Enron: Case Study and Evaluation of IFRS Elements

This report provides a case study of the downfall of Enron and an evaluation of the five elements as described in the IFRS. It discusses the mark-to-market accounting approach, SPE, and the main purpose of the stock option. It also explains measurement methodologies and the differences between US GAAP and IFRS.

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Advanced Financial Accounting Assessment item 2 — Assignment

Enron
Executive summary
The downfall of Enron is one of the apt examples where the company fabricated the accounts
and created a rosy picture. The accounting policies were misused that led to the downfall.
The investors were of the opinion that Enron was performing effectively, however, there was
an immense accounting issue which was hidden and not known to the stakeholders. The
report consists of two parts, the first part being the case study of fall of Enron written by
Paul M. Healy and Krishna G. Palepu where an in-depth analysis is being done of the fall and
how the mark-to-market was being used in a wrong manner. The second part is the evaluation
of the five elements as described in the IFRS.
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Contents
Introduction...........................................................................................................................................4
a. Mark-to-market accounting approach............................................................................................4
b. SPE................................................................................................................................................5
c. Main purpose of the stock option...................................................................................................5
b. Explanation of measurement method.................................................................................................7
c. US GAAP and IFRS......................................................................................................................8
Conclusion.............................................................................................................................................9
References...........................................................................................................................................10
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Introduction
Special purpose entity is the topic that can be attributed to being launched by the sponsors of
the company wherein it is the investors and the loan givers that actually fund the company to
run. Financial backup, asset threats, loan sanctioning and risk sharing are some of the tactical
terms in which the piled up special purpose entity fund goes into. The need of the financial
report in case of Enron can be seen from the beginning and this is why the company can be
attributed to the status of one that has acquired a stunning amount of assets just from the
special purpose entity section. The falsification and the changes made in the financial
statements are depicted in the article and also explained.
a. Mark-to-market accounting approach
In accordance with the important terms put up by Pual M.Healy and Krishna G.Palepu upon
The Enron, some of the guiding logic and discussion is as follows:
A. It can be seen as with today’s competition that the company is putting the assets and the
liabilities under the FV sector so as to follow the path of market-to-market accounting screen.
According to the theory gathered, it is seen that the base one is the one that is currently
prevailing in the market and the expected prices are thereby noted because the prices are the
terms that are subjected to fluctuations (Gay & Simnet, 2015). The PV of the future cash
flows becomes an important base ground on which the whole pillars of cost, assets and the
expenses can be structured if the vision of the company is in a verge of a long-term contract
only. The database gets filled with evaluation prices once the prevailing price fluctuates in
the market (Healy & Palepu, 2003). The expected values to be put up in the financial reports
were not at all in compliance with the original value and this led to the straightforward
understanding that the company was going to falsify the data in the financial reports. From
the gathered data and their respective understanding, it can be made clear that fluctuations
can cause the prices to set up a new height or can get a downfall as in comparison to the
previous price data.
The database was pre-filled with the expected future cash flow amounts and the expenses on
the FV list which can be the fact that the company was able to scene their total income very
quickly. This process indeed turned out to be fatal for the company as it very keenly ignored
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and made the company blind of the numerous side profits and the losses happening in the
company. Enron was seen to enter many contracts that had a long-term vision and the profit
percentage and the losses in the contract was treated as under PV cash flows and was pre-
determined by the company (Healy & Palepu, 2003). Some of the testifying procedures
followed by the company showed that these contracts were totally lethal and fatal to the
company on a large scale and this is the reason that the company was pressured to make
manipulations and falsify the data in the financial reports in order to maintain the financial
status and the reputation of the company from degrading in the market (Berensen, Richard &
Oppel, 2001).
b. SPE
The plan to buy the partner shares of the company was taken up by Enron when it set its eyes
upon joint venture term in the year 1997. the company kept on carrying on with its duties and
working without seeing the fact that this treaty has led to the leakage of both the profit and
loss statements of the company in the public as a whole. The company was keen enough to
launch a whole new structure as it had to clear all the doubts about its status running in the
market and had to prove that the company still has a well-defined state to carry on the joint
venture working. The adoption of the Chewco SPE in the books of the company made the
company hit many barriers of the accounting standards and the company was at least smart
enough in this one as not to include all this in the financial statements of the company. In
this fashion, debt, as well as liabilities was understated in the balance sheet of Enron and on
the contrary, earnings, as well a equity was overstated. The SPE formed the base of all the
turnings and the fittings of the company statements (Hoffelder, 2012). The public got a hint
and a little theoretical knowledge about the functions gong on in the company but they then
also trusted the company in investing with a believe in the financial statements of the same.
The main priority of the company was to hide all the SPE working from the outer public and
maintain the status and reputation of the company by falsifying the financial statements and
this was the top priority work of all the top level chiefs and officials working in the company
(Healy & Palepu, 2003).
c. Main purpose of the stock option
All the luxury facilities and also newly made and introduced stock option were provided to
the management officials of the company. These terms somehow seemed to be a copy of the
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ones provided to the investors of the company. All this has only one purpose and that was to
hide the doings of the company from the public which if leaked would lead to the status
downfall of the company (Healy & Palepu, 2003). The difference in workings of the Enron
with the other companies can simply be attributed to the fact that they were providing some
very strange stock options (Ross et. al, 2014). This can be called strange in a way because the
stock was not for resale again and this posed as lethal because it seriously aroused questions
about the working of the company. These are some of the pints that can only be explained by
the agency theory. The theory is based on own interest terms (Viney, 2010). The simple
language of the theory can be made up like this in which all the officials of the company
work for their own living and to increase their own personal wealth. There is two section in
which the above term can be divide and these are as follows; Firstly, in which the officials are
not thinking about the welfare of the company and is keen in doing his own job as to increase
the personal wealth on a large. Secondly, the official is skilful and honest enough to work for
the well being of the company on a large but also fulfilling his needs and thus increasing his
wealth also.
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Part B
a. Measurement Methodologies
Different terms exist in accounting section which can be explained. Wesfarmers group
Limited can become and ideal example as it has the same state. The total income of the
company is not thoroughly decided as it can change with future fluctuations. While on the
other hand, calculation are being made upright for the assets related to inventories as on the
basis of weighted average cost (Niemi & Sundgren, 2012).
The final or the financial report of the company seems to correct and honest enough because
it has been evaluated properly and after that a part of it has been put away as allowance
section. Also the loans taken up by the company at taken at a low rate and are paid off as
soon as possible. The difference between these two has been clearly reflected in the
consolidated statements of the organization.
b. Explanation of measurement method
The previously mentioned companies can be accounted for this report. Furthermore, it
cannot be ascertained whether any method is superior to another method or not. Moreover, by
the recognition measurement, it can be seen that one component is more effective in the case
of IFRS and one component is more beneficial in the US GAAP standard. Further, for better
understanding, several factors have been analysed that has facilitated in the construction of
many recognition methods (Needles & Powers, 2013). Moreover, if the revenue computation
is undertaken based on the standards of IFRS, it will become simpler to discover and
recognize the statement of income apart from the US GAAP. This is because the standards of
IFRS utilize the most usual strategy of recognition of revenue. Nevertheless, based under US
GAAP, differentiation of costs can be facilitated by function whereas in IFRS, the same is
conducted in two major ways namely function and nature of such costs that enhances the
simplicity in the level of understanding. In contrast to this, GAAP has many restrictions that
overburdens the standard in comparison to the IFRS (Leo, 2011). Thus, presentation of
financial statements as per the requirements of IFRS is more beneficial than the US GAAP
principle. Therefore, users can make proper decisions on the financial performance of
companies if their financial details are presented through the compliance of IFRS
requirements.
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c. US GAAP and IFRS
Both IFRS and US GAAP are distinct in the sense that their philosophies and requirements
are totally unmatchable. The first difference is that in the IFRS standards, the rules of income
statement do not have any particular rule but in US GAAP, there are various formats for
presenting the financials. The second difference is that in inventory valuation, the IFRS
requirements necessitate weighted average and FIFO method but the US GAAP requires
usage of LIFO basis only (Carmichael & Graham, 2012). The third difference is in relation to
adoption of fair value or historical cost accounting wherein IFRS requires both for
presentation of financials but US GAAP requires only historical cost accounting. These
differences can be easily taken into account to evaluate which method is superior above the
other. This is because IFRS requirements clearly does not have any restrictions in comparison
to the US GAAP requirements, which means that it can assist in better understanding on the
part of users so that better decisions can be made. Further, various values of figures and facts
can be obtained with the assistance of a company’s financials if such details are offered
without the presence of restrictions. Overall, the requirements of IFRS is more beneficial than
the US Generally Accepted Accounting Principles because the financials are presented in a
more enhanced way in IFRS and the same is easily understandable to the users. In contrast to
this, GAAP does not facilitate in a thorough understanding on the part of users because they
may face issues in coming at a relevant conclusion (Petersen & Plenborg, 2012).
Nevertheless, the benefits provided by the framework of IFRS are clear and efficient in
comparison to the US GAAP framework.
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Conclusion
Going by the overall analysis, it can be commented that the main motive of the Enron was to
project a rosy picture that can lure the investors. In tune to this, the various mechanism was
undertaken that led to the act. The mark-to-market was the chief approach that was used by
the accountants and another being the presence of SPE. Overall, the entire accounts were
fabricated and the article by Paul and Krishna emphasizes it. On the other hand, from the
second discussion, it can be commented that the requirements of IFRS are more beneficial
than the US Generally Accepted Accounting Principles because the financials are presented
in a more enhanced way in IFRS and the same is easily understandable to the users
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References
Berensen, A.,Richard, A., and Oppel, JR. (2001) Once-Mighty Enron Strains Under Scrutiny.
Available from https://www.nytimes.com/2001/10/28/business/once-mighty-enron-strains-
under-scrutiny.html [Accessed 26 September 2018]
Carmichael, D.R. and Graham, L. (2012) Accountants Handbook. Financial Accounting and
General Topics. John Wiley & Sons.
Gay, G. and Simnet, R. (2015) Auditing and Assurance Services. McGraw Hill
Healy, P.M & Palepu, K.G. (2003) The Fall of Enron. Journal of Economic Perspectives.
17(2), 3-26. Available from: https://www.aeaweb.org/articles?
id=10.1257/089533003765888403 [Accessed 26 September 2018]
Hoffelder, K. (2012) New Audit Standard Encourages More Talking. Harvard Press.
Leo, K. J. (2011). Company Accounting. Boston:McGraw Hill
Needles, B.E. & Powers, M. (2013) Principles of Financial Accounting. Financial
Accounting Series: Cengage Learning.
Niemi, L. and Sundgren, S. (2012) Are modified audit opinions related to the availability of
credit? Evidence from Finnish SMEs. European Accounting Review. [online]. 21(4), p. 767-
796. Available from: https://doi.org/10.1080/09638180.2012.671465 [Accessed 21 April
2018]
Petersen, C. and Plenborg, T. (2012) Financial statement analysis. Harlow, England:
Financial Times/Prentice Hall.
Ross, S., Christensen, M., Drew, M., Bianchi, R., Westerfield, R. an Jordan, B.(2014)
Fundamentals of Corporate Finance, 7th ed. North Ryde: McGraw-Hill Australia Pty Ltd.
Viney, C. (2010) McGrath’s Financial Institutions, Instruments and Markets, Sydney
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