Failures In Corporate Governance: Accounting Scandals Of Enron Co. Ltd. And Ricoh India

14th February, 2023 - 6:39 am Categories: Legal Issues 0 Comments

Introduction

The practice of what is known as ‘creative accounting’, is something that seeped into the corporate world decades ago. While corporate governance and finance are very significant to the functioning of a company, the scope for failure is wide, as companies are run by humans at the end of the day, who are well accustomed to fraud¹. Creative accounting which is also referred to as aggressive accounting and income smoothing, refers to the practice of accounting that does not abide by the rules. While this practice is unethical, it is not illegal as it does not really violate any law per se². This article will examine the accounting scandals of Enron and Ricoh, thus, looking into both international and domestic accounting frauds and highlight the importance of proper corporate finance and governance in the world today.

Accounting Frauds And Corporate Governance

A financial statement fraud is referred to as an accounting scandal when it is revealed. Financial statement fraud is the deliberate misrepresentation of an enterprise’s financial condition by the deliberate misstatement or omission of financial statement statistics or disclosures in order to deceive financial statement users³. A business may commit fraud for a number of reasons, but the principal one is to earn money and create a false feeling of security for the business in order to preserve its image in the market and to deceive government agencies in order to avoid paying excessive tax obligations⁴.

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Accounting frauds can be categorized into irregularities/ errors and manipulated earnings⁵. There is a fine distinction between these two categories that is based on just one factor – intent of the people involved. While errors may often only be limited to inaccuracies caused by accident,

irregularities may refer to those inaccuracies which were intention; i.e. there was a deliberate intention to deceive a third party and conceal certain information⁶. Accounting irregularities that do not fall under the ambit of accounting errors, are often deliberate and are done with the intention to conceal the actual performance of the company. Often the individual derives a personal profit from doing the same, that is not expressed in the books of accounting. These profits are not essentially monetary either.

Case Study Of Enron In Relation To Accounting Fraud

Enron Corporation was one of America’s biggest energy suppliers and was a product of a merger. The company was also known for its innovations as it created Enron Online that helped in trading the commodities manufactured by the company in early 1999⁷.

The company’s operations were seen as those that were beyond its time, with a futuristic use of equipment and technology. Enron was definitely one of the world’s biggest electricity, natural gas, communications, and pulp and paper companies until its bankruptcy in late 2001, with annual revenues increasing from around $9 billion in 1995 to over $100 billion in 2000. By the end of 2001, the company’s reported financial condition was found to be primarily based on institutionalized and deceptively constructed unethical accounting scam⁸.

The factors responsible for the downfall of Enron and the discovery of the 2001 scandal are as follows: (i) Lack of Honesty (ii) Conflicts of Interest (iii) The Accounting Fraud – Mark to Market and SPE⁹. While the company was admired for the way it functioned and excelled in all aspects relating to its corporate nature, the duty of good faith is something that is expected of every company – no matter its size or reputation.

There is a huge gap pertaining to the honesty behind the promises made by the CEO and the execution of his responsibilities during 2001. There were promises of the stocks going higher and higher day by day but there was no record pertaining to how this would be achieved and the selling

of stock that was done without informing the employees¹⁰. The creation of fake entries in the books just to settle the balance, that was later examined, may not essentially be illegal with the application of the right corporate laws being interpreted prima facie, but is definitely an unethical practice having a direct effect on the health of the company itself and everyone working for the same.

The very evident absence of supervision and oversight and the conflict of interest between the Board of Directors of the company, also contributed towards its downfall. All the policies with respect to compensation that have been formulated by the company, have also been made on a short-term basis, without taking into account all external factors¹¹. Things like these form the basis of corporate governance and finance, and failures in such practices ultimately lead to dilapidated functioning.

As a public firm, Enron was subject to external sources of control, including market pressures, government regulatory scrutiny, and oversight by private organizations such as auditors and credit rating agencies. The mark to market strategy requires that, after the execution of a long-term contract, the value at which the asset would potentially trade on the futures market be revealed on the current financial statement. Enron traders had to anticipate large future cash flows and a low discount rate on long-term Enron contracts to satisfy investors and make money. Profit is the difference between the computed net present value and the initial price paid, and Enron’s claimed net present value may not be have been realized throughout the contract’s years. These projections pertaining to long term incomes are what made the company prone to the inflation¹².

Case Study Of Ricoh India In Relation To Accounting Fraud

Ricoh Company is a Japanese electronics company, that merged with RPG Industries in India and opened Ricoh India in 1993. Before the accounting scandals came into the limelight, the company was regarded as one of the most ethically secure companies for around 5 years since its forming. The company was brought into mainstream media and the public’s eyes, after it failed to report its

financial updates in 2015 to the BSE¹³. Throughout the forensic audit, several infractions were uncovered. For instance, in March 2014, the debt was valued at around 3,570 million Rupees, but by March 2016, it had increased to 23,450 million Rupees, despite no major investments. Revenues and receivables were inflated to provide a more favorable picture of the business. Additionally, bogus sales and bad debts, as well as invoices for non-existent addresses, were created. Profitability and inventory levels were grossly inflated¹⁴.

The issue started in 2015 along with the change of the auditors in the company, who ensured the stakeholders that there was no malpractice being followed, as there was a delay in the financial reports that had to be submitted to the BSE. However, once the BSE classified the company as Z, alerting the public and shareholders to the prospect of misbehavior, the situation spiraled out of control for Ricoh’s management team.

The Ricoh India scam is alarmingly similar to the Satyam Computers scam. In the nine years after Satyam, Indian authorities have worked to improve India Inc’s corporate governance. Following several committee recommendations, the Companies Act (2013) and SEBI LODR Regulations were changed¹⁵. Existing protections have clearly failed to protect Indian investors from accounting fraud. To begin, it is unlikely that the auditors’ cooperation or deliberate ignorance resulted in major accounting fraud at Ricoh. SEBI chose an internal auditor for the firm.

 Conclusion

After observing the basic concepts of accounting frauds and the summaries of the Enron and Ricoh case study, it can be said that unethical practices of accounting are observed to be the same, all across the world. Domestic and International corporate governance scandals are actually strikingly similar and are caused by the same list of factors. Numerous basic governance characteristics have minimal bearing on the possibility of a firm restating its financial performance.

Author: Shrika.C, A Student of Symbiosis Law School, Pune, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at Khurana & Khurana, Advocates and IP Attorney.

¹Dr. Ruchi Gupta, Creative Accounting Practices: A Case Study of Enron and Satyam Scandals, 5(4), I.J.R.A.R., p. 238, p.238-242, 2018.

²A. Shah, S. Butt & Z. Syed, Use or Abuse of Creative Accounting Techniques, 2(6), I.J.T.E.F., 2011.

³Ibid.

⁴Varsha Rajora, Corporate Frauds in the World of Corporate Sector: A Critical Analysis, 2010, https://ssrn.com/abstract=1539013 , [Last visited: 9^th June, 2022, 6:17 PM]

⁵ M. Young, Accounting Irregularities and Financial Fraud, a Corporate Governance Guide, AL&B, 2001.

⁶R. Tiscini & F. Donato, The Relation between Accounting Frauds and Corporate Governance Systems: An Analysis of Recent Scandals, 2006, https://ssrn.com/abstract=1086624 , [Last visited: 9^th June, 2022, 8:30 PM]

⁷Troy Segal, Enron Scandal: The Fall of a Wall Street Darling, INVESTOPEDIA.COM, 2021, https://www.investopedia.com/updates/enron-scandal-summary/ , [Last visited: 9^th June, 2022, 10:00 PM]

⁸Yuhao Li, The Case Analysis of the Scandal of Enron, 5(10), I.J.B.M., p. 37, p.37-41, 2010.

⁹SPE – Special Purpose Entity.

¹⁰Supra note 9.

¹¹S. Bukhari, The Enron Case Study: History, Ethics and Governance Failures, RESEARCHGATE.NET, https://www.researchgate.net/publication/332247240_The_Enron_Case_Study_History_Ethics_and_Governance_Fa ilures , [Last visited: 10th June, 2022, 12:05 PM]

¹²Supra note 9.

¹³BSE – Bombay Stock Exchange.

¹⁴N. Singh & O. Amat, Detecting accounting fraud using quantitative techniques, Working Paper no. 1738, D.E.B., p.1, p.1-23, 2020.

¹⁵Aarati Krishnan, Trouble at Ricoh: a lot like Satyam, THE HINDU, https://www.thehindubusinessline.com/opinion/columns/trouble-at-ricoh-a-lot-like-satyam/article22764006.ece , [Last visited: 10th June, 2022, 11:31 PM]

independence of the board of directors and audit committee, as well as non-audit services provided by outside auditors¹⁶

¹⁶A. Agarwal & S. Chadha, Corporate Governance and Accounting Scandals, CITESEERX.COM, https://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.217.7391&rep=rep1&type=pdf , [Last visited: 11^th June, 2022, 9:00 AM]