Enron Case: Misuse of Accounting Theory and Special Purpose Entities

Running head: ACCOUNTING THEORY
Accounting Theory
Name of the Student
Name of the University
Author’s note

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Introduction
The essay tends to provide a detailed description regarding fall of the Enron case. In
the context of this discussion, certain points are important. The essay structures in the
following manner. In the beginning section, the mark-to-market accounting approach is
elaborated. The usage of this approach in accounting procedures is also briefed. In this
context different examples and situations are cited from the Enron case that shows the misuse
of this approach in order to portray a false picture. It is derived from this picture that the
management of Enron has misused this approach in order to increase their profitability figure
and enhance their performances.
The essay further talks about the special purpose entities which are used in accounting
and the usage of these entities in the Enron company for the purpose of funding contracts and
also to achieve the objectives of financial reporting. The essay moves on to discuss about the
stock options compensation scheme that is enjoyed by the top management of Enron. The
point is dictated through the agency theory. At the last section a complete picture is provided
regarding principles followed in the code of the conduct of professional accounting. In this
respect it is pointed out whether Enron company has abided by the code of conduct of
professional accounting. Suitable reasons are provided stating the justification of the
statements. Suitable points are noted down in order to provide a thorough and detailed
explanation of the fraud case of Enron company and necessary recommendations are also
given in order to curb such a critical issue.
Mark-to-market accounting approach and the misuse of this approach by Enron
company
Mark-to-market accounting approach can be defined as an accounting practice that
relates to the value of an asset for defining the current level of the market. It is recommended

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that all the companies must show the current market values of its accounts in its financial
statements at the end of each financial year (Ellul et al., 2014). There might be occurrence of
issues while the market-based measurement of the value of the asset does not tally with its
original value. One good example of this accounting approach can be seen when the
companies issue bonds to their lenders or investors. Due to the rise in the interest rates, the
market price of the bonds will be down and the same price should be reflected in the financial
statements as their original price.
Considering the case of Enron, the business of the company has been natural gas. It
was reported that the accounting of the business of natural gas has been fairly straightforward
in the early days (Healy & Palepu, 2003). During its early days, the company has recorded
the actual costs incurred while it was carrying out its process of supplying the gas. The
company was even recording its revenue correctly that was generated through the selling of
the gas. However, in the later days the company was found to introduce the mark-to-market
accounting approach in its business (Healy & Palepu, 2003). The company misused this
approach by signing long-term contracts and marking the future inflows of the stream as
present values of the stream. As a result, unrealised gains occurred in its financial statements.
In a similar manner, the company also misused the present value of the expected costs by
showing them as expensed (Haswell & Evans, 2018). The non-hedging of these long-term
contracts let to the discrepancies in the financial statements and the company has taken the
advantage of this in portraying a favourable picture of its profitability and financial
performance. Many examples have been observed that shows the above discrepancy in the
context of Enron.
In the year 2000, the company has signed a long-term contract of 20 years with
Blockbuster Video company in order to provide entertainment as demanded by the common
people of U.S. city (Markham, 2015). According to the contract, Enron company was

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supposed to store the entertainment and then stream it over its entire network globally. There
were many sample projects as initiated by Enron in cities like Portland, Seattle and Salt lake.
These projects were created to stream movie in only a limited number of apartments
(Markham, 2015). However, these projects experienced technical difficulties and the market
demand of them is also under question. Despite of this fact, Enron went on to account for
$110 million estimated profits from these pilot projects.
Another example is significant in this context. Enron has been reported to have
entered into another contract that was worth $1.3 billion. The time period of the contract was
15 years. The contract was made with Indianapolis company regarding the supply of
electricity. It was reported that Indianapolis has not come up with the deregulation of
electricity in the current situation due to lack of confirmation from Enron company (Conrad,
2018). The Enron also did not estimate the costs of service that would get impacted due to
this deregulation over the next ten years. However, the company has already accounted for
these costs and showed their present values as expenses in the financial statement.
From the above stated situations, it has become clear and evident that Enron company
has misled the mark-to-market accounting approach in order to come to a favourable situation
for itself. Mostly in the cases where the company has taken long-term contracts, it has falsely
shown the future cash flows as present revenues (Edel Lemus, 2014). In other situations, the
company has prepared its financial report highlighting the cost figures to be incurred
throughout the period of the contract. However, these cost figures were still under question
and their authenticity was still unclear. Despite of all these complicated situations, Enron has
quietly neglected their importance and has prepared its financial report accounting for its own
profitability.
Special purpose entities