Accounting of Enron
In recent months the rules regarding special purpose entitles have come under great scrutiny. Special purpose entities allow firms to raise debt while at the same time making it almost impossible for investors to determine the actual amount of debt exposure. ("Special Purpose Entities are Often a Clever Way to Raise Debt Levels") Thus was the case with Enron, which collapsed in 2001 when their fraudulent accounting practice were exposed. The purpose of this discussion is to investigate which accounting practices were violated as it relates to the SEC rules on Special Purpose Entities and full disclosure. We will also discuss the ethical issues that the company made regarding the firms' accounting practices.
Special Purpose Entities and the SEC Rules that Enron Broke
Special Purpose Entities are also called the securitization of debt. They are totally legal and most companies use them for legitimate reasons such as sheltering a new sector of a firm for the rest of the firm in case the new sector of the firm does not succeed. However, in the case of Enron the entities were used to hide the extent of the firms' debt from shareholders. The SPE is used as a trust,
To establish this trust, the company must sell the SPE an asset -- any of the ones listed on its balance sheet will do. In this case, it sells its receivable balance and therefore must remove it from the balance sheet. The SPE pays the company for the receivables with the money it collects from these new investors and the company gets to beef up the cash section of its balance sheet. So the SPE has one big asset on its books. It now can hit the pavement and go find some money for its new project. It is essentially using the receivable as a security to peddle to the market, hence the moniker -- the securitization of assets." ("Special Purpose Entities are Often a Clever Way to Raise Debt Levels")
The SEC rules for SPE's require that the company actually have a special purpose for creating the entity. As stated earlier when a company legitimately creates a SPE it is actually for the purpose of accessing capital or hedging risk. This was what the SEC had in mind when it created the Special Purpose Entity rules. The rules were not created to simply hide a firm's debt from...
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