Enron Scandal

Do you think it is possible to make one billion dollars magically appear? Most people think this is impossible to do, but in October of 2001 people found out that this actually happened. An energy company based in Houston, Texas, Enron, managed to make one billion dollars appear on their income statement. They were reporting a net income of 393 million dollars; however, when the net income was calculated following Generally Accepted Accounting Principles (GAAP) it was found to be a 644 million dollar loss! How was Enron able to make all of this extra cash show up on its income statement?

Enron pulled this off by taking advantage of accounting loopholes and using poor accounting. Also, they abused special purpose entities to help their net income look extremely inflated. Special purpose entities are companies that are formed to help out the main organization. Enron would make special deals with these companies that were extremely profitable for Enron. The special purpose entity would take a huge hit, and by taking this huge hit it would absorb part of Enron’s enormous net loss. However, Enron hid this practice from everyone so that when people looked at the company from the outside it appeared that they were doing extremely well. People were crazy about the great growth that Enron was having. This caused the stock price to skyrocket to around $90 a share.

Eventually, however, investors began to get suspicious of Enron’s activities. These suspicions were the beginning of the end for Enron. Enron’s stock plummeted to 25 cents a share, and eventually the company was forced to file for bankruptcy. Enron had 63.4 billion dollars in assets when they filed for bankruptcy. This made them the largest company to file for bankruptcy, until WorldCom filed for bankruptcy the following year.

The Enron scandal had a huge effect on the American public. Enron’s stockholders lost nearly 11 billion dollars when its stock collapsed. This collapse greatly affected the confidence of the American public. Most people had no idea how easy it was to mess with the numbers on the income statement. Even after the Sarbanes-Oxley was passed, people were still suspicious about how truthful the accounting practices of companies could be.

The accounting profession’s reputation has recovered from the scandals that happened around the time of the Enron Scandal. However, these scandals have had a lasting impact on how accounting is done. Accounting has learned from its dark past and continues to become more and more virtuous as time goes on.