Enron, the seventh largest public company within the united states in 2001. As an large company like Enron, there should be some business risk in their operation. Enron have to treat the risks seriously otherwise they will increase the chance of the material misstatements in company’s financial statement. The first business risk Enron faced is the technology demand and on-line huge cash flow. In 1999, to survive within the century of internet boom, Enron launched an online based trading web site, Enron online. Enron become the first company offer on-line trading service among the world.
The web trading system brings Enron a gross sale of $101 billion but the cost to induce this result should be terribly high. Enron need to improve their technology to make sure the business will run smoothly and ready to access with a high-speed web bandwidth and hire lots of specialists within the area of actuarial science, mathematics, physics, meteorology, and economics to make sure that they will manage the business risk by running the new on-line economy. The high cost become a business risk faced by Enron since it need an enormous amount of money to support the running of the web system. In the other hand, Enron on-line is handling over $1 billion of transactions daily. A large quantity of cash flow coming and monitored by the web system daily is the risk faced by Enron. it will cause an increasing in probability of a material misstatement for the balance sheet once the system is fail or one of the transactions being missed.
Besides that, the next business risks Enron faced is lack of independent of external audit firm. Enron is one of the biggest client of the accounting firm, Andersen. Andersen provide the external financial statement audit work and also the consulting service that is on Enron’s internal audit function. Andersen has been paid with a total amount of $52 million for the external financial audit and the internal audit function. As an external auditor, Andersen ought to only provide Enron external audit service to make sure they are independent.
However, Andersen also provide internal audit service at the same time. Therefore, Andersen is not independent with Enron. It becomes a business risk that faced by Enron and therefore the risk will increase the likelihood of material misstatement. It is possible that Andersen might miss some material misstatement like sale overstated, cost understated and omission of some expenses that will cause Enron’s profit in financial statement up or down due to their own advantages come from Enron since they are not independent. For instance, when Andersen was auditing for Enron’s 1997 results, they found that $51 million of the adjustment should be done in Enron’s book however Enron refused to make the adjustment since it will reduce their 50% annual income.
Andersen therefore determined that the adjustment is not material and just simply let it go uncorrected. If the $51 million adjustment is justified as a material misstatement, Enron’s 50% annual income are going to be cut down, from $105 million to $54 million, the profit will be cut down by $51 million too. Last but not least, the third business risk that Enron faced is the high degree of borrowings. Enron set up the “Special Purpose Entities”, sell off their assets in a share terms at over $100 per share, receiving an outside investment loan in a sale of assets term and without recording the liabilities on the company’s balance sheet. In result, Enron get a large fund with the heading of sale of assets and no recognize as a liability however it actually is a borrowing fund received from external investor by sell off assets to “Special Purpose Entities”. Enron rely on a large quantity of borrowing funds but never record them as a liability.
Enron’s financial statement looks extremely profitable and growth well, the stock valuation is also increasing continuously. this is entirely because of the existence of “Special Purpose Entities”. However, the “Special Purpose Entities” will cause a business risk for Enron since the borrowing fund will increase as long as the “Special Purpose Entities” running. The more investors to invest for the company, the more liabilities incurred without record on the balance sheet while the money inflows are coming in.
The likelihood of material misstatement within the financial statement are going to be increased.In conclusion, the business risks that faced by Enron which can increase the probability of material misstatement within the company’s financial statement are the technology demand and on-line huge cash flow daily, lack of independent of the external audit firm and the high degree of borrowing fund without recorded.