PART I PREFACE I.

The Company Overview Enron was founded originally as a natural gas pipeline company in Houston, Texas in 1985 and quickly expanded into creating a market for itself - the energy trade. Their business included many long term risky investments that had no short term revenues, which lead the company to create special purpose entities (SPEs) to spread the risk of these investments. Although this spread of risk was in itself not illegal, the way the SPEs were created and ultimately managed was. To create these illegal SPEs, Enron used the 3% rule (EITF 90-15), which states that 3% of subsidiarys startup capital must come from an outside investor; Enron actually received this outside investment from managers in Enron or their wives. Enrons auditor has also been accused of conducting business in an unethical manner in its attempt to retain the loyalty of Enron executives. Current laws and SEC regulations allow firms like Arthur Andersen to provided consulting services to a company and then turn around and provide the audited report about the financial results of these consulting activities; therefore making an independent audit by Arthur Andersen independent in name only. Our legal system allows companies like Enron to manage their own employee pension funds, producing a conflict of interest because the company has an incentive to use these funds in ways that benefit the company even when they negatively affect employees. Most companies also have codes of ethics that prohibit managers and executives from getting involved in another business. The managers and executives are faced with a conflict of interest because they have a duty to act in the best interest of the company and its shareholders.

Enrons top level management violated several accounting laws, SPE laws, and bent the accounting rules to satisfy their own desires to profit in the short term, completely ignoring long term repercussions for investors, stockholders, employees and the business itself. When Enron corrected these problems in their financial statements, they restated with a loss of $609 million, Wall Street devalued their equity by $1.2 billion, and less than a month later filed for bankruptcy. Most of the problems faced by Enron derive from the immoral and unethical actions taken on by the board of directors in their attempt to achieve personal profits. In order to prevent these unethical acts from re-occurring among other organizations, there needs to be an emphasis on the integrity of executives. Due to accounting frauds of organizations such as Enron, the SEC has begun to take significant steps in preventing loopholes within the accounting and financial disclosure system by enacting the SarbanesOxley bill. Due to the accounting frauds that occurred in the Enron scandal, several accounting firms have begun reorganizing their employees towards remaining loyal to the ethical standards demanded by the SEC. In order for companies to prevent an Enron-like scandal, there needs to be supervision over managers and executives as they exercise their own business judgments about what is in the best interest for an organization.

PART II

CONTENTS II.1 Accounting Firm and Partners Involved It was the job of Andersen Consulting, one of the nations top five recognized accounting firms, to ensure the accuracy and reliability of the financial statements of Enron so that creditors and investors could make good financial decisions. However, it is now Andersen that is under investigation for illegal and unethical accounting practices which places both companies, Andersen and Enron, in the spotlight in the largest account fraud cases at the time. Enron hired Andersen, the reputable accounting firm, , to conduct corporate financial audits. Enron was one of Andersens largest accounts, and also a major business partner to Enron as they sold millions of dollars in consulting service. Due to these relationships that Enron had with Arthur Andersen, it was just toessy for both Enron and the accounting firm to work together in covering up financial losses and debt. Andersen was also responsible for some of Enrons internal bookkeeping, with some of Andersens employees eventually leaving to work for Enron. At the Andersen reins of this accounting scandal is chief executive officer Joseph F. Berardino. Berardino fired the lead Enron auditor David Duncan after it was learned that he had ordered the shredding of Enron audit related documents that would have disclosed true financial representation. Arthur Andersen also by oversaw some of the key factors that triggered disproportionate earnings and growth. Enronstock peaked at over $90 per share but quickly bottomed out at 9 cents per share. Stockholders, investors, and creditors wanted to know how one of the nations top accounting firms could have missed such shifts and irregularities in Enrons accounting practices, which is one factor that led to investigation into the accounting practices of the firm. As a result, the US Department of Justice brought obstruction of justice charges against Andersen which ultimately ran Andersen out of business. With such charges Andersen found themselves in unfamiliar territory, and filed for bankruptcy shortly thereafter. II.2. Enrons Fraud

The Companys doing fraud in three ways : 1. By Derivative Scheme. Accounting and reporting standards for marketable securities, derivatives and financial contracts are found in FAS 115 and FAS 133. Changes in market values are reported in the income statement for certain financial assets and in shareholders equity (component of Accumulated Other Comprehensive Income) for others Gains often determined by proprietary formulas depending on many assumptions about interest rate, customers, costs and pricesprovides opportunities for management to create and manage earnings Enron often recognized revenue at the time contracts (even private) were signed based on net present value of all future estimated revenues and costs. Profits really tracked price of oil futuresalmost perfectly correlated 2. By 401 k Plan Pension Plans- Employee 401k contributions are automatically deducted from their paycheck each pay period. This money is taken out before the employees paycheck is taxed. The contributions are invested at the employees direction into one or more funds provided in the plan. Employers often "match" employee contributions, but are not required to do so. While the investments grow in the employees 401k account, they do not pay any taxes on it 3. By SPE Scheme. Enrons Use of Special Purpose Entities (SPEs) : To hide bad investments and poor-performing assets (Rhythms NetConnections). Declines in value of assets would not be recognized by Enron (Mark to Market). Earnings managementBlockbuster Video deal--$111 million gain (Bravehart, LJM1 and Chewco)

Quick execution of related-party transactions at desired prices. (LJM1 and LJM2) To report over $1 billion of false income To hide debt (Borrowed money was not put on financial statements of Enron) To manipulate cash flows, especially in 4th quarters Many SPE transactions were timed (or illegally back-dated) just near end of quarters so that income could be booked just in time and in amounts needed, to meet investor expectations. The Biggest Fraud that Enrons made, is by SPE schemes, The Company doing fraud was underlying by :

Major issue is whether SPEs should be consolidated*SPEs are only valuable if unconsolidated. 1977--Synthetic lease rules (Off-balance sheet financing) (Allowed even though owned more than 50%) 1984EITF 84-15 Grantor Trust Consolidations (Permitted non-consolidation if owned more than 50%) 1990EITF 90-15 (The 3% rule) Allowed corporations such as Enron to not consolidate if outsiders contributed even 3% of the capital (the other 97% could come from the company.) 90-15 was a license to create imaginary profits and hide genuine losses. FAS 57 requires disclosure of these types of relationships. 3% rule was formalized with FAS 125 and FAS 140, issued in September 2000.

Profit to Enron from all this? $10 mil in guarantee fee + fee based on loan balance to JEDI. A total of $25.7 mil revenues from this source. Increase in price of Enron stock held by JEDI. Enron recognized $126 million in the first quarter of 2000 from this. But everything began to fall apart when Enrons share price started to drop in Fall 2000

II.3 Case Study of One Scheme (Developed by Prof. Sue Ravenscroft, Accounting) Enrons creation of over 3000 (!) partnerships started about 1993 when it teamed with Calpers (Calif. Public Retirement System) to create JEDI (Joint Energy Development Investments) fund. Why partnerships? As long as Enron could find another partner to take at least a 3% stake, Enron was not required to report the partnerships financial condition in its own financial statements. Enron used partnerships to hide bad bets it made on speculative assets by selling these assets to the partnerships in return for IOUs backed by Enron stock as collateral! (over $1 billion by 2002) See the diagram Below.

In November 1997, Calpers wanted to cash out of JEDI. To keep JEDI afloat, Enron needed a new 3% partner.

It created another partnership Chewco (named for the Star Wars character Chewbacca) to buy out Calpers stake in JEDI.

See the diagram Below.

Chewco needs $383 million to give Calpers. it gets. $240 mil loan from Barclays bank guaranteed by Enron $132 mil credit from JEDI (whose only asset is Enron stock)

Chewco still must get 3% from some outside source to avoid inclusion in Enrons books (SEC filing, 1997). $115,000 from M. Kopper (worked at the time for Enron)

$11.4 mil loans from Big River and Little River (two new companies formed expressly by Enron for this purpose who get a loan from Barclays Bank)

After that there is another more complications for Enron : Barclays Bank begins to doubt the strength of the new companies Big River and Little River. It requires a cash reserve to be deposited (as security) for the $11.4 million dollar loans. This cash reserve is paid by JEDI, whose net worth by this time consists solely of Enron stock, putting Enron in the at-risk position for this amount. See the diagram Below.

II.4. Timeline of Scandal October, 2001- Enron informs Andersen to destroy all paper documents and emails concerning Enron. Shortly after, the SEC starts an investigation of the two companies. Lawyers defending Arthur Andersen argued that shredding documents was a routine practice. Eventually, Andersen was charged with obstruction of justice for destroying the documents before the collapse of the energy giant. II.5. Condition after Enrons Case. Many of Andersens auditing clients are choosing other accounting firms to perform auditing work. Andersen has lost over 130 publicly traded corporations. Firms like Oracle, International Paper, Sara Lee, Newell Rubbermaid, Federal Express, Delta Airlines, and Waste Management are choosing other auditors. Already attorneys for Enron shareholders and creditors have reached a tentative agreement to cap payments made by Andersen and their insurance company to between $250 and $300 million. A large number of partners and employees have either gone to work with other accounting firms or are considering leaving Andersen.. In a recent move to reduce costs, Andersen laid off 7,000 employees. Loss of quality employees may hamper Andersens ability to retain current clients and obtain new clients in the years ahead. major blow accounting firms worldwide sparked a wider debate about auditing practices in general. Possible that financial markets need an independent regulatory body, capable of both investigating disasters (such as Enron & AA) and preventing their recurrence.

II.5. Related With PSAK a. PSAK No.4: Mengatur penyajian laporan keuangan konsolidasi suatu kelompok perusahaan yang berada di bawah pengendalian suatu induk perusahaan (Enron) b. PSAK No.15 p.11 Investasi dalam perusahaan asosiasi dipertanggungjawabkan dengan metode ekuitas sejak tanggal pada saat investasi tersebut memenuhi definisi perusahaan asosiasi Selisih (baik positif maupun negatif) antara biaya perolehan (acquisition cost) dengan bagian investor atas nilai wajar aset neto yang dapat diidentifikasi (net identificable asset) pada tanggal akuisisi harus dipertanggungjawabkan sesuai PSAK No. 22 tentang Akuntansi Penggabungan Usaha c. PSAK No.22 p.2 Penggabungan usaha dapat dilakukan dengan berbagai cara yang didasarkan pada pertimbangan hukum, perpajakan, atau alasan lainnya Penggabungan usaha dapat berupa pembentukan suatu badan usaha baru (new enterprise) untuk mengendalikan perusahaan yang bergabung, pengalihan aset neto dari satu atau lebih badan usaha yang bergabung kepada badan usaha lain, atau pembubaran satu atau lebih badan usaha yang bergabung d. PSAK No.38 p.9 Transaksi restrukturisasi antara entitas sependali berupa pengalihan aset, kewajiban, saham, atau instrumen kepemilikan lainnya yang dilakukan dalam rangka reorganisasi entitas-entitas yang berada dalam suatu kelompok usaha yang sama, bukan merupakan perubahan pemilikan dalam arti substansi ekonomi, sehingga transaksi demikian tidak dapat menimbulkan laba atau rugi bagi seluruh kelompok perusahaan ataupun bagi entitas individual dalam kelompok perusahaan tersebut

PART III CONCLUSION Bases on Enron case, we can conclude that fraud will be occurred if : 1. Individual and collective greedcompany, its employees, analysts, auditors, bankers, rating agencies and investorsdidnt want to believe the company looked too good to be true. 2. Atmosphere of market euphoria and corporate arrogance 3. High risk deals that went sour 4. Deceptive reporting practiceslack of transparency in reporting financial affairs 5. Unduly aggressive earnings targets and management bonuses based on meeting targets 6. Excessive interest in maintaining stock prices

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