Lenders and financial analysts reviewing the numbers should look beyond earnings to the entity’s cash flow as possible warning signs。 Enron reported $979 million in net income, including $1。4 billion in non-cash items in 2000。 Cash—not earnings—services a company’s debt。 A careful review of cash flow should have set off an alarm, as would Enron’s combined high leverage and rapid growth。 Furthermore, analyzing Enron’s balance sheets shows large increases in owners’ equity, but even larger increases in the number of shares outstanding; also, liquidity, working capital, and other summary ratios fluctuate but Enron’s stock is only going up。 These seeming contradictions show that CPAs and other financial professionals should have more carefully fulfilled their duties。

Anderson and others missed (or choose to ignore) obvious red flags that should have gen- erated questions that could have brought Enron’s true financial position to light much sooner。 Enron’s demise actually began when investors became aware of thousands of off-balance sheet partnerships that hid billions of dollars of Enron’s liabilities。 Enron used SPEs since, according to Emerging Issues Task Force Statement D14 (1990), as long as it received at least 3% of its capital from outsiders, the parent need not consolidate (i。e。, recognize) the SPE’s operations。 Enron executives apparently used SPEs to deceive shareholders and en- rich themselves, by structuring transactions to hide many liabilities and commitments, while reaping massive personal gains。 Such Enron transactions do not appear to have been made at arm’s length, although its (detailed) footnotes stated otherwise (Benston and Hartgraves, 2002, p。 108)。 These SPEs also included many aspects of Enron’s business: synthetic lease transactions; sales to SPEs of “financial assets” (i。e。, debt or equity interests that Enron owned); sales to merchant “hedging” SPEs of Enron stock and contracts to receive Enron stock; and transfers of other assets to entities that had limited outside equity。 Enron   paid

Andersen over $5 million to help set up these SPEs, and continued to use them, even when the issue of control of the SPE became suspect。

Enron apparently also recorded improperly notes receivables from its equity partners in various limited partnerships, although GAAP requires reporting subscribed equity as deductions from stockholders equity。 Enron, in a circular way, became tied to the price of its own stock; it never escaped the risk of loss since it had an economic stake in its own hedging transactions。 It manipulated balances using SPEs, disguised loans as revenues, made inadequate disclosures thereon, and otherwise relied on “untrustworthy numbers” (Benston and Hartgraves, 2002)。 Not consolidating the SPEs or disclosing the related party nature of these financial instruments was fraudulent, making Andersen a party in Enron’s distortion of its financial statements。 Enron used SPEs to keep some major liabilities off its books, recognize unrealized gains on Enron assets sold to SPEs, obtain transmission rights below market prices, and record gains on its own stock。

A review of the 1999 and 2000 disclosures of related party transactions in their annual reports reveals that Enron made inadequate and indecipherable disclosures about its business dealings and inaccurately communicated that they were “representative, fairly priced, arm’s length transactions。” Neither consolidating the SPEs nor disclosing the related party nature of these financial instruments borders on fraudulent behavior, and Andersen by its inaction on these issues made itself a willing party in helping Enron to distort its financial statements。 According to Benston and Hartgraves (2002), Andersen neither examined nor was concerned about many significant accounting issues arising from the SPE transactions, as well as failing to follow the dictates of SAS No。 45 in reviewing the adequacy of related-party transactions。