Advance Financial Accounting: Enron's Misuse of Mark-to-Market Accounting and Special Purpose Entities

This article discusses Enron's misuse of mark-to-market accounting and special purpose entities, and the high compensation provided to its management. It also evaluates the measurement methodologies used by BHP Billiton and how they provide decision-useful information.

Running head: ADVANCE FINANCIAL ACCOUNTING
Advance Financial Accounting
Name of the Student:
Name of the University:
Authors Note:

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Table of Contents
Assessment Task Part A:............................................................................................................2
a) Defining the overall mark-to-market accounting approach with examples, while detecting
the misuse, this was conducted by Enron’s Management for portraying a rose picture of its
performance:..............................................................................................................................2
b) Discussing about the special purpose entities, while indicating how the management of
Enron was able to fund contracts or achieve financial reporting objectives:.............................3
c) Discussing and arguing about the high compensation, this has been conducted by Enron’s
management, while using adequate agency theory:...................................................................4
Assessment Task Part B:............................................................................................................5
a) Quoting examples of measurement methodologies from company’s annual reports:...........5
b) Explaining how the measurement method provided decision-usefulness information, while
understanding the decision useful information to be:................................................................6
c) Providing critical analysis of the techniques the selected companies have used for
deploying more useful or practice than another method:...........................................................7
References and Bibliography:....................................................................................................9

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Assessment Task Part A:
a) Defining the overall mark-to-market accounting approach with examples, while
detecting the misuse, this was conducted by Enron’s Management for portraying a rose
picture of its performance:
Mark-to-market accounting approach relevantly allows the organisation for using the
current accounting rules and present value framework for recording transactions, which might
allow the management to forecast its future earnings. Therefore, with the help of Mark-to-
market accounting approach the management of Enron was mainly able to recognise the
income and forecast the overall ungory prices and interest rates in future. The Mark-to-
market accounting approach can eventually allow the organisation to evaluate a particular
scenario, where the financial performance of the organisation can be forecasted in accordance
with the approach. Healy & Palepu (2003) argued that due to the loopholes in the Mark-to-
market accounting approach the organisations were mainly able to manipulate their annual
report and portray high yielding results in their annual report for future performances.
The manipulation was mainly conducted by the management in their Mark-to-market
accounting approach, where the unreleased gains and expenses were accounted by the
organisation without the possibility of its occurrence. The primary problem was mainly
detected, when the overall Blockbuster deal was signed for 20-years for the value of $110
million, where the management went ahead and recognised the estimated profits in the annual
report even when the serious questions was arising regarding he technical vitality of the deal.
The second major mistake, which was made by the management of Enron, was the inclusion
of contract for supplying the electricity to Indianapolis for $1.3 billion. The management
discounted the overall income, which increased the level overall revenues for the fiscal year

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by half a billion (Carberry & Zajac, 2017). The income of the organisation was mainly not
realised in actual where the estimated income of the organisation was mainly depicted with
the help of Mark-to-market accounting approach. This increment in revenue was mainly not
realised by the organisation, which inflated the financial position of the organisation even
when the actual income was not generated by the organisation. Hence, with the help of Mark-
to-market accounting approach the management of Enron was able to manipulate their annual
report and increase the level of income from their operations.
b) Discussing about the special purpose entities, while indicating how the management
of Enron was able to fund contracts or achieve financial reporting objectives:
The management of Enron was mainly utilising off-balance sheet financing estimates
known as Special Purpose Entities for financing many of their transactions. The relevant
reposting issues of Enron were mainly detected in the Special Purpose Entities, which was
manipulated by the organisation for conducting their operations. The management was
mainly using the Special Purpose Entities for acquiring the gas reserves from producers,
where investor of the special purpose was provided with stream of revenue from the sales of
the reserves (Markham, 2015). The management of Enron was mainly utilising the Special
Purpose Entities for supporting the purchase of forward contract with gas producers for
supplying the gas to utilities under long-term fixed contracts. During the fiscal year of 2001,
the organisation was holding hundreds of the Special Purpose Entities for supporting their
purchases and reduces the risk attributes of the operations. Nevertheless, the management of
Enron was manipulating the Special Purpose Entities for manipulating their overall financial
reports for reducing their acquired debt (Markham, 2015).
The management of Enron directly utilised the Special Purpose Entities for
manipulating their acquisition of different joint ventures and reduce the occurrence of debt in

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their balance sheet. The acquisition of Chewco, Powers, Troubh and Winokur was mainly
conducted by the organisation with the help of Special Purpose Entities, where the debt used
for acquiring the assets was not disclosed in the annual report of Enron. The accounting
failure was directly detected, where the protection that was used by the organisation for
downsized risk was relevantly not present. Therefore, it could also be detected that the
Special Purpose Entities allowed the organisation and some employees to earn handsomely
raising the question regarding the fulfilment of sensibilities that was conducted by the
organisation (Turnage, 2016).
c) Discussing and arguing about the high compensation, this has been conducted by
Enron’s management, while using adequate agency theory:
The discussion on the article also indicated the measures, which was being used by
Enron for increase the compensation of their directors over the fiscal years. The data
evaluation direct indicates that the managers of the organisation was heavily compensated
using the stock options. The management of Enron in complementing the financial progress
relevantly uses this high compensation mechanism. During the period of 2000 December, the
company had 96 million shares outstanding under the stock options, which is considered to
be the 13% of the common shares outstanding. The management of the organisation was paid
handsomely for the activities that were being conducted during the fiscal years. The actions
conducted by the management of Enron directly indicates the level of support that is
conducted on agency theory, where concerns of the investors increase rapidly due to the high
level of compensation provided to the management (Aven, 2015).
The compensation condition of the Enron was rising exponentially, where the
managers were provided with 13% of the total outstanding shares of the organisation as
compensation. The methodology for conducting the high compensation for managers in form

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of share options is to increase the share price values in future. However, in context of the
agency theory, the compensation of stock options only increases the value of share for short
duration it does not have impact for long or medium-term share value. Therefore, the actions
taken by the managers of Enron for increases the level of compensation was not adequate,
which created problems for the organisation during the fiscal year of 2000 (Tang et al., 2018).
Assessment Task Part B:
a) Quoting examples of measurement methodologies from company’s annual reports:
The overall evaluation of the annual report of BHP Billiton mainly helps in detecting
the level of measurement methodologies, which has been used by the organisation during the
fiscal years. BHP Billiton has mainly used the fair value approach for identifying the level of
exposure, which the company has followed over the period. The fair value approach is mainly
used for calculating the standard valuation techniques with the current market inputs, which
has allowed the organisation to accurately value their hedges in market value. In addition, the
other methodologies are used by the organisation such as straight-line basis, which is helpful
in reducing the value of buildings, equipment’s, and plant of BHP Billiton. Therefore, it
could be understood that the current operations of BHP Billiton are relevantly evaluated in
accordance with the measures of the IFRS system (Bhp.com, 2018).
The measurement methodologies have relevantly indicated that BHP Billiton has been
using adequate financial valuation system to depict their actual financial performance in the
annual report. Beatty & Liao (2014) mentioned that use of fair value measures has mainly
allowed the organisation in portraying their current financial performance in the annual
report. On the other hand, Henderson et al., (2015) argued that fair value measures are only
used for hedging purposes and not for the depreciation of building, plant and equipment’s.

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b) Explaining how the measurement method provided decision-usefulness information,
while understanding the decision useful information to be:
The measurement method provided has provided adequate decision-useful
information to the management in making adequate managerial decisions. The evaluation of
the annual report directly helps in detecting the overall measurement methods, which has
been used by BHP Billiton for detecting its fair value. In addition, from the evaluation it can
be detected that using the measurement method allow the managers of BHP Billiton to
understand level of reduction in the total assets of the company, which has been imposed by
the straight-line method. Christine & Martiano (2015) indicated that with the implementation
of straight-line method the organisations are able to reduce the value of their assets and depict
the accurate financial position to their shareholders.
The decision useful information are the only measures, which are used by
organisations for improving their current financial performance by analysing different
segments of its operations. In addition, the decision useful information is directly related to
significant operations of the company, which the management needs to evaluate before taking
any steps of essential decisions. Lafond, McAleer & Wentzel (2016) argued that the
management is not able to understand the level of valuation of the assets and make adequate
decisions without conducting adequate measurement techniques. The decision useful
information will eventually allow the management to understand the basic condition of the
operations and make adequate decisions for attaining high growth and profitability.

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c) Providing critical analysis of the techniques the selected companies have used for
deploying more useful or practice than another method:
Figure 1: Depicting the measurement methodology used by BHP Billiton in 2018
(Source: Bhp.com, 2018)
The above figure directly indicates the level of measurement methodology, which has
been used by the organisation over the period of fiscal years. In addition, the measurement
has allowed the organisation for accurately valuing their assets and portraying the correct
financial performance in the annual report. The evaluation directly indicates that the
organisation was using the fair vale approach for detecting the interest rate, commodity prices
and exchange rates. The use of fair value has been considered to be one of the adequate
measures for detecting the accurate valuation of the overall instruments used by the
organisation for fulling their measurement methodology. In addition, the fair value hedges
have been used by the organisation to detect the level of exposure, which the organisation has
been continuing, while engulfing itself in the international trade. Furthermore, the use of fair
value approach directly helps in reducing the occurrence of wrong valuation that the
organisation conducted for its hedges.

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The fair value approach is mainly uses the internal valuations system with standard
valuation techniques and current market inputs. In addition, the measure also includes interest
rates and forward commodity prices and exchange rates. The overall uses of Quoted market
prices or dealer quotes for similar instruments are used for long-term debt instruments held
by the organisation. Trotman & Carson (2018) mentioned that with the help of fair value
method the organisation is able to depict the accurate financial position in their annual report.

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References and Bibliography:
Aven, B. L. (2015). The paradox of corrupt networks: An analysis of organizational crime at
Enron. Organization Science, 26(4), 980-996.
Beatty, A., & Liao, S. (2014). Financial accounting in the banking industry: A review of the
empirical literature. Journal of Accounting and Economics, 58(2-3), 339-383.
Bhp.com. (2018). Bhp.com. Retrieved 27 September 2018, from
https://www.bhp.com/-/media/documents/investors/annual-reports/2018/
bhpannualreport2018.pdf
Carberry, E., & Zajac, E. (2017). How US Corporations Changed Executive Compensation
after Enron: Substance and Symbol. In Academy of Management Proceedings (Vol.
2017, No. 1, p. 15134). Briarcliff Manor, NY 10510: Academy of Management.
Christine, D., & Martiano, F. (2015). Review of the revenue recognition in accordance with
statement of financial accounting standard (PSAK) no. 23/2010 at Damri
Corporation. International Journal of Scientific & Technology Research, 4(8), 373-
379.
Healy, P. M., & Palepu, K. G. (2003). The fall of Enron. Journal of economic
perspectives, 17(2), 3-26.
Henderson, S., Peirson, G., Herbohn, K., & Howieson, B. (2015). Issues in financial
accounting. Pearson Higher Education AU.
Lafond, C. A., McAleer, A. C., & Wentzel, K. (2016). Enhancing the Link between
Technology and Accounting in Introductory Courses: Evidence From
Students. Journal of the Academy of Business Education, 17.

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Macve, R. (2015). A Conceptual Framework for Financial Accounting and Reporting:
Vision, Tool, Or Threat?. Routledge.
Markham, J. W. (2015). A financial history of modern US corporate scandals: From Enron
to reform. Routledge.
Markham, J. W. (2015). A financial history of the United States: From Enron-era scandals to
the subprime crisis (2004-2006); From the subprime crisis to the Great Recession
(2006-2009). Routledge.
Tang, T. L. P., Sutarso, T., Ansari, M. A., Lim, V. K., Teo, T. S., Arias-Galicia, F., ... &
Vlerick, P. (2018). Monetary Intelligence and Behavioral Economics: The Enron
Effect—Love of money, corporate ethical values, Corruption Perceptions Index (CPI),
and dishonesty across 31 geopolitical entities. Journal of Business Ethics, 148(4),
919-937.
Trotman, K., & Carson, E. (2018). Financial accounting: an integrated approach. Cengage
AU.
Turnage, A. (2016). Electronic discourse, agency, and organizational change at Enron
Corporation. Western Journal of Communication, 80(2), 204-219.