ENRON DEBACLE – WHAT DOES IT REVEAL?

One of the important recommendations of Rakesh Mohan Committee is that the Government should initiate the process of restructuring of financial accounts of Indian Railway so that the financial statements produced are understood by the financial community and public at large. My response to this was submitted some time back. Recent Enron debacle has strengthened our view that the format of any accounts is not so important and there are no real virtues in the company accounts as claimed. I would like to share some of the highlights of Enron episode which I happened to read.

The first and notable victim seems to be the renowned auditing firm Andersen. They were not only the auditors for full 16 years, since the Company’s formation, but also were rendering internal audit and consultancy services. The firm had apparently ‘failed’ to detect the fact that Enron was publishing incorrect financial statements. The Andersen’s plight is miserable as they are facing legal claims from thousands of staff, shareholders and creditors who were affected financially by Enron’s collapse.

How did this happen? All fingers point to Andersen, holding the accountants at fault; but credit rating agencies and investment bankers are also not spared. CEO of Andersen admitted to an ‘error of judgment’ over one of the off-balance sheet entities Chewco. Companies use special purpose vehicles to acquire more capital without adding debt to their balance sheets! But auditors take shelter under the fact that there are inadequate rules on off-balance-sheet vehicles, financial reporting model is outdated and there is an urgent need to introduce strict regulation and discipline apart from improvements to audit effectiveness! One of the outcome of this debacle is that Financial Accounting Standards Board (FASB) is having a relook on the rules. The Board is contemplating a change in its rule to decide on consolidation; upto now ownership rather than control decided the necessity for consolidation. Enron’s off-balance sheet entities, however, required consolidation even as per existing rules. When the company decided to recast its accounts from 1997 to 2000 in November this year, there was a whopping reduction of $591 million in profit and an increase in debt of $628 million resulting in huge public outcry on the failure of Andersen to bring this out!

Another interesting fallout of the debacle is the urgency for more regulation in financial standards! There was apparently a lack of transparent financial reporting. The regulators like FASB failed to unfathom the irregularities. Noting that tougher regulation is the need of the hour, Securities and Exchange Commission of America has decided to monitor the annual reports of all Fortune 500 companies, stepping up a drive to understand and crack down on corporate disclosures. It is also trying to reform the complex sets of accounting and disclosure rules that US Corporations must follow!

The startling revelation of this sordid affair is that “Proforma” financial statements, issued periodically through quarterly reports and press releases intended for consumption by the media and general public, are often manipulated by using the terms “core” “normalized” or “adjusted” for the financial results. Often these statement skirt over the accounting rules either to reveal good results through extraneous conventions or hide bad performance by ignoring unpleasant facts. Security Exchange Commission Chairman Harvey Pilt has now made it clear that SEC will hunt down those who make misleading or fraudulent disclosures under the guise of “proforma” reporting!

Public Accountability and Parliamentary Control over the accounts of Indian Railways are too well known to need elaboration! Let the readers draw their own conclusions!