Business

What Were the Consequences of the Enron Scandal

As a result of the fraud investigations, the company was forced to file for bankruptcy in December 2001. While the bankruptcy of a small company is taken as a routine, Enron’s case is different as the company was ranked seventh by Fortune 5001.During the 1990s, Enron expanded quickly into several areas such as developing a power plant and a pipeline. This expansion, however, required large initial capital investments and long gestation period. By that time, Enron already raised a lot of debt funds from the market and hence any other attempt to raise funds would affect Enron’s credit rating. But Enron had to maintain the credit ranking at the investment rate in order to continue business. On top of that, the company wasn’t making enough profits either, as it promised to investors. Hence, Enron began making partnerships and other special arrangements (Special Purpose Entity, or SPE). These companies were used to keep Enron’s debts and losses away from its balance sheets, therefore allowing it to have a good credit rating and look good in front of the investors.Enron’s goal was to bypass the rules of consolidation and still increase credibility. If a parent company (in this case Enron) financed less than 97% of an initial investment in an SPE, it didn’t have to consolidate it into its own accounts. If properly done, the legal isolation and the third party control over the SPE, reduce the risk of the credit. Therefore, off-balance sheet treatment of such an SPE involves enough third-party equity. The third party’s equity must be at risk, otherwise the transferor would be required to consolidate the SPE into its own financial statements.Up to the end of 2000, no one pointed fingers at Enron. For 2000, the corporation reported $101 billion in revenue and the auditors gave a clean report. But, at this stage, Enron announced its intention that during the third quarter of 2001, it would book a loss of $1.01 billion and, at the same time, reducing shareholders’ funds by $1.2 billion as a result of correcting accounting errors in the past.

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