Accounting for Enron: Mark to Market Accounting and Special Purpose Entities

This article discusses Enron's use of mark to market accounting and special purpose entities to hide debts and overvalue equity. It also analyzes Walmart's measurement methodology for financial statements.

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

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Contents
Part A:..............................................................................................................................................2
Part B:..............................................................................................................................................4
References:......................................................................................................................................9

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Part A:
Mark to market accounting:
(a) Mark to market accounting:
The concept of mark to market accounting better known as Fair Value Accounting (FVA) is the
concept of using current market price to disclose the amount of assets and liabilities of an
organization in financial statements. The inability of historic and traditional valuation method to
correctly disclose the value of non-current and financial assets has led to the development of an
alternative valuation method in accounting, i.e. mark to market account or FVA. In case of assets
that have ready market to sale these are valued using the current market price in such market. In
absence of such market, assets and liabilities are valued on the basis of best available information
about expected prices in the future.
In order to improve the quality of book keeping system and financial reporting Internal
Accounting Standards Board has never shied away from experimenting. Accounting information
are generally presented in the books of accounts using Historical cost basis. However, for
number of years accounting experts have also talked about the benefits of fair value accounting.
In fair value accounting the assets and liabilities are reported at fair values. Marked to market is
nothing but fair value accounting. Thus, under mark to market the business assets of an entity are
revalued at fair market value. The resultant increase or decrease for revaluation of business
assets is adjusted with the profit attributable to the shareholders (Callen, and Luo, 2018).
Though the whole concept of mark to market or fair value accounting was to provide better
financial information to the users of financial statements however, in reality the managements
have made unethical uses of such accounting concept to show higher profit attributable to the

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shareholders and increased amount of assets to paint a better financial picture than the actual
financial state of an organization (Ellul et. al. 2014).
In case of Enron, the company used traditional accounting system to reports its income and
losses from business. However, Skilling demanded that the natural gas business of Enron to
adopt mark to market accounting to reflect true economic value of the natural gas business.
Subsequent to that the natural gas business of the company became the first non-financial
company to use mar to market accounting. Even for complex long term contracts were also
reported using fair value assumptions (Kim, Wasley. and Wu, 2016). In order to measure long
the complex contracts of natural gas business of the company the stakeholders of the business
were provided with false and misleading information. It was done mainly due to the large
discrepancies in matching profit and cash of the business. As a result the profit from long term
contracts that were recorded in the books of accounts under fair value accounting often not even
realized due to unforeseen circumstances. In future years once the long term contracts end up
incurring losses the management continued providing misleading information to appease the
investors. Thus, the objective of Skilling cannot be questioned but the mark to market accounting
resulted in circulation of misleading information about the profit and financial state of the
company (Mixa, Bryant and Sigurjonsson, 2016).
(b) Special purpose entities:
Limited partnerships and companies were created by Enron with the objective of managing the
risks associated with specific assets. By creating special purpose entities Enron started hiding its
debts in the market to portray a better financial picture of the company to ensure that the shares
prices are not affected. In fact by the time it was 2001 the company used more than 100 special
purpose entities to hide its debts in the market. Circumvention of accounting principles and

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policies. As a result the financial reports of Enron undervalued its liabilities by a significant
margin and increased its equity. The actual financial performance and position of the company
were not reflected due to the mark to market and creation of special purpose entities to transfer
and hide the debts (Bekçioğlu et. al. 2016).
Thus, from the above it is clear that the management of Enron used special purpose entities with
the objective of achieving financial reporting goals of undervaluing liabilities and overvaluing
equity of the company (Sokil, 2017).
(c) High compensation and stock options to top management:
Even immediately prior to the massive fall of Enron, the top management personnel of the
company were in receipts of high compensation and remuneration. The top management of the
company was also in receipts of stock options. The reason top management personnel was
allowed stock options was that the management expected the stock prices to keep on rising. This
will increase the wealth of the top management as the stock prices continued to rise till the
company failed completely. As the management expected that it will continue to fool the
investors and other stakeholders by window dressing the financial statements of the company.
Thus, the main objective behind issuing stock options to the top management was to enhance the
wealth of the top management (Gusc van Veen-Dirks, 2017).
The stock option compensation scheme of Enron was specifically made with the intention of
maximizing the profit of the shareholders at the expense of the company. As per an agency
theory the shareholders are not agents of the company in fact they are the principle. If the
company would have not identified the issue with accounting of the company then who knows

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the top management personnel could have increased their wealth by multiple times (Vysochan,
2014).
The whole objective behind shifting from traditional accounting method to fair value accounting
method is to increase the wealth of the shareholders of the company. The undervaluation of
liabilities reported in the financial reports worked perfectly to appease the investors for certain
period of time as a result the share prices kept on rising till the fraud came into the forefront
(Hussin et. al. 2017).
Part B:
(a) Measurement methodology:
In order to complete this part of the assignment the annual report 2018 of Walmart Inc. shall be
referred.
International Financial Reporting Standards Board along with International Accounting
Standards Board are continuously looking to improve the quality of financial reporting. Apart
from formulating and developing accounting standards and financial reporting standards IFRSB
has also discussed about five elements of financial elements (Minnis and Sutherland, 2017).
According to the IFRSBs the five important and key elements of financial statements are as
following:
I. Assets.
II. Liabilities.
III. Equity
IV. Revenue and
V. Expenses.

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In international Conceptual Framework, i.e. IFRS framework the clear recognition and
guidelines have been provided of the five elements of financial elements (Robinson et. al.
2015). As per the IFRS framework the five elements have been defined as following:
Assets: Assets is the resources held by an organization that expected to provide economic
benefits to the organization that is measurable in monetary value. The most important
attribute is that an entity is expected to get future economic benefits from the use of such
asset.
(b) Measurement used by the company:
Walmart Inc. in its annual report has clearly mentioned that all the assets and liabilities
expected financial assets, instruments and inventories have been valued using historic
accounting method of valuation. For financial assets, instruments and inventories the
company has used Fair Value Accounting to measure these in the financial reports of the
company. In case of annual report of Walmart Inc. the assets included the following:
Cash and cash equivalents: This is the amount of cash in hand and at bank as at the end of the
accounting year (Henderson et. al. 2015).
Receivables, net: The amount receivable from customers for sale of goods and products on
credit.
Inventories: The Company is a retailer giant with huge inventories. These are assets that can
be sold and from sale of such assets the company can generate future economic benefits.

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Prepaid expenses and others: Often an organization pays expenditures in advance before
incurring such expenditure. For example payment of an insurance policy as March, 2018 for
a period of 10 months (Abata, 2015).
Property and equipment: This is the amount of property and equipment held by the
organization to earn economic benefits in the future.
Goodwill: Goodwill is the monetary valuation of the reputation of an organization in the
market. For example the brand name of luxury phone is the goodwill of such company as the
name of the brand infuse confidence on someone. In case Walmart the company has reported
$18,242 million as goodwill in 2018 (Minnis, 2011).
Other assets and deferred charges: The Company has also reported $11,798 million as other
assets and deferred charges.
Liabilities:
As per the accounting principle liabilities represent expected outflow of economic benefits
determinable in monetary value in the future. The liabilities of Walmart for 2018 include the
following:
Short term borrowing: The amount of short term borrowings of the company at the end of the
financial year in 2018 $5,257 million (Lisowsky, Minnis and Sutherland, 2017).
Accounts payable: Accounts payable is the amount an organization owes to the suppliers and
employees of the organization. In 2018 the balance in accounts payable account is $46,092
million.

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Accrued liabilities: These are the amount of expenditures that have incurred and due but yet
not been paid.
Accrued income taxes: It is the amount of income tax to be payable after a particular time.
Long term debt due within a year and capital lease and financial lease obligation due within a
year: The Company has long term debt that would have to be paid in the year along with capital
and financial obligation that is also payable today (Badertsche et. al. 2017).
Long term debt of the company $30,045 in 2018 and long term capital lease finance obligations
that are not due in the short have been classified as long term debt.
Deferred income taxes and other: Deferred income liabilities have been created to provide for the
timing differences in taxation in the future.
Equity:
The equity is the amount of owners’ funds that include share capital issued, i.e. Common stock,
capital in excess of par value, retained earnings, and accumulated other comprehensive income.
The total equity of the shareholders of Walmart excluding non-controlling interests is $77,869 at
the end of the financial year.
Revenue:
As per the US GAAP revenue is the amount of income earned from sale of goods or services by
an organization. Walmart has reported a total revenue of $500,343 million in 2018 that includes
net sales membership and other income.
Expenses:

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It is the amount of payment made or to be made in the future for conducting day to day business
affairs of an organization. The company has reported cost of revenue or cost of sales of $373,396
and operating, selling and administrative expenditures of $106,510 million in 2018.
(c) Critical analysis:
The company has measured each element of financial statements by complying with the
accounting principles and policies. As per accounting principles and policies the revenue has
been included in the income statement only when it has become certain that such revenue will be
received in the future or has already been received. Expenditures have been included as and
when incurred even if not paid. Assets have been measured after assessing that the same are
within the controls of the organization and can be used for earning economic benefits in the
future.
Accounting techniques include cash and accrual basis of accounting to measure items of income
and expenditures. In case of cash basis of accounting the items of revenue and expenditures are
included in the books of accounts at the tie of receipts and payments. In accrual basis of
accounting the revenues and expenditures incurred as and when the same has either been earned
or incurred in the future. Walmart Inc. has used accrual basis of accounting to record each of the
five element in the financial statements.

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