Enron Collapse: Accounting Techniques and Special Purpose Entities

This article discusses the accounting techniques and special purpose entities used by Enron that led to its collapse. It also compares the financial reporting frameworks of IFRS and US GAAP.

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ADVANCE FINANCIAL ACCOUNTING

Part A
As per the points and the key factors listed by Pual M.Healy and Krishna G.Palepu with
respect to the collapse of Enron, these are some of the explanations:
a. The assets and the liabilities of the company that are categorized as FV can be accounted
for by the company to gather the market-to-market accounting screen that is common in
nature to the present situation. In the above mentioned technique, it can be seen that the
present prices are taken as the base ones and the expectation are kept high and totally off-
guard as the prices are the ones that are exposed to various types of fluctuations. This is the
techniques which are taken up by the company when the talk is about long-term contracts and
it is seen that all the costs assets and the expenditure are kept to be structured on the PV of
the future cash flows (Healy & Palepu, 2003). It leads to the fact that the increase or decrease
in the price in relation to the market is not noted down in the records. The income, as well as
the profits of the company, were totally controversial as to they have expected which lead the
financial report to be made with manipulated data. It can be understood from the study that
the fluctuation in the prices can either make the expenses high or can keep them
competitively low as compared to the previous records.
The future cash flows of the company and all the expenses with respect to FV were already
occupied which led the company to decide its revenue early on. As time passed on, it was
seen that this process was a disadvantage as it led the company to ignore or stun the profits or
the losses that it had been suffering. There were many contracts entered by the Enron
company in which all the future incoming profits and the expenses involved were in the form
of PV as cash flows of the future transactions related to the services of the contract. It was
seen that a test initiation proved many such contracts to be lethal and void for the company
after which the management of the company decided to make alterations and manipulations
in the financial reports which can support and maintain the financial and service reputation of
the company in the upcoming future terms.
b. It is the sponsor who is responsible for the development of the special purpose entities but
the point to be noted is that all the funding takes place through debt financing and equity
investors. The money gathered from the special purpose entities is used for the facts like loan
sanctioning, risk sharing, financial support in case of threats and also asset transfer. Enron
can be marked as a company who has gathered a large wealth through this special purpose
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entities technique and has used it to take over projects as the demand of the financial report
(Geoffrey, Joleen, Kelli & David, 2016). All the manipulation are scanned and the
explanation is put up in the following article. It was in the year 1997 that Enron took up a
plan to buy the partner share as it has been entering a joint venture process. The company was
working on the terms and did not notice that the transaction results and the losses were
exposed to the public as well without and initiative from the company or from the JV in the
financial statements (Gay & Simnet, 2015). A structure was formally announced and made by
the company which would successfully eliminate all these disclosures an made the company
seem that it was still well to engage in a joint venture. It was the formal following of the
Chewco SPE that led the company to break many accounting standards and rules and so the
company was precise enough, not to include this in the accounting and the financial reports.
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 (Ross et. al, 2014).
All the disclosures by the company were done in association with the SPE. The public knew
about such techniques being used by the same but then also trusted the company and were
keen to invest in it despite the allowance of the SPE formally in the company databases. All
the skilful and the chief representatives were allotted the task of looking after the disclosures
of the SPE and using the gathered funds to take over projects and thus maintain the financial
reports and the level of the company (Viney, 2010).
The chief management officials of the company gave top priority which also included the
stock options. These priorities were seemed to be similar to the ones offered to the investors.
These were done so that the employees would turn towards the company and help them to
hide their bad intentions and raise the company to a new height. The stock potion provided by
the company was carrying a policy of banning on resale which was in no match as from other
companies in the market (Vaitilingam, 2014). This can be seen as a fact that threats can arise
as the stock have been barred from transferring. Also, the management has no purpose by
issuing such stock options. This can be explained by the agency theory. As per the theory,
both the principal, as well as the agent is driven by self-interest. The fact and the base of the
theory are that all the officials work for their own interest and their own wealth only. The
company has two options while pertaining to the fact that either the officials can either work
for their own wealth and sake or they can somehow manage to get both the company raising
and can fulfil their accounts as well (Rezaee & Kedia, 2012). With respect to Enron, it can be
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seen that the officials of the management are the ones who are provided with all the stock
options. It was seen to be necessary to be necessary that the public investor’s wealth was
increased which can only be done if the financial position of the company was itself
undergoing a rise in every way.
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Assessment part B
(a) There are many different types of mechanism present which can be used to determine the
different elements of the financial accounts of an organization. A better understanding can be
made with the help of examining Wesfarmers group Limited which is having a similar
framework. Evaluation of the revenue can be made at the fair value which has been received
or is going to be received by the firm in future (Wesfarmer, 2017). Whereas the computation
of inventories is being made at the cost of the net realizable value of the Asset whichever is
lower so that determination can be made on the basis of weighted average cost.
The annual report of the organization also states that the thread has been made upon the fair
value and later the cost was amortized using the method of effective interest in which a small
value is subtracted as a part of allowance. It was also observed that the borrowings were
valued at fair value with lower transaction costs and these costs were later amortized
(Brigham & Ehrhardt, 2011). The difference between these two has been clearly reflected in
the consolidated statements of the organization.
Income statement
Another company in the United States has been considered in order to make a comparison of
the financial statements in relation to the principles of the GAAP. The name of the company
is Mackay Golf Club. All the financial accounts in this company follow a particular method
for computation of values. The recognition of revenue is being made on the basis of the
expenses that have been made by the organization in terms of percentage of the method of
completion which is further stated to be as the input method.
The cost of the inventory is determined by the market price of the cost price whichever is
lower in amount. The assessment of the cost takes place in two different steps which contain
raw materials on FIFO and work in progress and finished goods are determined with the help
of direct and indirect manufacturing cost. The other assets lakes long-term trade receivables
and any other type of receivables is presented in there estimated values. The fixed assets are
measured on the basis of cost detection and depreciation which is computed with the help of
the straight-line method in relation to the useful life of the asset that has been left. Vital
information has been provided by the annual report of the organization which can be used to
ascertain many different facts.
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(b)The above-prescribed companies in the report use two various routes for the making of the
financial statements. It’s difficult to comment with overall accuracy that which method is
superior to another. By the measurement recognition, one element ranks higher in the case of
IFRS and another element ranks higher in U.S GAAP. For this objective various samples are
taken into consideration that constructs the different method of recognition. If the calculation
of revenue is done by the IFRS than not only it will become easy to discover but it also
identifies the income statement instead of the U.S GAAP because the IFRS uses the most
common method of Revenue Recognition. Under the U.S GAAP differentiation of the
expenses are done by function while under IFRS differentiation of expenses are done in two
part that is the nature of expenses and function that makes it simpler in terms of
understanding of the expenses feature in the income statement and when it comes to the
presentation of financial statement, GAAP provides forbidding requirements as compared to
IFRS. Therefore it is useful in terms of IFRS presentation. On talking about remaining
examples, the evaluation, as well as identification under the IFRS is simpler in comparison to
GAAP thereby conforming to better decision making (Brigham & Daves, 2012). It becomes
simpler for the users to understand the financial statement and leads to better funding when
the financial statements are made effective.
(c)IFRS and U.S GAAP
The proper comparability will not be ensured if both the companies are considered for the
critical evaluation by considering the effectiveness of the method employed. One of the major
reason is that both the companies operate in different areas thereby, identify on a general
outlook will be considered perfect.
Comparison Technique of IFRS technique of U.S GAAP
Rules of income statement No Format is being stated. There are different formats
presented for the
preparation of accounts.
Recognising and
classifying the expenses
In accordance with the
rules of IFRS there are
various ways for the
recognition of expenses
Classification is made only
of the basis of the function.
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Utilization of historical
costs or Fair Value/
revalued costs
Both can be utilised for the
preparation of accounts
The use of Historical cost
is to be made while using
GAAP
Valuation of Inventory Only the use of the
weighted average method
and FIFO is allowed under
this framework.
LIFO can be used for
the valuation purposes.
Disclosure of
extraordinary items
The extraordinary items
can be disclosed by the
firm if this framework is
followed. The items can be
mentioned in the notes to
the financial statements.
If the principles of
GAAP are adopted, then
the items can be disclosed
in the notes to accounts or
in the income statement.
The above-mentioned examples are stated with the help of the financial statements of the
organization which is selective in nature. An analysis can also be made from the table of
comparison that can determine that there are different methods as well as techniques which
can be utilized under the international financial reporting system which can further make it
easier for the task of computation and understanding of the accounts in a much more
elaborate manner. Also, values of different facts and figures can be attained with the help of
measurement of financial statements if the information has been provided without
restrictions. Hence it can be stated that the IFRS framework of accounting is much better than
the US Generally Accepted Accounting Principles because it is much easier and simpler to
understand. The above discussion shut the clear light on the benefit that is provided by the
different frameworks which are GAAP and IFRS.
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References
Brigham, E., & Daves, P. (2012) Intermediate Financial Management. USA: Cengage
Learning.
Brigham, E.F. & Ehrhardt, M.C. (2011) Financial Management: Theory and Practice, USA:
Cengage Learning.
Gay, G. and Simnet, R. (2015) Auditing and Assurance Services. McGraw Hill
Geoffrey D. B, Joleen K, K. Kelli S. and David A. W. (2016) Attracting Applicants for In-
House and Outsourced Internal Audit Positions: Views from External Auditors. Accounting
Horizons. [online] 30(1), pp. 143-156. Available from https://doi.org/10.2308/acch-51309
[Accessed 9 April 2018]
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
Rezaee, Z & Kedia, B. L. (2012) Role of Corporate Governance Participants in Preventing
and Detecting Financial Statement Fraud. Journal of Forensic & Investigative Accounting.
[online]. 4(2), pp. 176-205. Available from: doi: 10.1016/j.sbspro.2014.06.041 [Accessed 9
April 2018]
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.
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.
Vaitilingam, R. (2014) The Financial Times Guide to Using the Financial Pages. London: FT
Prentice Hall
Viney, C. (2010) McGrath’s Financial Institutions, Instruments and Markets, Sydney
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Wesfarmer. (2017) Wesfarmer annual report and accounts 2017 [online]. Available from:
https://www.wesfarmers.com.au/docs/default-source/default-document-library/2017-annual-
report.pdf?sfvrsn=0 [Accessed 25 September 2018]
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