An Explanation of Off-balance Sheet Financing at Enron

Enron’s use of off-balance sheet financing, namely through Special Purpose Entities (SPEs), is one of the most clear abuses of rules-based GAAP in the entire breakdown of this scandal. There are several standards set up in SFAS 125 and SFAS 140 related to these types of financing entities. While technical guidance related to these standards is quite complex, the following is a simple breakdown of Enron’s method for concealing the activities of SPEs from its own financial statements.

Enron creates an SPE, a separate legal entity, which obtains financing for its activities from investors and lending companies. At least 3 percent of the SPEs new capital comes from investors unrelated to Enron, and Enron retains a 49 percent or less ownership stake in the SPE. What is important to note here, is that generally the SPE has undertaken an enormous amount of debt to this point, sometimes with Enron stock being used as collateral to lenders. With the newly raised cash, the SPE purchases assets from Enron, sometimes even Enron common stock.

Regardless of the “asset” that Enron relinquished in this type of an exchange, the company had raised a heap of additional cash each time. These SPEs were not revealed to investors, which is how the company was able to create more than 3,000 Special Purpose Entities, concealing more than $2 billion of debt. One specific example of Enron’s abuse of SPEs is when the company would sell an asset to an SPE it had created, and then lease back that same asset, but record the transaction as an operating lease. By taking advantage of rules-based GAAP outlined in SFAS 15, Enron further concealed liabilities and vaulted asset values. By skirting the rules, Enron was able to avoid consolidating SPEs with its financial statements, thereby hiding massive amounts of debt, decreasing perceived risk, and recording excess income through sales to SPEs. Ultimately it was in early 2000 that investors caught wind of the personal financial gains that Enron officers had booked in conjunction with transactions with the SPEs, and began to ask questions related to such that ultimately contributed to the unraveling of the greatest financial scandal in recent history (Edward Ketz, Accounting Ethics, pg. 368).


Ketz, J. Edward. Accounting Ethics: Critical Perspectives on Business and Management. London: Routledge, 2006. Print.

Introduction to the Enron Scandal

The financial scandal surrounding Enron is one of the most notable in recent US business history, and was, at the time, the largest bankruptcy ever. Enron was led by a group of unsavory businesspersons, namely Jeff Skilling (CEO), Andrew Fastow (CFO), and Rick Causey (CAO) who received favorable and negligent treatment by auditors of Arthur Anderson, the company’s independent auditor. Enron’s leaders primarily took advantage of rules-based accounting standards relating to revenue recognition of contracts and the concealing of debt through off-balance sheet financing vehicles. These topics are discussed in depth herein, as the ‘how’ of Enron’s collapse is unveiled.

Areas of Key Importance in the Enron Collapse

1) Revenue recognition/mark-to-market accounting (recognizing the present-value of future contracts as revenue in the current period, abuse of SAB 101 "Revenue Recognition in Financial Statements")
2) Off-balance sheet financing (i.e. 3,000 Special Purpose Entities and SFAS 125/SFAS 140 used to conceal at least $2b of debt, abuse of rules-based GAAP)
3) Corporate governance (tone at the top, management's behavior, pressure from wall-street, executive compensation, resulting SOX legislation, subsequent legal proceedings, etc.)
4) Arthur Andersen as auditor (chain of command issues, failure to halt or limit fraudulent accounting practices, subsequent dissolution of the firm)