Acct 530 Week 7 Enron Essay

Submitted By amiej0
Words: 1036
Pages: 5

Enron – Related Party Transactions

Julia Brewer

April 20, 2014

The notorious Enron scandal was surrounded by unethical related party transactions within Enron as well as between Enron and Arthur Andersen. The accounting errors related to the inappropriate accounting treatment of related party transactions required Enron to restate their financial statements for reporting years 1997 to 2001, which resulted in a $544 million decrease in earnings. Enron used SPEs, special purpose entities, as a resource for many of the related party transactions. Special purpose entities are legal entities formed in order to carry out certain business and financing transactions. They are often used in securitizations where a pool of assets is sold in order to secure additional financing. The accounting treatment for SPEs is beneficial in that the assets and liabilities of the SPE are not included on the corporation balance sheet. There are strict rules and guidelines in order to take advantage of the SPE accounting rules, with the most important being that a third party equity investor must control the activities of the SPE and bear the risk of the investment. Enron failed to meet the requirements when establishing the SPEs, the following content of this paper will describe the related party transactions related to the SPEs of Enron. Chewco Investments, LP was a partnership formed in order to become the other partner with Enron in the Joint Energy Development Investment Limited Partnership (JEDI). Enron needed the original partner in this venture to invest in another project, therefore needing to replace their role in order for JEDI assets and liabilities to stay off the balance sheet of Enron. Attempts to find a legitimate third party equity investor failed; therefore Enron came up with the idea of Chewco. Michael Kopper, who worked in the finance department for Enron under Andrew Fastow, became the owner and manager of Chewco. Chewco proceeded to finance the investment in JEDI using debt financing. This was a direct violation to the requirement of an equity investor to establish an SPE. Enron’s code of conduct strictly prohibited Enron employees having a financial or managerial role in SPEs or other related companies unless the participation “does not adversely affect the best interests of the Company”. Andrew Fastow was the Enron Chief Financial Officer (CFO). Fastow was the manager and investor in two partnerships known as the LJM partnerships. The business that Enron conducted with the LJM partnerships consisted of asset sales and hedging transactions. The sale of assets to LJM often occurred at the end of reporting periods when Enron needed to report higher earnings. During Fastow’s testimony, he stated the LJM partnerships were created so Enron executives could report earnings they wanted to report. “In most cases LJM served as a "warehouse" for assets so that Enron could record sales when it wanted to and avoid reporting losses”. (Perin, 2006). Fastow’s involvement with the LJM partnership along with the Enron transactions with the partnerships was done with full approval of the Enron Board of Directors. The Boards position was that the LJM partnerships would offer great business benefit, and despite the conflict of interest regarding Fastow’s involvement, the Board believed the risks could be mitigated with extensive controls and procedures to ensure the transactions were fair to Enron. Arthur Andersen was one of the “Big 5” international accounting firms that provided consulting services as well as auditing services to Enron. Andersen received professional fees of $5.7 million for consulting on the Chewco and LJM transactions described above. The business relationship between Andersen and Enron was ‘close’ to say the least. Andersen auditors and consultants were given permanent office space at Enron’s headquarters. They participated in Enron corporate sponsored trips and…