Advanced Financial Accounting: Enron's Mark-to-Market Accounting Approach and Special Purpose Entities

This study delves into Enron's mark-to-market accounting approach and special purpose entities. It discusses the motive of the management in terms of funding the contracts and achieving the objectives associated with financial reporting. It also analyzes the measurement methodologies from the annual report and provides a critical analysis of the techniques deployed by the company.

Running head: ADVANCED FINANCIAL ACCOUNTING
Advanced Financial Accounting
Name of the Student
Name of the University
Authors Note
Course ID
Table of Content

1ADVANCED FINANCIAL ACCOUNTING
s
Introduction................................................................................................................................2
Assessment Task Part A.............................................................................................................2
a) Mark to market accounting approach.................................................................................2
b) Special purpose entities and how management of Enron has used to fund the contract
and achieve the reporting objectives......................................................................................3
c) Main purpose of the stock options compensation scheme.................................................4
Assessment Task Part B.............................................................................................................5
a) Examples of measurement methodologies from the annual report....................................5
b) Measurement of the elements and methods useful for the decision making.....................5
c) Critical analysis of company’s techniques deployed.........................................................6
Conclusion..................................................................................................................................7
References..................................................................................................................................9

2ADVANCED FINANCIAL ACCOUNTING
Introduction
The main discussions of the study have been segregated two sections. The first part of
the study has explained concepts associated to the mark to market accounting in terms of the
approach followed by Enron’s management. The discussions pertaining to the study has also
identified the motive of the management in terms of funding the contracts and achieving the
objectives associated to the financial reporting. In addition to this, the discourse of the study
has also showed how the top management of Enron has enjoyed the high remuneration/
compensation. This is inclusive of the stock options and the purpose of the reports which are
seen to be considered in terms of the various aspects of the reporting has been discussed with
the main purpose of the stock options compensation scheme facilitated by the top
management. The second section of the study has included the different measures pertaining
to assessment of the annual report of the company and at the same time clearly referring to
the sources. This section has further explained on how company measured the important
elements of the decision making. The report has also provided the critical analysis of the
approaches selected as per the techniques which are used by the companies and practical
method of using the same (Goh et al. 2015).
Assessment Task Part A
a) Mark to market accounting approach
Mark to market measure of the company is identified as a fair value of the accounting
concept which changes over time like liabilities and assets. This concept aims to depict the
realistic appraisal of the present financial situation of the company (Ellul et al. 2014).
Enron’s trading business has been identified to adopt the M-to-M approach accounting. This
suggests that once the long-term contract is signed with the PV pertaining to the stream of
cash flows, PV of the stream of future cash flows were expensed. The primary hurdles faced

3ADVANCED FINANCIAL ACCOUNTING
by Enron by mark-to-market accounting was recognised as per the use of MV agreements
which was considered for more than 20 years. In case of Enron the income was carefully
expensed at PV of the net future cash flows even though there was a serious concern of
viability pertaining to the associated costs and contracts. In July 2000 the company signed a
20-year agreement with Blockbuster Video to introduce for entertainment on demand. As per
the consideration of this case Enron went ahead to identify the profit as more than $110
million from the Blockbuster deal, even if there was a serious question of technical feasibility
and market demand (Haswell and Evans 2018).
b) Special purpose entities and how management of Enron has used to fund the contract
and achieve the reporting objectives
In general, special purpose entities are considered as legal Limited companies or
partnerships which aimed at fulfilling temporal or narrow objectives. The use of SPE is
mainly evident among companies which try to isolate the different types of financial risk.
Typically, entities transferred assets to SPE for better management or providing the rights to
the larger projects so that they are able to achieve narrow set of goals without putting the
operations of firm at risk (Sainati, Brookes and Locatelli 2017).
The use of SPE by Enron is evident with managing or funding dangers concerned
with specific assets. Enron used such methods for funding the acquisition pertaining to gas
reserves from the producers. Due to this, the investors in the SPE received a source of
revenues associated to selling of reserves. Since 2001, Enron has utilised more than 100 such
SPEs. In 1997, Enron aimed at buying out the partner’s stake in one of the leading joint
ventures dealing (Coyne 2017). However, the company did not want to account for any debt
pertaining to financing of any business combination. The company used Chewco as a SPE
entity to raise the debt and guarantee that the company acquired joint venture stake worth $
383 million. Moreover, the deal was planned in such a manner that Enron was not required to

4ADVANCED FINANCIAL ACCOUNTING
consolidate either joint venture or the SPE entity into its financials, thereby allowing for
acquiring partnership interest in absence of any additional debt. Furthermore, the details of
Chewco was duly provided under the appendix of the company. In October 2001 it was
revealed that Enron violated the accounting standards by not maintaining a minimum
ownership of independent equity investors of 3%. The ignorance of such a requirement Enron
was able to dodge consideration of SPEs (Demere, Donohoe and Lisowsky 2017).
c) Main purpose of the stock options compensation scheme
Agency theory is described as the relationship of agents and principles in a business.
The main concerns associated to agency theory is related to the resolution of the problem is
which may exist in agency relationships because of non-aligned goals and differing versions
of this level pertaining to risk. In common parlance, the relationship in agency theory is
identified among shareholders who are known as the principal and executives of company
who are considered as agents (Bosse and Phillips 2016).
As evident in most of the US companies, the management at Enron highly relied on
using stock options. Moreover, the high amount of use of stock options are associated with
the short-term stock price evaluations which focuses on the Enron’s management and
creation of expectations associated with rapid growth and its reporting is related to online for
meeting the expectation of Wall Street. The application of agency theory is evident with the
intention of the company to align with the welfares of the management (agents) and
shareholders or principal. However, it was noted that in majority of the programs the sizable
amount for the option grant was suffering from short-term accounting performance and
typically there were only few requirements for the managers for holding the stock purchased
with option program exercised in the long-term. Moreover, the overall experience of Enron
with other firms raise significant issues for the possibility of stock compensation programs

5ADVANCED FINANCIAL ACCOUNTING
which was presently designed to motivate the executives and boost the short-term stock
performance thereby including the long-term value (Shi, Connelly and Hoskisson 2017).
Assessment Task Part B
a) Examples of measurement methodologies from the annual report
As per the depictions made in the annual report published by the company in 2000 it
can be seen that FASB issued several statements pertaining to “SFAS No. 133” and
“Accounting for Derivative Instruments and Hedging Activities”. This was subsequently
provided and amended in “SFAS No. 137” and “SFAS No. 138”. Moreover, the application
of SFAS No. 133 was applied to David instruments and certain derivatives which included
hybrid instruments record the balance sheet as either an asset or liability measure with fair
value through earnings and allowance specific type of qualifying hedges. For instance, the
adoption of “SFAS No. 133” by Enron was evident with the recognition of after-tax non-cash
loss of $ 5 million in earnings and PAT non-cash gains. Therefore, the total impact of such a
measure on Enron was identified with other comprehensive income which were dependent on
pending interpretations (Picker.uchicago.edu. 2018).
The on comparing the results with company such as Nordstrom which relies on US
GAAP and applies measurement provisions of SFAS No. 123 seen with significant difference
among the stock-based compensation program and expenses. More evidently, the overall
evaluation under such accounting system not only considers fair value of the options at the
date of branding was also risk-free interest rates for measuring the volatility of shares. This
particular phenomenon was absent in case of company like Enron following requirements
prescribed by IASB (About.nordstrom.com 2018).

6ADVANCED FINANCIAL ACCOUNTING
b) Measurement of the elements and methods useful for the decision making
The concept of measurement in accounts is associated with quantification of business
transactions into financial terms by using monetary units. In case, and even cannot be
quantified in monetary terms it is not regarded as being recorded under financial accounts.
This is the main reason why important decisions such as appointment of new manager,
possible changes in personnel and entering into new contracts are generally not revealed in
the books of accounts. The implementation of diagnostic measurements by Enron shows that
the incorporation of Enron PMC is responsible for real-time monitoring of events which
tracks unusual changes pertaining to energy demand which instantly helps in addressing
problems prior to energy costs getting out of control (Shi, Connelly and Hoskisson 2017).
Secondly, the measurement date of Enron plan and ESOP was set in September 30,
2000. The benefit plans under the ESOP considered the consolation of the amount pertaining
to concentrate on the balance sheet and other assets. For the purpose of measurement, the
10% and 6% annual rate is where identified with annual increase of per capita which
addressed the healthcare benefits considered during 2000 to 2001 for general post retirement
plans (Ferrell and Fraedrich 2015).
Lastly, the chief operating decision-making group of Enron allocated resources as for
income before minority interest, net income, interest and IBIT. In addition to this, certain
costs related to the company by functions were incorporated into the segments. Despite of
this, interest worn by corporate debt was primarily maintained among the corporate segments.
Therefore, the management of the company believed that measurements pertaining to IBIT
was dominant in nature and segment and profits consisted of consolidated financial statement
of Enron. In the beginning of 2000, the company’s communication was managed separately
by operating segment which was named after broadband services and the important criteria
set under this was identified with SFAS No. 131 (Collier 2015).

7ADVANCED FINANCIAL ACCOUNTING
c) Critical analysis of company’s techniques deployed
The fall of the company in 2000 was evident with the deployment of its own
techniques. The CEO Enron Jeffrey Skilling was identified with using different types of
unscrupulous methods for hiding the financial losses pertaining to trading and other
operations. This is mainly referred as mark to market accounting. This technique
implemented by the company was used for measuring the value of security as for the current
MV instead of PV. Despite of its success among trading securities, this technique can be
disastrous when implemented into actual practice (Iphofen 2016). This practice was used by
the company in building assets such as construction of power plant and subsequently
claiming for profit even though the property did not generate even a dime.
Henceforth, in case the revenue associated with the power plant was more than the
actual amount. Instead of bearing the loss, the company transferred into an asset into the
books of Corporation which led to several losses going unreported. This kind of accounting
led for writing off several types of unprofitable activities without having any detrimental
effect on Enron (Fischer and Marsh 2017). Moreover, the mark to market practice gave rise
to several types of other schemes which were construed to hide losses and make the company
appear to be more profitable than it was in reality. In order to compensate the mounting
liabilities, the CFO in 1998 came up with a solution of making the company appear to be
having a more stable financial condition despite of the subsidiaries losing considerable
amount of money.
Moreover, the use of techniques such as using of off-balance sheet SPVs for special
purpose entities concealed the mounting amount of debt pertaining to toxic assets from
creditors and investors. Enron would you such SPV for subsequently using the stock foraging
and assets listed in the balance sheet of the company and guarantee that such tools reduced
counterparty risk (Mixa, Bryant and Sigurjonsson 2016).

8ADVANCED FINANCIAL ACCOUNTING
Conclusion
The study of Mark to market accounting approach for Enron is recognised with
signing long-term contract with the current value pertaining to the source of cash flows. At
the time of this signing of the PV of the stream of future cash flows were expensed. Enron
further used SPE methods for funding the acquisition pertaining to gas reserves from the
producers. The company used Chewco as a SPE entity to raise the debt and guarantee that the
company acquired joint venture stake worth $ 383 million. Moreover, the deal was structured
in such a manner that Enron was not required to consolidate either joint venture or the SPE
entity into its financials, thereby allowing for acquiring partnership interest in absence of any
additional debt.

9ADVANCED FINANCIAL ACCOUNTING
References
About.nordstrom.com. 2018. What makes Nordstrom unique? [online] Available at:
http://about.nordstrom.com/aboutus/investor/ar/2000/NOR2000AR.pdf [Accessed 23 Sep.
2018].
Bosse, D.A. and Phillips, R.A., 2016. Agency theory and bounded self-interest. Academy of
Management Review, 41(2), pp.276-297.
Collier, P.M., 2015. Accounting for managers: Interpreting accounting information for
decision making. John Wiley & Sons.
Coyne, M.P., 2017. A Historical Examination of the Mark to Market Accounting
Rule. Journal of Economics and Banking, (1).
Demere, P., Donohoe, M.P. and Lisowsky, P., 2017. The economic effects of special purpose
entities on corporate tax avoidance.
Ellul, A., Jotikasthira, C., Lundblad, C.T. and Wang, Y., 2014. Mark-to-market accounting
and systemic risk: evidence from the insurance industry. Economic Policy, 29(78), pp.297-
341.
Ferrell, O.C. and Fraedrich, J., 2015. Business ethics: Ethical decision making & cases.
Nelson Education.
Fischer, M. and Marsh, T., 2017. Special Business Entity Reporting: One Plugged Hole is
better than none. ASBBS Proceedings, 24(1), p.188.
Goh, B.W., Li, D., Ng, J. and Yong, K.O., 2015. Market pricing of banks’ fair value assets
reported under SFAS 157 since the 2008 financial crisis. Journal of Accounting and Public
Policy, 34(2), pp.129-145.

10ADVANCED FINANCIAL ACCOUNTING
Haswell, S. and Evans, E., 2018. Enron, fair value accounting, and financial crises: a concise
history. Accounting, Auditing & Accountability Journal, 31(1), pp.25-50.
Iphofen, R., 2016. Ethical decision making in social research: A practical guide. Springer.
Mixa, M.W., Bryant, M. and Sigurjonsson, T.O., 2016. The reverse side effects of mark to
market accounting: Exista and the saga of leveraged paper profits. International Journal of
Critical Accounting, 8(5-6), pp.463-477.
Picker.uchicago.edu. 2018. Enron Annual Report 2000 [online] Available at:
http://picker.uchicago.edu/Enron/EnronAnnualReport2000.pdf [Accessed 23 Sep. 2018].
Sainati, T., Brookes, N. and Locatelli, G., 2017. Special purpose entities in megaprojects:
empty boxes or real companies?. Project Management Journal, 48(2), pp.55-73.
Shi, W., Connelly, B.L. and Hoskisson, R.E., 2017. External corporate governance and
financial fraud: Cognitive evaluation theory insights on agency theory
prescriptions. Strategic Management Journal, 38(6), pp.1268-1286.