The Fall of Enron and Methods of Valuing Assets and Liabilities

Advanced Financial Accounting1
Advanced Financial Accounting
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Advanced Financial Accounting2
Introduction
International accounting and reporting standards are important for ensuring proper
and transparent financial reporting for listed companies. These regulations ensure that the
users of the company financial information are able to understand and interpret company
financial information (Accounting for Management, 2018). This not only helps the investors
in making decisions but also assist the management in identifying areas that need
improvement. This paper will focus on the case of “The Fall of Enron” and identify various
reasons that led to the fall. Moving forward the paper will shed light on the five elements of
financial statements and identify the various methods used in determining the value of assets
(a) The mark to market accounting approach is where a business is at liberty to
revalue all the assets and liabilities in accordance with the fair market value. The resulting
increase or decrease in value is then subtracted or added to the available profit distribution to
shareholders to determine the business profit or loss. This type of accounting helps a
company to record the value of an asset or liability based on current market value rather than
the cost of the asset. The alternative to this method is the historical cost method that records
the historical value of an asset and only uses the market value once an asset is sold(Amiram,
Bozanic and Rouen, 2014).
The mark to market accounting has been witnessed in the case of Enron in that it
signed a contract that would see it provide power to a power plant, which was still under
construction. From such a contract, Enron made declared the profits to be recorded. In such a
case, the estimation of market value was inconvenient as some contracts ran as long as twenty
years. For instance, a contract that was signed in July 2000 by Enron and Blockbuster Video
ran for 20 years. Despite the question of the viability of the idea Enron went ahead to declare
a profit of more than $110 million based on pilot projects(Palepu and Healy, 2013). This
measure avoided the reality and was more of a dream created by Jeff Skilling as there was no
market to mark. In a real sense, the company was losing a lot of many, which eventually
forced the company to resort in manipulating the cash flow and balance sheet. This resulted
in an abuse of fair value or mark-to-mark (Davis and Stone, 2014).
(b) Special purpose entities are organizations that are shaped by sponsors and
funded via unbiased fairness investor and debt financing. In the case of Enron special purpose
entities were used to fund the purchase of gas reserves and the investor who put money inside

Advanced Financial Accounting3
the special purpose entity could earn money through selling reserves (Plosser, 2018). The
special purpose entities assist to manipulate the risks related to the unique assets. Enron in
general used the special purpose entity to acquire ahead contracts with fuel producers and
supply the gasoline under long-time period contracts. The best part that Enron used a special
purpose entity when it intended to acquire an associate’s stake in one of its joint ventures.
The employer fashioned a special purpose entity and named it Chewco, which helped collect
the stake at the same time permitting Enron not to reveal any debt from financing the
purchase. At the same time, Enron did not want to consolidate Chewco (Ahmed, Islam and
Uddin, 2015).
This was a clear indication of how Enron was skirting the accounting rules. Such rule
includes the one that requires independent equity investor to not to own more than 3% of the
asset. By violating this rule, Enron understated it liabilities since it did not consolidate the
special purpose entities. Moreover, the third part owner ought to have 50% financial interest
in the special purpose entity. Enron minimal disclosure regarding special purpose entity,
changed into using the shareholders stocks as the guarantee for funds acquisition in the
special entities leaving the company exposed to downside risk (Basu and Waymire, 2017).
(c) According to Jeff Skilling, the aim of awarding the top management with
stocks was to align the interest of the shareholders with those of the management. The
management acts as an agent of the shareholders and in such a position, the management
ensures that the shareholders’ interests are considered in company decision (Healy and
Palepu, 2012). Another reason as to why the company was compensating the top
management with shares was to ensure that they are always protecting their interest, thereby
doing anything at the expense of the company financial health to ensure that the company
share price favours their interest. By so doing this also ensured that the shareholders were
happy as their shares were priced higher. According to the article, the stock compensation
program was designed to make sure that the managers were motivated in making decisions
that would pump up short-term stock performance rather than create medium and long-term
value. In addition, the stock compensation program was initiated to ensure create an
expectation of rapid growth, which is appealing to the shareholders, and at the same time
exaggerate the reported earnings to meet Wall Street’s expectations (Kim and Im, 2017).