FINANCIAL STATEMENTS….CAN WE TRUST THEM?

MBUS624 Finance Theory and PracticeCASE PRESENTATION by

Brian Belsby John Dieckman

Mike Dvolz Penjor Ngudup

Chao (Jerry) Qin

The Three R’s of Financial Reporting Relevance

Sufficient and appropriate information so that investors evaluate past performance and predict future performance.

Reliability Accurately represent economic conditions or events.

Representational FaithfulnessAbility of financial statements to reflect the real

economics of the transaction being reported

Additional Characteristics of Good Financial Reporting

Comparable with similar information about other companies and with similar information about the same company for some other time period

Consistent application of accounting standards to similar transactions.

Complete enough to enable investors to understand past events and predict future performance

Clear enough to promote the understanding of a reasonable person.

ENRON The Rising Star of the early 90’s

Intricate web of over 3000 partnerships

Special Purpose Entities (SPE) and partnerships:Braveheart, Raptors, Chewco, LJMS etc.

THE “SPE” GAME PLAN

OPERATION BRAVEHEART

UNAUDITED SUMMARY OF LJMs TRANSACTIONS 

LJM INVESTME

NT

CASH AND OTHER VALUE

RECEIVED BY LJM

LJM NET

CASH FLOW

IMPACT OF LJM TRANSACTIONS

ON ENRON'S PRE-TAX

EARNINGS

 

 

 

Summary Totals:

Sale of Assets $30.00 $32.40 $2.40 $87.30

Purchases of Equity/Debt in Enron-Sponsored Special Purpose Entities $174.50 $132.30 ($42.20) $2.40

Investments in Enron Affiliates $114.40 $70.00 ($44.40) $16.90

Portfolio Special Purpose Entities $191.10 $319.20 $128.10 $471.20

Call Option $11.30 $12.50 $1.20

Transactions with LJM and Other Entities $7.50 $11.70 $4.20

Transaction with LJM and Whitewing $40.30 $38.50 ($1.80)  

Total $569.10 $616.60 $47.50 $577.80

ENRON CORP.Restatement of Net Income in Millions

  1997 1998 1999 2000

Net income as reported $105.00 $703.00 $893.00 $979.00

Restatements:

Consolidation of JEDI and Chewco ($45.00) ($107.00) ($153.00) ($91.00)

Consolidation of LJM1 subsidiary ($95.00) ($8.00)

Raptor equity adjustment

Prior year proposed audit

adjustments and reclassifications ($51.00) ($6.00) ($2.00) ($33.00)

NET INCOME RESTATED $9.00 $590.00 $643.00 $847.00

Net Income 1997-2000

Net Income 1997-2000

$0.00

$200.00

$400.00

$600.00

$800.00

$1,000.00

$1,200.00

1997 1998 1999 2000

Net income asreported

NET INCOMERESTATED

Debt 1997-2000

Debt 1997-2000

$0.00

$2,000.00

$4,000.00

$6,000.00

$8,000.00

$10,000.00

$12,000.00

1997 1998 1999 2000

Debt as reported

DEBT RESTATED

Equity 1997-2000

Equity 1997-2000

$0.00

$2,000.00

$4,000.00

$6,000.00

$8,000.00

$10,000.00

$12,000.00

$14,000.00

1997 1998 1999 2000

Equity as reported

EQUITY RESTATED

Why Enron went bankrupt? Assets in, Earnings Out

Better financial performance Parking Space for Debt

Loans from financial market at low costMeet the financing needs

Financial HitCan’t get loans any moreForced to reduce equity

Collapse

ENRON & PARTNERSPOLITICAL CLOUT Citigroup misrepresented its $ 1 Billion loan to

help hide Enron’s true financial position.

Citigroup’s Robert Rubin’s infamous call to Undersecretary of Domestic Finance Peter Fisher to hold off credit agencies in order to buy time.

Rubin never made to testify in Senate Investigation.

POLITICAL CONTRIBUTIONS

RECOMMENDATIONS Reduce incentive for Senior Executive Stock Price Inflation

Require six months holding period after leaving company before exercising mature options.

Auditing and Consulting Services cannot be held by the same CompanyConflict of interest between auditing services and consulting

services.

CEO, CFO accountability of accounting statement accuracyFormal CEO, CFO statement signoff.Specific legal requirements for attaching liability for accuracy of

statements.

CONCLUSION Generally financial statements reflect the true

financial position of a company.

However, various accounting practices can be executed to tailor a company’s financial statements.

More government scrutiny can tighter legal requirements required to protect the general public from deception.