Financial Factors That Caused Enrons Fall
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Initially the gas industry had two segments which composed of the pipeline companies that transported gas from the main producers and the local distributors who played the role of selling the gas to the final consumer. In 1985 there were ten pipeline companies and 28 distributors. Enron was the most successful in terms of revenue accumulation and it was formed in this year when Houston Natural Gas and InterNorth pipeline companies merged. Scandals in the company were exposed in 2001 which finally led Enron Corporation being declared bankrupt. (Warren, Reeve, & Duchac, 2001)
Financial problems were the main cause of Enron’s fall down that resulted from off the balance sheet reports though there were other issues too. The company’s accounting practices in preparing its income statement which included unearned revenues. Most of its trading involved booked contracts of two or less years. The company had also contracts that a lifespan of twenty four years. The income of these contracts were all accounted in the year when the contracted was entered. The amounts entered were based on estimates of receipts and not profit to be earned from the contracts. The income statement of Enron Company therefore showed untrue financial position of the company due to continuous overstatement of revenues. (Warren Reeve, & Duchac, 2001)
Enron Company did not pay tax as it used to come up with schemes that will enable it avoid tax payment. The main scheme used was allocation of compensation to executive staffs in the company. One such compensation was done in 2000 when the company recorded 979 million dollars corporate profit and allocated to two hundred executives 1.4 billion dollars as compensation. This amount deducted from the annual income as expenses resulting to no taxable income. 1.5 million dollars were also deducted as an expense in the same year as an exercise of stock option. Differed compensation tactics were also used. In this plan the income was placed on trusts where the executives were not able to access the money and therefore remained to be the company’s asset. Since this was an asset to the company the company used the income to pay its debts. The executives in turn were not taxed on these incomes. A ten percent penalty is charged for early withdrawal. In the last days of the company the executives applied early withdrawal with the ten percent charge and withdrew an amount exceeding 53 million dollars. During this time 401-k of the company were frozen and employees could not access their savings every day. (Warren, Reeve, & Duchac, 2001)
Enron Company also made bad and expennsive international investments which also contributed to the financial problems. One of such investment was a power plant in India that had a value of three billion dollars but no one would have paid its electricity even the largest customer where Enron had a 63% share. Enron also entered into partnership which formed Azurix water utility in England that resulted into financial expenses and obligations to Enron. In the project there was an agreement that if Enron’s share price dropped then the partnership would grant the company 915 billion dollars. (SonicHgHog, 2000)
Enron also operated on credits to finance its operation which eventually led to non credibility that affected its trading negatively. Apart from the financial problems there were also unclear dealings from the beginning. The first deal was trading that was booked in 1986 and was not recorded. Also illegal activities by the company were recognised in 1987 when a bank in the New York informed executives in Enron of the unusual transactions in their books. Operations in Enron were conducted in a culture made up of cliques, groups and highly induced political process. Executives were driven by personal interests and working with impunity and restrain so that they can get favours. All these factors led to the dramatic fall of Enron Company.