Mark-to-market Accounting Theory

In 1985, Enron through its pioneers like Kenneth Lay and Jeffrey Skilling transformed itself into America`s seventh biggest companies dealing with natural gases.  It was formed as a result of the merger between two natural gas companies, and  Houston Natural Gas.  At it highest level the company was worth $70 billion though it sold its shares at $90 each. However, in 2007 it collapsion made headlines due to its real perpetration on accounting frauds that were carried out by the then managers and audit firm. Sherron Watkins is credited as the leading whistle-blower that created news which showed the loss of $60 billion which occurred in the accounting frauds that were adopted by the company.  The scandals were discovered some time back in 2001 and it has brought shame to the company that has its presence in Texas, Houston among other states.

Arthur Andersen, previously considered among the leading audit firms in the world soiled itself in the mishandling of Enron companies by making fortunes of $52 billion as well as $27 which served as consultation fee out of the dying company. Trying to conceal the evidence, the Chicago auditing company was forced out of the business when it was found having participated in the doctoring and shredding the documents touching the audit report on Enron. The perpetrators that included the then assistant treasurer was arrested and jailed for one-year imprisonment and another year that was supervised at home. The company misused some of the accounting theories that eventually resulted in the mischievious eventualities (Markham, 2015, np).

This a type accounting that gives the company authority to secure the cost of a liability or an asset according to the present market cost or the expected changes in the free market and not according to the real value of the assets or liabilities. The method is unique from the traditional measurement of an asset in such a manner that the market value of an asset is not recognised until the good is sold while the historical while value is known at the disposal. Mark to market was at the beginning very instrumental for the company but later become a tool for greed and exploitation not only in the corporate world and state regulations but also entered into the political arena in the United  States. The success of the accounting technique lies in its capability to ensure particular assets and liabilities are valued at fair value as determined by the consumers and in the absence of such price than the management`s approximation from the data concerning the assets to come up with the fair value.  

Instances of Misuse of MTM

The mark to market concept applies partially to assets and not all of them when used. It is convenient in cases when it involves an asset which often fluctuates so much that the traditional method of determining prices of assets cannot apply anymore. Enron company could conveniently use the mark to market because of the two crucial tenets of MTM in 1990`s, that consumers` quoted value should be used to determine the fair value of the asset and only the absence the same can mandate the firm to come up with their prices. Away from the natural gas, MTM did permit Enron to use on other assets, but the company violated the guidelines on the usage of the technique (Chernov, and Sornette, 2016,pp.190).

By the end of the year 2000, the Enron had represented 35% of its assets using its partisan determination of their worth out which was $ 22.8 billion out of the total $65 billion of all the assets (Allen and Carletti, 2015, pp.360 ). The decision made by the company to adopt the method was not only fictional but was also purported even though it was clear to the stakeholders that it did not apply to all the assets. The valuation abuses that gave out the wrong accounting practice was the main problem and not the approach itself. Experts had determined that MTM much better compared to the historical method in deciding prices when its tenets are adhered to accordingly as it provides reliable information on the asset (Heaton and McDonald, 2014, pp. 67).

The decision apply in other areas such as electricity, paper, and coal which were not appropriate at all to determine their gains and losses in the interests pension determination system for employees in California. Such an encounter does not change in it worth with time in the price because it is not a commodity and therefore does meet the requirements and do not fluctuate that favours the use of MTM accounting method (Sapra, 2016, pp 81). Furthermore, the commodities do not grant the public the opportunity to participate in the valuation process. The company worsened the situation when it applied MTM elsewhere like merchant investment which was not appropriate proved that the company was unethical and pervasive as a result of their success of the previous errors. There is no public participation in merchant investment entirely and does not involve fluctuations. Consequently, Generally Accepted Accounting Principles (GAAP) does not support the use of MTM in merchant and instead promoted the use of the technique in venture capital companies (Benston, 2017,pp.470).

Use of Special Purpose Entities to Achieve Financial Reporting Objectives

The company used the method to doctor the books of account such as a statement of performance and positions to depict their perceived profits and escalated their stock worth hence disseminating fantasy on the firm economic superiority in the market. They record activities and products before they had actually been initiated or bought and the information therein and in itself was unfaithfully represented hence deceiving monetary institutions and the general public. Regretfully, the deception made the retiring employees buy shares and invest in the company while the purposes like Jeff Skilling and Kenneth Lay were selling their shares in the recent years (Benston, and Hartgraves, 2014, pp.107).

The use of Special Purpose Entitiesto Achieve Financial Reporting Objectives

Individual purpose entities are established for discreet and distinct function, to follow particular economic or business goals, a small firm or beginning point under which the theory build. The concept was to hinder the scope in risk to both assets and liabilities  in particular purpose entity so that the possible investors and equity holders profits or loss will be attributed purely on what happened in respect with liabilities and assets located in SPE. These entities fall under three broad groups which include the synthetic lease, joint venture finally securitisation of assets or financing which is off-balance (Schwarz, 2013, pp.1309).

In this type of SPE, more than entities combine to do a transaction which is different from their specific bodies. The joint could be identified as a partnership, a trust or corporation. For instance regarding Enron, is when another company that is responsible for drilling oil in another country abroad (Healy and Palepu, 2013, pp.20).

This is a financing framework in which a firm structure the possession assets  in such a manner that the asset is managed by SPE yet leased to operating firm following an operating lease for accounting.the motivation beneath the use of synthetic lease is the return on tax and the impact on the firm`s monetary statements (Duke, and Hsieh, 2016, pp. 50)

The company benefited from the perspective of operating lease during the reporting of the financial position of the firm because the lessee only uses the asset to acquire profit for a period and return to the owner. The lessee term the transaction operating output and the payment as a rental fee at the time of the lease. On the other hand, the capital lease is not favoured by the lessee because the lessee is obligated to give an account for the business as though they were acquiring the asset (Duke, and Hsieh, 2016, pp. 50). The value the lessee should include in the balance sheet should reflect the cost of the asset at the moment as calculated at the time of inception of the lease as well as the depreciation and interest cost to show the monetary worth of the acquired commodity. The outcome is the reduction of net income. Enron structured the transactions to an operating lease to get the efficient and favourable treating during accounting reports and avoidance of tax.

Analysis of Five Elements of Financial Elements Using Examples from Company Annual Reports

The firm would transfer a set of assets that are being accounted for to an SPE with the aim of getting a future benefit financially and the entity, in turn, give out some security regarding cash.  The investors pay is dependent on the creditworthiness of the assets transferred to SPE,  the safety in the form of equity or debt that can be given back to the originator. The situation is a win-win for the firm which might have a pressing need for the cash, and sometimes it is a win-win for the all players involved (Schwarcz, S.L., 2015, pp.1539).

The senior employees in the company work under pressure, unlike the lower-ranking workers. The situation was dog eat dog scenario that discouraged the questioning of the mischief in a rank of the company and contributed to poor checks and balances as those who were bold enough to ask questions were demoted or sacked. The lack of ethics in the company led to frequent fraud mistakes that contributed to the collapse of the company (Bergstresser and Philippon, 2012, pp.520).

There are five known features in the financial world and can be categorised into two. Initially, the group that is associated with a financial position of the company includes assets, equity, and liabilities while the second group is related to the performance and are income and expenses. An asset is a resource owned by the firm due to the previous events and which have future anticipated monetary gains while a liability is the current responsibility of the firm that accrues due to the last and its settlement has future expected economic benefit. Equity, on the other hand, is the future interest that an asset attracts after the subtraction of its liabilities in the firm.

Economically, income is defined as the increase from economic gains at an accounting time in form flows in cash that comes in. Alternatively, it can be the increase in asset and reduction of liabilities that causes a positive movement in equity apart from the contribution of participants. The decrease in the economic gains at the accounting time in outflows or assets getting depleted or the decrease in investment as a result of high liabilities.  

There various methods of determining the worth of a company based on the elements present in the firm. For example, a company like Samsung can use historical cost to determine the price of an asset (phone) by recording the initial amount of acquiring the phone with the consideration of fair value (Rezaee, 2012, np). The method aids in establishing the profit and loss margin. Current cost is used to determine the worth of an asset or liability when acquired at the moment.

Majority of companies use realisable assets to ascertain the financial position of their firm by determining the amount of cash or value equivalents which could presently be achieved by selling an asset in an orderly manner. Liabilities are determined from their settlement costs. In an attempt to present information in the most relevant and by faithful representation companies such as Telstra and Rio Tinto in Australia use realisable assets in depicting the level of investments, cash, account receivables, land, and equipment (Henderson, and Howieson, 2015, np). The expenses and income are measured regarding the profit and loss that the companies made during the fiscal year due to the transactions of the company. International Financial Reporting Standards guides on the manner in which a company should present information on their financial position and the progress of its performance in the annual reports (Nielsen, and Schaper, 2016,pp20).

To finalise, Enron company made unexpected errors in the accounting of the firm`s resources ranging from the auditing to the manner of management as shown by the top officials. The misuse of MTM to exaggerate the financial prowess of Enron natural gas company explains the fall of Houston based company that had gained global recognised in the years back. The failure brought suspicion and lots of discussion about the use of both MTM to determine the fair prices and use of SPEs in accounting. However, experts have asserts that the methods had nothing to with the downfall of the company, but the misuse by the management was responsible. Therefore, the recommended practices and techniques should be adopted to measure the worth of a company as proposed by recognised bodies such as IFRS and GAAP.

References

Allen, F. and Carletti, E., 2015. Mark-to-market accounting and liquidity pricing. Journal of accounting and economics, 45(2-3), pp.358-378.

Benston, G.J., 2017. Fair-value accounting: A cautionary tale from Enron. Journal of Accounting and Public Policy, 25(4), pp.465-484.

Benston, G.J. and Hartgraves, A.L., 2014. Enron: what happened and what we can learn from it. Journal of Accounting and Public Policy, 21(2), pp.105-127.

Bergstresser, D. and Philippon, T., 2012. CEO incentives and earnings management. Journal of financial economics, 80(3), pp.511-529.

Chernov, D. and Sornette, D., 2016. Dynamics of information flow before significant crises: lessons from the collapse of Enron, the subprime mortgage crisis and other high impact disasters in the industrial sector. In Disaster Forensics (pp. 175-221). Springer, Cham.

Duke, J.C., and Hsieh, S.J., 2016. Capturing the benefits of operating and synthetic leases. Journal of Corporate Accounting & Finance, 18(1), pp.45-52.

Heaton, J.C., Lucas, D. and McDonald, R.L., 2014. Is mark-to-market accounting destabilising? Analysis and implications for policy. Journal of Monetary Economics, 57(1), pp.64-75.

Healy, P.M. and Palepu, K.G., 2013. The fall of Enron. Journal of economic perspectives, 17(2), pp.3-26.

Henderson, S., Peirson, G., Herbohn, K. and Howieson, B., 2015. Issues in financial accounting. Pearson Higher Education AU.

Markham, J.W., 2015. Financial history of the United States: From Enron-era scandals to the subprime crisis (2004-2006); From the subprime crisis to the Great Recession (2006-2009). Routledge.

Nielsen, C., Roslender, R. and Schaper, S., 2016. March. Continuities in the use of the intellectual capital statement approach: Elements of an institutional theory analysis. In Accounting Forum (Vol. 40, No. 1, pp. 16-28). Elsevier.

Rezaee, Z., 2012. Financial statement fraud: prevention and detection. John Wiley & Sons.

Sapra, H., 2016. Do accounting measurement regimes matter? A discussion of mark-to-market accounting and liquidity pricing. Journal of Accounting and Economics, 45(2-3), pp.379-387.

Schwarz, S.L., 2013. Enron and the use and abuse of individual purpose entities in corporate structures. U. Cin. L. Rev., 70, p.1309.

Schwarcz, S.L., 2015. Securitization Post-Enron. Cardozo L. Rev., 25, p.1539.