Enron and Offbalance Sheet Financing

It is argued that bad accounting practices had inflated earnings and capital employed by the use of off-balance-sheet financing. Such practices had not been blocked by Enron’s auditors, Arthur Anderson, and it is claimed that the rules which applied to the company in the US were not robust enough to prevent such accounting practice. this has led to criticism of the auditors and of financial reporting practice and those who regulate it. In the wake of the collapse, there has been much activity designed to tighten up the rules relating to financial reporting and auditing, including legislation (the Sarbanes- Oxley act) and new rules imposed by the Securities and Exchange Commission and the New York Stock Exchange. The impact of these changes is still unfolding but extends worldwide as they affect all companies which seek a listing in the US.The objective of this case study is to try to understand why Enron collapsed and how financial reporting practices failed to alert investors and other stakeholders to the problems of the company in time to avoid the huge losses sustained. In particular, it focuses on the accounting areas of income recognition and off-balance-sheet financing which are said to lie at the root of the problems.Information needed to understand and analyze the issues involved are taken from newspapers, magazines articles, and internet sources.Hartgraves, A.L. and Benston, G. J. (2002) said that critics harshly criticized Enron’s auditor, Arthur Andersen, for allowing Enron to exclude from its financial statements (Financial Terms, 2005) the SPEs it sponsored, thereby keeping a substantial amount of debt off its balance sheet and recognizing substantially higher profits from transactions with SPEs. SPEs refer to special purpose entities.