Enron, the natural gas and energy services giant, has been in the headlines in recent months regarding a massive restatement of shareholder equity that caused a shudder on Wall Street. Enron's auditor, Andersen, is in the thick of a controversy involving a 20% overstatement in Enron's net earnings and financial statements dating back to 1997 that will have to be restated.
An article in Monday's Wall Street Journal points to basic accounting errors in Enron's financial statements and implies that even a first year accounting student should have caught the errors.
One of the main causes for the restatements of financial reports that will be required of Enron relates to transactions in which Enron issued shares of its own stock in exchange for notes receivable. The notes were recorded as assets on the company books, and the stock was recorded as equity. However, Lynn Turner, former SEC chief accountant, points out, "It is basic accounting that you don't record equity until you get cash, and a note doesn't count as cash. The question that raises is: How did both partners and the manager on this audit miss this simple Accounting 101 rule?"
In addition, Enron has acknowledged overstating its income in the past four years of financial statements to the tune of $586 million, or 20%. The misstatements reportedly result from "audit adjustments and reclassifications" that were proposed by auditors but were determined to be "immaterial."
There is a chance that such immaterialities will be determined to be unlawful. An SEC accounting bulletin states that certain adjustments that might fall beneath a materiality threshold aren't necessarily immaterial if such misstatements, when combined with other misstatements, render "the financial statements taken as a whole to be materially misleading."
Andersen stated: "This is an unfortunate situation. Issues have surfaced that have caused the company to restate its financial statements and to advise investors that they should not rely on its financial statements or our audit reports. We are cooperating with the company and its special committee to bring resolution to these matters."
The SEC is investigating the Enron situation.