During the major accounting scandals of 2001, Enron attempted to transfer significant debt and business losses to special purpose entities in order to keep negative financial information out of its publicly disclosed financial statements.
An accounting entity is an organization that records and reports business or financial information separately from other businesses. The accounting entities must have economic transactions resulting from distance transactions in the business field; these transactions indicate that the entity is a legal company and has material financial information that must be reported to internal or external users. Accounting entities can be an independent company, a subsidiary, or an individual division of a parent company. A subsidiary or divisional accounting entity must present its financial information separately from the information or financial statements of the parent. Parent companies must follow specific accounting or legal rules when doing business with their subsidiaries.
Major scandals rocked the accounting industry in the early 2000s.
To be considered an independent business operation, accounting entities must not have more than 50% of their voting shares owned by another company. Generally Accepted Accounting Principles (GAAP) require parent companies to report business information in consolidated financial statements if they own more than 50% of the voting stock of another company. This rule also applies to the levels of ownership that parent companies have in subsidiary companies. The percentage of ownership interest between a parent company and an individual accounting entity is a basic guide to determine how each company reports business information in the financial statements.
Companies should proceed with extreme caution when reporting financial information about individual accounting entities or subsidiary businesses. Attempting to transfer significant debts or other obligations of the parent company to a separate accounting entity can have serious legal implications. The transfer of income or business assets from an accounting entity to a parent company can also have serious complications, as it will present false information to private investors. Public companies may also be subject to independent investigations by the United States Securities and Exchange Commission (SEC) regarding their activities in the use of a separate accounting entity to conduct business. These independent investigations date back to the early 2000s, when some major accounting scandals rocked the accounting industry.
During the major accounting scandals of 2001, Enron attempted to transfer significant debt and business losses to special purpose entities in order to keep negative financial information out of its publicly disclosed financial statements. This transfer of financial information was later declared illegal by federal regulators; Enron was forced to restate its earnings in financial statements for several prior accounting periods, resulting in operating losses rather than profits. Enron is now considered a classic example of the misuse of an individual accounting entity to misrepresent financial information.