This article surveys what happened at Enron, the egregious accounting errors that were made, and future mitigants to this operational risk now under consideration.
Enron's annual report states that its business is: ...to create value and opportunity for your business by combining financial resources, access to physical commodities, and market knowledge to create innovative solutions to challenging industrial problems.
Formed from a merger in 1985 of Houston Natural Gas and InterNorth, Enron shortly transformed from a regulated natural gas company into one of the world's largest energy traders. Enron was, in large measure, an unregulated derivative-trading company. It generated funds by entering into extremely volatile and expensive hedging transactions that relied on very complicated financial transactions.
Enron had recently changed its business focus from that of primarily delivering and brokering energy domestically to focusing on three new business areas: water, international brokerage of energy, and broadband transmission of communications. Enron's stock jumped initially when it entered these new markets, but all three endeavors soured, causing the stock value to plummet. To maintain its reported profitability and buttress its stock price, Enron began to "cook the books."
Federal investigations have largely focused on sham operations that were performed to allegedly keep debt and risk out of the financial statements and create phony income. Table 1 summarizes many of the major accounting issues at Enron.
Enron's November 8, 2001 Form 8-K filing reported that it intended to restate previously issued financial statements dating back as far as 1997. This filing disclosed that the company should have consolidated three previously unconsolidated special-purpose entities (SPEs), whose basic purpose was to structure transaction(s) to achieve off-balance-sheet treatment of assets and liabilities so that they would not appear on the transferor's financial statements. Enron had about 500 such SPEs and thousands of other questionable partnerships. Enron executives also frequently held large personal interests and made massive personal gains in these transactions. …