RE: On the Enron Debacle

["Thomas, Doug" <THOMASD@gt-corp.com>]

Jonathan Siegel has written a very interesting, and insightful, summary
of what apparently happened at Enron. I am especially intrigued with his
statement that auditors should have been able to "know what questions to
ask to be able to make such a comparison..."

>From my perspective, the issue is something that all accounting and
financial professionals should be discussing publicly.  As I understand
the "business model" - interestingly, a term used several times without
explanation by the CEO of Arthur Anderson Sunday morning, the management
of Enron took contractual agreements to deliver energy products in the
future, and classified those agreements as income.

Apparently, that income was not offset with a requirement to deliver in
the future.  Income is not profit, but apparently Enron considered it to
be so.

I don't believe the customers involved actually parted with cash - they
were agreements to deliver at agreed prices in a future timeframe.  The
deliveries would then be paid for, and that is the income - cost to the
customer and income which hopefully included a small and reasonable
profit to the seller.

The agreements to deliver (contracts) became, in effect, a liability, in
the sense that something had been sold which did not exist at the point
in time the agreement was signed.  As the contract would be fulfilled,
i.e. the product delivered, the sales liability would gradually become
income.  Operating expenses, etc. would be paid and a portion could
rightfully be designated as income.  The agreement to deliver is
normally classified as a sale.  And, a sale carries obligations and
expense components. Those were the elements apparently missing from the
Enron balance sheet.

Had no energy products been delivered, then the customers would have
cause for action, as their business operations would suffer.  

It is one thing to be unable to deliver due to unforeseen circumstances
such as weather, catastrophe or war. But to agree to deliver something
that you cannot produce, even through a subsidiary, ultimately must come
back to bite the seller, big-time.

Even if the actual performance of the delivery is passed to another
company, over which you hold control, the ultimate responsibility
remains the seller's.  Therefore, monitoring of the performance of a
third party becomes essential.

The management of Enron should be ashamed, and the independent auditors
should certainly have been more open with explanations of their
findings. Either the books are in order or they are not.

Doug Thomas

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