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The Misuse of Accounting Policies and Financial Manipulation

1. Read the following article written by Paul M. Healy and Krishna G. Palepu, the fall of Enron case study by Paul M. Healy and Krishna G and write a report that addresses the following issues: The Article is on Bb.

a) Define and explain mark-to-market accounting approach and give examples where Enron’s management / accountants perhaps misused this approach to portray a rosy picture of its performance / profitability?

b) What are special purpose entities and how Enron’s management used them to fund contracts or achieve financial reporting objectives?

c) Enron’s top management enjoyed high compensation/ remuneration including stock options, what was the main purpose of the stock options compensation scheme provided to top management. Your explanation, discussion and argument should principally be based on the assumption of the agency theory.

2. Describe and analyse the different ways that the five elements of financial elements, as defined in the International FRS conceptual framework, can be measured by listed companies. You are not constrained in this analysis to any one country or set of national accounting standards. Of course Australia is under International Financial Reporting Standards but your research could identify examples of companies operating under U.S. GAAP or some other regulations/guidelines that illustrate what you want to discuss. In completing this assignment, you are required to:

a) Quote examples of measurement methodologies from company’s annual reports and clearly reference your sources.

b) In explaining how a company has measured an element, explain how the measurement method provided decision-useful information and what you understand decision-useful information to be.

c) Provide a critical analysis of the techniques the selected company has used and why a technique deployed may be more useful or practical than another method.

As an example, two (2) techniques have been appended that show how bond liabilities and interest expense are reported and measured in Australia and the USA. The first technique is called The Effective Interest Method and the other is called the Straight Line Method. The Effective Interest Method is permitted under both IFRS and US GAAP. The Straight Line method is only permitted under US GAAP. If you were writing on example on bond liabilities you could get into a discussion on these different techniques and whether one provides more decision useful information than the other. Or you may conclude that neither technique is very satisfactory and the bond liability should be reported in the balance sheet at market value because if the company wanted to redeem the debt by buying back the securities in the open market it would have to pay fair value (and that would be based on a current trading price for the bond).

The Misuse of Accounting Policies and Financial Manipulation

The downfall of Enron can be linked to the wrong usage of the accounting policy by the management. Further, SPE was one of the major factors that created immense threats to the company.  The false charges and statements made in the financial statements led to the massive fall. The rosy picture of Enron claimed a different position while it was altogether different for the company. The rosy picture influenced the investors but to their dismay, it came out to be forge and eroded all the wealth of the investors.

The case study of Enron has been described in the case of Pual M.Healy and Krishna G.Palepu that shed light on the loopholes and the mechanism that were undertaken.

Going by the competition prevailing in the current era, it can be commented that the company is providing assets, as well as liabilities under the Fair value so that the concept of mark-to-market is followed. As per the theory, it can be stated that the base is one that prevails in the normal course of action while the expected price are considered so that the changes in the prices are considered (Berensen, Richard & Oppel, 2001). The present value of the future cash flow is a vital arena where the cost, expenses, and assets can be framed if the company’s vision pertains to the long term.  When the price prevailing in the market goes for alteration, the database tends to be acquainted with prices.  The expected values to be projected in the annual report were not in link to the real value and this coins the fact that the company was in  full scope to alter the financial reports (Rezaee & Kedia, 2015). From the data that is gathered, it became clear that the alterations in the prices will establish a new peak or can lead it to severe crash in comparison to the past data.

The database was decorated with the clash flow amount that is expected and the expenses were there on the FV list that was the major fact that the company was in a position to transform their income in a short span of time.  However, the process turned out to be severe because the company ignored many aspects of the profit and loss. There were numerous contract under which Enron entered but failed to keep an eye on the long term perspective. Further, the percentage of profit and losses in the contract was treated under present value of cash flow and was pre decided by the company (Hoffelder, 2012). The devastating procedure followed by the company was seen in the contracts that were fatal and this is the main reason why the company decided to go for fabrication in the financial reports so that the status of the company can remain undisturbed (Ross et. al, 2014).

The Case Study of Enron and Financial Statement Presentation

In the wake of the Joint venture, Enron decided to buy the partner shares. The company decided to manage the duties without considering the fact that the treaty will cause a reveal of the profit and loss statement of the company in the public. It was decided by Enron to launch a completely new structure because all the doubts need to be clarified and the company needs to show that the accounts were free from all obstacles.  When the company adopted Chewco SPE in the company books, it led to the exposure of the company to various accounting standards and the company in a diligent manner did not expose all the elements in the financial statements (Brigham & Daves, 2012). Hence, the debt and liabilities were not exposed and understated in the Enron balance sheet, on the contrary, the equity and earnings were exaggerated.  The SPE acted as a base for all statements of the company. The public was able to have a slight indication but going by the credentials of the company they believed in it and still invested. The main aim of the company was to conceal all the working of the SPE from the public and maintain the status as was present in the market. This was done by tampering the financial statements as a whole.

The company’s management decided to provide stock option feature to the employee. The terms were similar to the ones that were provided to the investors. The main aim of going for stock options resides in the fact that the company wanted to conceal the facts from the public because if leaked it would lead to the severe crash of the company.  A difference was observed when it comes to the stock options because the stock options were strange in nature. the major reason for calling it a strange resides in the fact that the stock could not be resold and this lead to immense questions on the working of the company.  The action of the company and stock options matter can be best described with the help of agency theory. The theory resides on the terms of ownership interest. It is well understood that the employee works for their own benefit and the company (Niemi & Sundgren, 2012). Hence, two major point comes in this discussion is that the employee works for their own benefit and a second point arise is that the employee works for the benefit of the company as a whole.

Comparing IFRS and GAAP for Financial Statement Presentation

International Financial Reporting Standards have provided five different components of conceptual framework for presentation of financial information in the annual reports. These components are assets, income, equity, liabilities, and expenses. Such components can be ascertained by companies in the following ways:

In the situation of Wesfarmers Ltd that is an Australian company listed on the ASX, it is observable that the company has calculated its revenues based on the amount of consideration that is received or is yet to be received. In addition, the inventories calculation has been facilitated through lower of net realizable amount or the actual cost. Moreover, this cost is determined through the implementation of weighted average method. Furthermore, the company’s trade and other receivables are measured or recorded at their fair value and are amortized later using effective interest. Further, the company’s fixed assets like machineries and PPE are being valued at their respective costs less depreciation that is also ascertained through the implementation of straight-line method (Needles & powers, 2013). Lastly, in relation to the company’s borrowings, the same is valued at their respective fair values with lesser transactions and thereafter, amortization process is being facilitated.

In order to undertake a proper comparative analysis, it is beneficial to choose one company from the US so that the principles of GAAP can be compared with that of the IFRS standards. Therefore, Mackay Golf Club has been selected for this study so that a comparison can be made betwixt both these standards (Brigham & Daves, 2012). It is observable from the company’s annual report that recognition of revenue is being performed on the basis of percentage of completion manner and the same is computed through the usage of input method. Furthermore, for recognition of expenses as well, this same method is being chosen. Moreover, the fixed assets are recorded based on straight-line basis over the asset’s useful lives.

In relation to the companies mentioned in the previous segments, there are two primary methods for the presentation of financial statements of companies. However, which method is far above than the other cannot be determined through a comparative analysis. Further, both the methods have their own efficacies and inefficacies and this is the reason why choosing one single method only through a comparative analysis is problematic in nature. In relation to this, various examples are accounted for so that the recognition methods can be assessed altogether. Hence, if the revenue measurement is chosen based on the IFRS requirements, it must be noted that the same can be easier and simpler to understand in relation to determination of income and when compared to the US GAAP requirements. Moreover, IFRS has been very convenient in this segment as it utilizes the most effective method of revenue recognition (Leo, 2011). In contrast to this, there are major requirements while complying with the US GAAP principles and that makes it complicated and harder to understand for users in their decision-making process. The following table can be referred for a better comparison between these two frameworks.

>

Details

IFRS framework

US GAAP

Classification and recognition of expenses

There are dual requirements in IFRS frameworks.

This framework follows only one basis that is through classification by function.

Rules of income statement

IFRS does not specify any rules in relation to income statement.

There are several formats or single format in US GAAP framework.

Inventories valuation

Only FIFO and weighted average cost method is being followed in IFRS.

Only LIFO system is being followed in the case of US GAAP.

The aforesaid table clearly sheds light on the fact that IFRS requirements are easier to understand in comparison to the US GAAP framework. Even though both the methods of preparing financials are different in nature, a comparative analysis cannot help in offering a conclusion as to which method is superior above the other.

Conclusion

Based on the aforesaid discussion, it can be said that IFRS framework is more efficient than the US GAAP framework because users can make better decisions from the same. This is the reason why IFRS requirement is more suitable for companies in the current scenario. Nevertheless, the preparation and presentation of financial statements from the perspective of IFRS is easier to understand on the part of users in their decision-making process.

References

Berensen, A.,Richard, A., and Oppel, JR. (2001) Once-Mighty Enron Strains Under Scrutiny. Available from https://www.nytimes.com/2001/10/28/business/once-mighty-enron-strains-under-scrutiny.html [Accessed 26 September 2018]

Brigham, E., & Daves, P. (2012) Intermediate Financial Management.  USA: Cengage Learning

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 [Accessed 26 September 2018]

Hoffelder, K. (2012)  New Audit Standard Encourages More Talking. Harvard Press.

Leo, K. J. (2011). Company Accounting. Boston:McGraw Hill

Needles, B.E. &  Powers, M. (2013) Principles of Financial Accounting. Financial Accounting Series: Cengage Learning.

Niemi, L. and Sundgren, S. (2012) Are modified audit opinions related to the availability of credit? Evidence from Finnish SMEs. European Accounting Review. [online]. 21(4), p. 767-796. Available from: https://doi.org/10.1080/09638180.2012.671465 [Accessed 21 April 2018]

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 26 September 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.

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[Accessed 23 July 2024].

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My Assignment Help. The Enron Essay: A Study On Accounting Policy Misuse And Financial Manipulation. [Internet]. My Assignment Help. 2021 [cited 23 July 2024]. Available from: https://myassignmenthelp.com/free-samples/ha3011-advanced-financial-accounting/a-case-study-on-the-fall-of-enron.html.

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