’t stop here. By using creative accounting and fraud to manipulate profits, they were able to affect the stock price, the next logical and illegal step was to start to trade the stock to benefit from the inside knowledge they had. This is know as insider trading and is illegal in most countries.