Special purpose entries (SPE's) the money borrowed from banks did not show up on Enron's books because of the partnership status as separate entities. Enron's management transferred assets (and any related debt) to the special purpose entities at an appraised value above the net cost of the assets, recording a gain on the transfer. Such transactions would have an effect on increasing Enron's net assets the transaction involves no cash receipts the only way it increases cash flow is by Moving debt off the balance sheet and increasing equity, thus improving the company's ability to borrow more funds. The recorded gain increases its return on assets thereby enhancing its earnings performance and stock prices, as well as its ability to borrow.
Enron made special purpose entries to conceal loses and increase its ability to borrow money.
What are three criteria necessary to avoid fraudulent financial reporting, and how did Enron's management comply or not comply with each? .
• Technical Compliance: a transaction must be recorded in accordance with generally accepted accounting principles (GAAP). Enron may have met the first criteria because its transactions were apparently recorded in technical compliance with GAAP. But, technical compliance is not sufficient for truthful accounting. Meeting the other two criteria is essential, and here Enron failed. .
• Economic substance: The financial statements must represent the economic substance of the event that occurred. Enron did not meet the second criteria because the recording of the transactions did not reflect the economic substance of the events that occurred. This is true for three reasons. First, many of the assets Enron transferred to SPE's were not producing enough income to justify their cost as recorded on the balance sheet. They were assets for projects that never got off the ground. Under GAAP, the value of the assets would be judged impaired, and they would normally be written down, showing a loss rather than a gain.