Advanced Financial Accounting Assignment: Enron Case Study Analysis

This report provides a comprehensive analysis of the Enron case study, addressing key issues related to financial accounting and reporting. Part A defines and explains mark-to-market accounting, illustrating how Enron's management potentially misused this approach to inflate its performance. It also examines the role of special purpose entities (SPEs) in funding contracts and achieving financial reporting goals. Furthermore, it explores Enron's high compensation packages, including stock options, and analyzes them through the lens of agency theory. Part B describes and analyzes how the five elements of financial statements are measured by listed companies, comparing the measurement methods under IFRS and GAAP. The report compares the accounting treatments of revenue, expenses, and other financial statement components between Woolworths and Mackay Golf Club. It concludes by emphasizing the significance of IFRS in providing a clearer understanding of financial statements for both users and companies, as well as highlighting the benefits of adopting IFRS over US GAAP.

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Advanced Financial Accounting Assessment item 2 — Assignment

Enron
Assessment Part - A
It is observable from the given article that various factors resulted in the disintegration of
Enron:
1. Funding of special purpose entities are facilitated through debt financing or
independent investors. These entities can be used for various motives such as risk
sharing, securitization of loan, etc. However, in relation to Enron, the firm also
established various special entities to facilitate financing of forward contracts and to
obtain corporate reporting goals. In the year 1997, Enron intended to buy the partner
share in relation to a joint venture contract. However, it was decided that the debts
would not be disclosed in the financials (Healy & Palepu, 2003). Moreover, the SPE’s
controlling power was controlled by the firm’s executive who had raised a debt
guarantee. Further, such debt was used for procuring the relationship of the venture.
Besides, the structure was designed in a manner that nothing associated to the debt
financing transaction was reflected in the financials, thereby making the firm efficient
in the partnership acquisition in venture. The SPE (Chewco) resulted in the
contravention of many accounting standards and hence, the firm failed to consolidate
the accounts with that of Chewco. Nevertheless, liabilities and debt were not properly
stated in the Enron’s financials and earnings as well as equity was exaggerated.
Therefore, absence of proper awareness amongst the investors permitted Enron to use
the stocks to such special purpose entity and the entire transaction of debt was also
guaranteed (Healy & Palepu, 2003). Besides, the firm even engaged various officers
in the transaction and hence, was able to fund many contracts and attained the
corporate reporting goals on a whole.
2. The mark-to market measure can be stated to be the fair value accounting of liabilities
and assets that relies on the prices of market in the present scenario. In such
accounting, the present prices of market are regarded as the base of any transaction
and it is prone to extreme volatility as such prices are vulnerable to massive
fluctuations (Roberts, Weetman & Gordon, 2008). Nevertheless, such method is used
in relation to long-term contracts wherein the income and expenses are regarded by
depending on the present value of future flow of cash (Healy & Palepu, 2003).
Therefore, when the prices decrease or increase, it cannot be adjusted in the
company’s books. Moreover, the company determined its revenues as the fair value of
all the inflow of cash in the upcoming tenure. In addition, it also booked all its
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Enron
expenses. Therefore, the losses and gains became unrealized in the upcoming tenure
(Porter & Norton, 2014). Further, Enron involved itself into many long-term business
contracts that reflected the present value of all future flows of cash as income and
present value of expenses as the service cost respectively. Nonetheless, there were
various contracts that failed to examine the efficacy of such contract in the upcoming
years and the company became capable of reflecting a fraudulent picture of its
performance when it accounted for such long-term contracts and failed to safeguard
variations in the expenses and income that will be incurred or generated (Healy &
Palepu, 2003).
3. The superior authorities of the firm were provided high compensatory allowances that
accommodated stock options. This is because this could facilitate in attracting the
shareholders and management having the same level of interest. Besides, employees
were offered stock options so that decision-making could be altered and they can be
influenced to reflect a fraudulent portrait of the firm. Such stock option were offered
without any prohibition of additional resale and was also distinct when compared to
other companies (Healy & Palepu, 2003). When such stock options are offered
without any prohibition, an extreme complication can incur for the company. Further,
there were no specific requirements for the entire management in relation to the
purchase of stock options. Agency theory can be reflected through this discussion
because both agent and principal are driven by self-interest and in this case, the same
happened. Moreover, this theory relies on the assumption that an agent functions for
self-interest and to maximize personal wealth. Hence, to challenge such assumption, it
is required that the agent terminates the work for attaining self-interest motives or can
function with proper rules and regulations to maximize both personal and company’s
wealth on a whole (Healy & Palepu, 2003). However, in relation to Enron, its
management were the agent who were offered high compensation including stock
options. Besides, it was required that the public wealth must be enhanced but only the
financial performance was falsely exaggerated, thereby reflecting unethical measures
on the part of Enron.
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Enron
Part – B
The five components of financial statements are equity, income, liability, expense, and asset
respectively based on the conceptual framework under the IFRS standards. Besides, all
companies have different measurement levels like fair value accounting, historical cost
accounting, etc. In relation to this, the following must be accounted for:
1. Components of financial statements can be determined through various methods for
example in relation to Woolworths, calculation of revenue is undertaken at the fair
value of consideration receivable by it. Further, inventories are calculated based on
lower of net realizable value or cost and such cost is calculated based on weighted
average basis (Vaitilingam, 2014). Besides, from the annual report, receivables are
computed based on fair value and are determined at amortized cost through the usage
of effective interest method. In addition, PPE of the company are measured at cost by
subtracting the depreciation and such depreciation is arrived at by the usage of
straight-line basis (Parrino, Kidwell & Bates, 2012). Lastly, the borrowings of the
company are valued at their fair values with lower cost of transaction and are
thereafter, amortized on a whole. Overall, the distinction betwixt these two are
properly disclosed by the company in its annual report.
Statement of income
In order to facilitate a proper comparative analysis, a US company is being taken into
consideration that uses GAAP principles for preparing its financials. Hence, Mackay Golf
Club is being chosen for this discussion wherein the revenue and expense recognition is
undertaken based on percent of completion method and such method is further calculated
based on input method. Nevertheless, inventories are measured at lesser of cost or price of
markets. Such cost ascertainment is facilitated through two ways namely indirect and direct
manufacturing costs that gives finished goods or work in progress, and FIFO that gives raw
materials. Besides, the long-term receivables are calculated as per their estimated present
values (Petty et. al, 2012). In addition, PPE are being measured at cost minus their
depreciation and straight-line method is used to compute the depreciation value.
2. Both the projected companies have utilized two distinct measures for preparing their
financials. It cannot be concluded that any method is superior above one method as
both has their own efficacy and drawbacks. However, it is observable that IFRS
measurement is better in one segment while GAAP is better in one segment. For
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instance, if revenue measurement is undertaken through IFRS, it can be properly
determined and recognized in the financials because the revenue recognition method
is more effective than that of GAAP. In contrast to this, expense classification is
undertaken in GAAP while in the IFRS scenario, such classification can be done in
two ways namely function and nature that allows easier understanding of such
segment (Laux, 2014). Hence, recognition and measurements are effective in IFRS
that facilitates better decision-making on the part of users.
3. In relation to both companies, it can be stated that a comparative analysis betwixt
their methods cannot be feasible because they operate in different areas and hence, a
general idea can assist in arriving at a conclusion (Petty et. al, 2012)
For instance, in relation to recognition and classification of expenses, there are dual
alternatives in IFRS while there is only method in the case of US GAAP. Further, in case of
rules of income statement, there is no fixed format under IFRS whereas there must be a
specific format under US GAAP. Further, in relation to valuation of inventories, FIFO or
weighted average cost basis is used in IFRS whereas LIFO is used in case of US GAAP.
Further, in case of usage of fair value or historical costs, IFRS permits usage of both while
only historical basis is permitted under US GAAP.
The previously mentioned discussion is related to illustrations that are attained from the
financials statements. Moreover, it is clearly observable from the comparison that the
methods of IFRS are more consistent and simpler when compared to the US GAAP
principles. Therefore, IFRS measures can be easily understood by users in comparison to the
latter. In addition, the measurement and valuation of financials can be thoroughly undertaken
by companies in the prevalence of lesser limitations or restrictions (Deegan, 2011). Overall, it
can be stated that the standard of IFRS is more effective than the US GAAP standard because
proper understanding is possible only in the case of IFRS that makes it easier for the
management to recognize all potential elements or components of the financial statements. In
addition, it can be concluded that users and companies both can attain maximum benefits
from the adoption of IFRS measures in comparison to the US GAAP standard that is more
restricted in nature and can disallow in proper decision-making (Zeff, 2010).
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References
Deegan, C. M. (2011) In Financial accounting theory. North Ryde, N.S.W: 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
Laux, B. (2014) Discussion of The role of revenue recognition in performance reporting.
Accounting and Business Research. [online]. 44(4), 380-382. Available from:
http://www.ccsenet.org/journal/index.php/ijbm/article/viewFile/4235/3672 [Accessed 25
September 2018]
Parrino, R, Kidwell, D. & Bates, T. (2012) Fundamentals of corporate finance. Hoboken,
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Financial Management: Principles and Applications, 6th ed. Australia: Pearson Education
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Texas: Cengage Learning
Roberts, C., Weetman, P. & Gordon, P. (2008) International Corporate Reporting. Prentice
Hall, Harlow.
Vaitilingam, R. (2014) The Financial Times Guide to Using the Financial Pages. London: FT
Prentice Hall.
Woolworths limited. (2017) Woolworths limited Annual Report and accounts 2017. [online]
Available from: https://www.woolworthsgroup.com.au/page/investors/our-performance/
reports/Reports/Annual_Reports [Accessed 26 September 2018]
Zeff, S.A. (2010) Political Lobbying on Accounting Standards – US, UK and International
Experience. Prentice-Hall, Harlow.
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