IntroductionEnron was one of the leading energy companies in the world until its collapse in the year 2001 due to a huge corporate scandal. The collapse of Houston based Enron Corporation led to dissolution of Arthur Andersen. Arthur Andersen was among the five biggest audit and accountancy partnerships around the world. Apart from Enron being the largest bankruptcy reorganization in the history of America, it is also viewed as the largest audit failure. Investigation into the causes of the collapse of Enron cited creative accounting as the major factor that contributed to the failure of the company.
The company’s auditor, Author Anderson, which was one of the renowned auditing firms, was greatly involved in manipulative accounting practices. The management of the organization, the Chief Financial Officer and other executives not only misdirected Enron's board of directors and audit committee on high-risk accounting practices, but also forced Anderson to disregard the issues. Through their creative accounting practices they were able to falsely display Enron Corporation as one of the most innovative, fastest growing and effective managed entity within the United States of America.
Therefore, by utilizing Enron Corporation as a case study, this paper seeks to evaluate creative accounting as a problem in managerial accounting. Creative accounting as a problem in managerial accountingCreative accounting refers to accounting practices that comply with regulations of accounting standards however in real sense they diverge from the same standards. The practice can also be described as a process where accountants apply their accounting knowledge to maneuver or manipulate reported figures. The practice has for many years proved to be a problem in managerial accounting.
Managerial accounting, which mainly concerns with provision of information to managers, has for a long time been affected by creative accounting practices (Warren and Reeve 720). The use of creative accounting practices has for a long time misinformed managers, particularly on matters relating to company’s revenues, profits, assets, inventories and liabilities (Mowen 150). In Enron Corporation, managers were misinformed regarding the performance of the company. Accountants in the company employed creative accounting in a number of ways so as to manipulate profits, revenues, assets and liabilities. One of the ways through which Enron’s accountants and audit firm performed Creative accounting was by creating multiple trading entities.
The accountants in Enron created several entities for trading purposes. They divided the company’s operations into sectors that executed specialist functions. Trade was then undertaken among these entities. During the process of trading, costs, expenses and losses of the entities were not recorded, but instead the accountants recorded only income, revenue and profits obtained from the transactions made. The company therefore at this period recorded excellent performance with an attractive increase in revenues, profits and income.
However, this was not the real situation in the corporation. The corporation was experiencing huge losses, but through creative accounting, accountants were able to misinform managers that the company was performing well (Kammerer 18). Another way through which Enron’s accountants and audit firm performed Creative accounting was by moving the segments of the business offshore. Enron developed several entities offshore so as to practice creative accounting. The creation of business segments offshore was majorly practiced during accounting and tax planning. Enron’s accountants engaged in this practice so as to minimize the amount of taxes the company pays.
The accountants, through creative accounting practices such as tax avoidance and tax evasion, greatly affected managerial accounting and in the process made the corporation to collapse. Offshore entities normally enjoy an increased privacy level. This kind of privacy level normally makes it hard for local governments and auditors to understand the real situation in an organization. Enron Corporation, for a long time, seemed to have successfully managed to hide from auditors, investors and potential whistle-blowers about the company’s real situation until in 2001 when it was realized that the managerial accounting was being affected by some accounting malpractices.
The losses incurred by the entities were being recorded away from the financial statements. It was therefore hard for investors and staffs to know about the losses.