Question

Enron Corporation was a darling in the energy-provider arena, and in January 2001 its stock price rose above $100 per share. A collapse of investor confidence in 2001 and revelations of accounting fraud led to one of the largest bankruptcies in U.S. history. By the end of the year, Enron’s stock price had plummeted to less than $1 per share. Investigations and lawsuits followed. One problem area concerned transactions with related parties that were not adequately disclosed in the company’s financial statements. Critics stated that the lack of information about these transactions made it difficult for analysts following Enron to identify problems the company was experiencing.

Access the FASB Accounting Standards Codification at the FASB website (www.fasb.org). Determine each of the following:

1. The specific eight-digit Codification citation (XXX-XX-XX-X) that outlines the required information on related-party disclosures that must be included in the notes to the financial statements?

2. Describe the disclosures required for related-party transactions.

3. Use EDGAR (www.gov.sec) or another method to locate the December 31, 2000, financial statements of Enron. Search for the related-party disclosure. Briefly describe the relationship central to the various transactions described.

4. Why is it important that companies disclose related-party transactions? Use the Enron disclosure of the sale of dark fiber inventory in your answer.

Answer 1

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Answer-

2. When related party transactions occur, companies should disclose the nature of relationship involved and also provide a description of transactions and also report the amount of transaction along with any amount due from or to related party.

3. The related party transactions disclosure notes tells transaction with limited a partnership whose general partner's managing member is a senior officer of Enron. The transaction includes various hedging and derivative transactions with the related party as well as the sale of inventory and other assets to the related party.

4. The possible problem with related party transaction is that their economic substance can differ from their legal form. One of the Enron's disclosed transactions involved sale of dark fiber inventory to the related party in exchange of $30 million in cash and $70 million in note receivable form.

Enron recognized gross margin on the sale of $67 million. Now the question arises -: Is the $100 million sales price an appropriate representation of the sale price of the inventory in a normal transaction to an unrelated party? Is the interest rate charged by Enron on the note a fair interest rate? If the answers to these questions is no then wealth has been transferred from one party to other, to the detriment of the shareholders of one the entities for the benefit of other.