Fair Value Accounting and Enron Scandal: A Case Study

Running head: ADVANCE FINANCIAL ACCOUNTING
Advance Financial Accounting
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Contents
Introduction:....................................................................................................................................2
Part A:..............................................................................................................................................2
Part B:..............................................................................................................................................6
Conclusion:......................................................................................................................................8
References:......................................................................................................................................9

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Introduction:
Fair Value Accounting (FVA) also sometimes referred to as Mark-to-market accounting
used different methodology and approach to measure financial assets and liabilities as opposed to
age old norms used in traditional historical accounting basis. Mark-to-market accounting takes a
different view while valuing assets and liabilities in financial reports of an organization.
Ensuring proper disclosure in financial reports of one’s assets and liabilities was the objective
behind the concept of Mark-to-market accounting. However, subsequent to number of
accounting scandals, most notably Enron’s accounting scandal and subsequent collapse sceptics
are up in arm to term FVA as a disaster. A brief discussion by considering the facts of Enron
shall enable the readers to make their own minds as to usefulness or lack of it of Mark-to-market
accounting.
Part A:
(a) Definition of Mark-to-market accounting:
Mark-to-market accounting takes a holistic approach to measure the value of assets and liabilities
of an organization. It can be defined as the alternative accounting approach where assets and
liabilities are valued on the basis their current market price or consideration as the case may be.
Also known as Fair Value Accounting the concept considers the fair value of assets and
liabilities to value and disclose these in the books of accounts and financial reports ( Di Maggio
& Pagano, 2017). Unlike historical cost approach to accounting where the considerations paid to
acquire an asset even if that was a long time ago, FVA considers the expected market price of
such assets to value these in the books of accounts (Marra, 2016). Historical cost does not
consider the effects of time value of money, the changes in market conditions, inflation,

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environmental and technological changes that may depreciate the value of an asset and other
factors. It values assets and liabilities at the amount paid to acquire these or consideration
payable to discharge obligations. Mark-to-market accounting on the other hands takes the effects
of market condition, technological evolution, importance, usefulness of an asset, inflation and
other necessary conditions to determine the current or expected market price of an assets and
liabilities to measure value and disclose such value in the financial reports (Chen, Shroff &
Zhang, 2017).
Enron’s management used the Mark-to-market accounting approach to value long term
contracts of Enron’s Gas division in the books of accounts of the contract. The complex long
term contracts and expected revenues were valued using FVA concept. High amount of profits
were recorded in the books of accounts by using complex accounting structure of the company to
show high amount of profits in the books of accounts. Despite number of uncertainties, the top
executives of the company on the advice of Skilling valued long term contracts and recognize
significant amount of revenue from such contract by using Mark-to-market accounting. As a
results the book profits of the company soared. With every passing year the management started
manipulation of accounts by showing fictitious long term contracts and recognizing revenue
from such contracts (Magnan, Menini & Parbonetti, 2015). Valuing long term contracts and
recognizing revenue from such contracts despite huge uncertainties regarding the actual
recoverability of such revenue increased the expectations of the shareholders to sky rocket the
share prices. However, the company started struggling to match the cash flows of the company
with its profits to eventually collapse after the news about the huge accounting scandal surfaced
(Laux & Leuz, 2010).
(b)