Enron - The accounting disaster

Prepared and presented by Phoenix

Phoenix”“The company’s success was based on artificially inflated profits, dubious accounting practices, and –

some say – fraud.

Phoenix

•In 1985 Enron was born from the merger of Houston Natural Gas and InterNorth.

•Started trading futures in Gas Contracts.

•Soon got the control of over 25% of the all Gas business.

“Mid 1980s: Enron business entirely in the USA, focused on

gas pipelines and power”

Phoenix

“2001: Enron trading in hundreds of commodities

Interests in: USA, South America, Europe, Asia and Australia”

•Entered into the derivatives business.

•Began trading in commodities like steel, coal, weather risk etc.

•By 2000, even stepped into the dot.com business.

Phoenix

“2001: Enron trading in hundreds of commodities

Interests in: USA, South America, Europe, Asia and Australia”

•Entered into the derivatives business.

•Began trading in commodities like steel, coal, weather risk etc.

•By 2000, even stepped into the dot.com business.

Phoenix

•Global energy crises by late 90s.

•In India, lost the Dabhol Power project, in which Enron had committed $2.9bn.

•Beginning of Dot.Com bubble crises and fallout of blockbuster internet deal.

•Enron delivered smoothly growing earnings (but not cash flows).

Phoenix

•Global energy crises by late 90s.

•In India, lost the Dabhol Power project, in which Enron had committed $2.9bn.

•Beginning of Dot.Com bubble crises and fallout of blockbuster internet deal.

•Enron delivered smoothly growing earnings (but not cash flows).

Phoenix

•Global energy crises by late 90s.

•In India, lost the Dabhol Power project, in which Enron had committed $2.9bn.

•Beginning of Dot.Com bubble crises and fallout of blockbuster internet deal.

•Enron delivered smoothly growing earnings (but not cash flows).

Phoenix

•Global energy crises by late 90s.

•In India, lost the Dabhol Power project, in which Enron had committed $2.9bn.

•Beginning of Dot.Com bubble crises and fallout of blockbuster internet deal.

•Enron delivered smoothly growing earnings (but not cash flows).

Phoenix

•Global energy crises by late 90s.

•In India, lost the Dabhol Power project, in which Enron had committed $2.9bn.

•Beginning of Dot.Com bubble crises and fallout of blockbuster internet deal.

•Enron delivered smoothly growing earnings (but not cash flows).

Phoenix

•Enron was a trading company, yet was given very high PE of 70 as compared to PE of 20, given to other trading companies

•During 2000, Enron’s derivatives-related assets increased from $2.2bln to $12bln and derivates-related liabilities increased from $1.8bln to $10.5bln

•Enron’s top management gave it’s managers a blank order to “just do it”

Phoenix

•Enron was a trading company, yet was given very high PE of 70 as compared to PE of 20, given to other trading companies

•During 2000, Enron’s derivatives-related assets increased from $2.2bln to $12bln and derivates-related liabilities increased from $1.8bln to $10.5bln

•Enron’s top management gave it’s managers a blank order to “just do it”

Phoenix

•Enron was a trading company, yet was given very high PE of 70 as compared to PE of 20, given to other trading companies

•During 2000, Enron’s derivatives-related assets increased from $2.2bln to $12bln and derivates-related liabilities increased from $1.8bln to $10.5bln

•Enron’s top management gave it’s managers a blank order to “just do it”

Phoenix

•Stock had already fallen to $30 from $90 in Feb, 2001.

•Oct, 2001 – Moody’s downgraded Enron’s debt.

•May, 2001 – Mr. Baxter, the Vice Chairman resigns.

•14th Aug, 2001 – Jeff Skilling resigned as CEO.

Masterminds: (left to right): founder Ken Lay; Jeff Skilling; Andy Fastow; and Lou Pai

Phoenix

•8th Nov, 2001 – Told investors that they were restating earnings for past 4 and ¾ years.

•By end of Nov, 2001 stock reached $0.3 falling from its peak price $90 in just 8 months.

•2nd Dec, 2001 – Filed Bankruptcy.

Phoenix

Energy producer fears warm weather. Pays Enron to hedge against the collapse

of demand and prices due to warm

weather.

Electricity company fears cold

weather. Pays Enron to hedge

against rise in price and demand due to

cold weather.Enron, as market maker, profits by taking commission on hedge in both eventualities.

Phoenix

SENATE

HOUSE OF REPS

“Kenneth Lay himself had strong personal ties to two

Republican Presidents”

Total donations during 1989-2001 amounted$1,133,981 ($1.1mn)

Phoenix

ENRON

ENRON

PartnershipPartnership

SpecialPurpos

eEntity(SPE)

SpecialPurpos

eEntity(SPE)

AccountIn

Profit

AccountIn

Profit

3

4

2

1

5

1. Enron sets up partnership using stock as funding

2. Partnership sets up SPE3. SPE agrees contract to pay Enron if

its investment declines in value4. Payment made as investment

declines5. Payment posted as profit, even

though it is Enron’s own money

”“A huge hole had opened in the

accounts.-BBC

Phoenix

Phoenix

-2

-1

0

1

2

3

4

3months

6months

9months

Year

1998

1999

2000

2001

Negative Cash Flows: 1st three quarters in 1999, 2000 & 2001

Phoenix

•Sherron Watkins, an Enron vice-president, wrote an anonymous letter to Kenneth Lay setting out her fears of an impending scandal.

•Fearing the predictable collapse she ordered Enron's lawyers to conduct an investigation into the partnerships.

•Mr. Lay was also moving to reassure the markets. He was doing all he could to "restore investor confidence" he told staff and shareholders.

•But amid the selling, Mr. Lay himself joined the crowd as he exercised options on 83,000 shares worth almost $2m.

Sherron Watkins

Kenneth Lay

Phoenix

•Andersen executives including chief Enron auditor David Duncan, decided to consult lawyers over whether or not the partnerships were legal.

•Andersen told Enron that it had no

•At some point after this, staff in Andersen’s Houston office began shredding documents relating to Enron.

other choice but to change the way it was accounting for its special partnerships.

Phoenix

•Arthur Andersen was one of the world’s five leading accounting firms.

•Legal examination of Sherron Watkins's concerns concluded that the partnerships in question, Raptor and Condor, had been approved by Andersen.

•Was paid $52mn in 2000, the majority for non-audit related consulting services.

Arthur Andersen’s Houston branch

The firm said destroying

documents was routine

Phoenix

Year Reported Income

Revised Income

True debt restated by

True equity restated by

1997 $105m $77m Up $771m Down $258m

1998 $733m $600m Up $561m Down $391m

1999 $893m $645m Up $685m Down $710m

2000 $979m $880m Up $628m Down $754m

Reported and revised income, debt and shareholder equity 1997-2000 following special partnership

revelations.

Enron’s Accounts: The Company announced the restated figures

Phoenix

In spite of all help,

failed to save

Enron

”“I take responsibility for what happened at Enron, both good and bad. But I cannot take responsibility

for criminal conduct that I was unaware of. -Kenneth Lay

Phoenix

Phoenix

Phoenix

J P Morgan:$900m

Sumitomo Mitsui Corp:$210m

Citigroup:$800m

Nikko Cordial:$207m

Credit Lyonnais:$250m

Principal Financial Group:$171m

Bank of Tokyo Mitsubishi:$248m

Abbey National:$164m

Chubb Corp:$220m

National Australia Bank:$104m

Canadian Imperial Bank:$215m

Duke Energy Corp:$100m

Some 25 further companies have declared Enron exposure totaling an estimated $1bn.Total global investment exposure of at least

$4bn

Phoenix”“Laid-off and

retired 4000 employees from the company lost most of their life savings, which was in company stock.

Phoenix