The Enron Case Study: Analysis Of Financial Elements In Listed Companies (essay).

In addition, to other relevant articles, for assessment task part A, please 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.

1. 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?
2. b) What are special purpose entities and how Enron’s management used them to fund contracts or achieve financial reporting objectives?
3. 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.

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:

Required:

1. a) Quote examples of measurement methodologies from company’s annual reports and clearly reference your sources.
2. 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.
3. 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.

Overview of Enron's Collapse and Key Factors

Part A

As per the points and the key factors listed by Pual M.Healy and Krishna G.Palepu with respect to the collapse of Enron, these are some of the explanations:  

The assets and the liabilities of the company that are categorized as FV can be accounted for by the company to gather the market-to-market accounting screen that is common in nature to the present situation. In the above mentioned technique, it can be seen that the present prices are taken as the base ones and the expectation are kept high and totally off-guard as the prices are the ones that are exposed to various types of fluctuations. This is the techniques which are taken up by the company when the talk is about long-term contracts and it is seen that all the costs assets and the expenditure are kept to be structured on the PV of the future cash flows (Healy & Palepu, 2003). It leads to the fact that the increase or decrease in the price in relation to the market is not noted down in the records. The income, as well as the profits of the company, were totally controversial as to they have expected which lead the financial report to be made with manipulated data. It can be understood from the study that the fluctuation in the prices can either make the expenses high or can keep them competitively low as compared to the previous records.

The future cash flows of the company and all the expenses with respect to FV were already occupied which led the company to decide its revenue early on. As time passed on, it was seen that this process was a disadvantage as it led the company to ignore or stun the profits or the losses that it had been suffering. There were many contracts entered by the Enron company in which all the future incoming profits and the expenses involved were in the form of PV as cash flows of the future transactions related to the services of the contract. It was seen that a test initiation proved many such contracts to be lethal and void for the company after which the management of the company decided to make alterations and manipulations in the financial reports which can support and maintain the financial and service reputation of the company in the upcoming future terms.        

It is the sponsor who is responsible for the development of the special purpose entities but the point to be noted is that all the funding takes place through debt financing and equity investors. The money gathered from the special purpose entities is used for the facts like loan sanctioning, risk sharing, financial support in case of threats and also asset transfer. Enron can be marked as a company who has gathered a large wealth through this special purpose entities technique and has used it to take over projects as the demand of the financial report (Geoffrey, Joleen, Kelli & David, 2016). All the manipulation are scanned and the explanation is put up in the following article. It was in the year 1997 that Enron took up a plan to buy the partner share as it has been entering a joint venture process. The company was working on the terms and did not notice that the transaction results and the losses were exposed to the public as well without and initiative from the company or from the JV in the financial statements (Gay &Simnet, 2015). A structure was formally announced and made by the company which would successfully eliminate all these disclosures an made the company seem that it was still well to engage in a joint venture. It was the formal following of the Chewco SPE that led the company to break many accounting standards and rules and so the company was precise enough, not to include this in the accounting and the financial reports. In this fashion, debt, as well as liabilities was understated in the balance sheet of Enron and on the contrary, earnings, as well a equity was overstated (Ross et. al, 2014).

Analysis of the Five Financial Elements

All the disclosures by the company were done in association with the SPE. The public knew about such techniques being used by the same but then also trusted the company and were keen to invest in it despite the allowance of the SPE formally in the company databases. All the skilful and the chief representatives were allotted the task of looking after the disclosures of the SPE and using the gathered funds to take over projects and thus maintain the financial reports and the level of the company (Viney, 2010).  

The chief management officials of the company gave top priority which also included the stock options. These priorities were seemed to be similar to the ones offered to the investors. These were done so that the employees would turn towards the company and help them to hide their bad intentions and raise the company to a new height. The stock potion provided by the company was carrying a policy of banning on resale which was in no match as from other companies in the market (Vaitilingam, 2014). This can be seen as a fact that threats can arise as the stock have been barred from transferring. Also, the management has no purpose by issuing such stock options. This can be explained by the agency theory. As per the theory, both the principal, as well as the agent is driven by self-interest. The fact and the base of the theory are that all the officials work for their own interest and their own wealth only. The company has two options while pertaining to the fact that either the officials can either work for their own wealth and sake or they can somehow manage to get both the company raising and can fulfil their accounts as well (Rezaee & Kedia, 2012). With respect to Enron, it can be seen that the officials of the management are the ones who are provided with all the stock options. It was seen to be necessary to be necessary that the public investor’s wealth was increased which can only be done if the financial position of the company was itself undergoing a rise in every way.          

Assessment part B

(a) There are many different types of mechanism present which can be used to determine the different elements of the financial accounts of an organization. A better understanding can be made with the help of examining Wesfarmers group Limited which is having a similar framework. Evaluation of the revenue can be made at the fair value which has been received or is going to be received by the firm in future (Wesfarmer, 2017). Whereas the computation of inventories is being made at the cost of the net realizable value of the Asset whichever is lower so that determination can be made on the basis of weighted average cost.

Comparison of Wesfarmers Group Limited and the Mackay Gold Club

The annual report of the organization also states that the thread has been made upon the fair value and later the cost was amortized using the method of effective interest in which a small value is subtracted as a part of allowance. It was also observed that the borrowings were valued at fair value with lower transaction costs and these costs were later amortized (Brigham & Ehrhardt, 2011). The difference between these two has been clearly reflected in the consolidated statements of the organization.

Income statement

Another company in the United States has been considered in order to make a comparison of the financial statements in relation to the principles of the GAAP. The name of the company is Mackay Golf Club. All the financial accounts in this company follow a particular method for computation of values. The recognition of revenue is being made on the basis of the expenses that have been made by the organization in terms of percentage of the method of completion which is further stated to be as the input method.

The cost of the inventory is determined by the market price of the cost price whichever is lower in amount. The assessment of the cost takes place in two different steps which contain raw materials on FIFO and work in progress and finished goods are determined with the help of direct and indirect manufacturing cost. The other assets lakes long-term trade receivables and any other type of receivables is presented in there estimated values. The fixed assets are measured on the basis of cost detection and depreciation which is computed with the help of the straight-line method in relation to the useful life of the asset that has been left. Vital information has been provided by the annual report of the organization which can be used to ascertain many different facts.

(b)The above-prescribed companies in the report use two various routes for the making of the financial statements. It’s difficult to comment with overall accuracy that which method is superior to another. By the measurement recognition, one element ranks higher in the case of IFRS and another element ranks higher in U.S GAAP. For this objective various samples are taken into consideration that constructs the different method of recognition. If the calculation of revenue is done by the IFRS than not only it will become easy to discover but it also identifies the income statement instead of the U.S GAAP because the IFRS uses the most common method of Revenue Recognition. Under the U.S GAAP differentiation of the expenses are done by function while under IFRS differentiation of expenses are done in two part that is the nature of expenses and function that makes it simpler in terms of understanding of the expenses feature in the income statement and when it comes to the presentation of financial statement, GAAP provides forbidding requirements as compared to IFRS. Therefore it is useful in terms of IFRS presentation. On talking about remaining examples, the evaluation, as well as identification under the IFRS is simpler in comparison to GAAP thereby conforming to better decision making (Brigham & Daves, 2012). It becomes simpler for the users to understand the financial statement and leads to better funding when the financial statements are made effective.

IFRS and US GAAP

(c)IFRS and U.S GAAP

The proper comparability will not be ensured if both the companies are considered for the critical evaluation by considering the effectiveness of the method employed. One of the major reason is that both the companies operate in different areas thereby, identify on a general outlook will be considered perfect.

The above-mentioned examples are stated with the help of the financial statements of the organization which is selective in nature. An analysis can also be made from the table of comparison that can determine that there are different methods as well as techniques which can be utilized under the international financial reporting system which can further make it easier for the task of computation and understanding of the accounts in a much more elaborate manner. Also, values of different facts and figures can be attained with the help of measurement of financial statements if the information has been provided without restrictions. Hence it can be stated that the IFRS framework of accounting is much better than the US Generally Accepted Accounting Principles because it is much easier and simpler to understand. The above discussion shut the clear light on the benefit that is provided by the different frameworks which are GAAP and IFRS.

References

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

Brigham, E.F. & Ehrhardt, M.C. (2011) Financial Management: Theory and Practice, USA: Cengage Learning.

Gay, G. and Simnet, R. (2015)  Auditing and Assurance Services. McGraw Hill

Geoffrey D. B, Joleen K, K. Kelli S. and David A. W. (2016) Attracting Applicants for In-House and Outsourced Internal Audit Positions: Views from External Auditors. Accounting Horizons. [online] 30(1), pp. 143-156. Available from https://doi.org/10.2308/acch-51309  [Accessed 9 April 2018]

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

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 9 April 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.

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.

Vaitilingam, R. (2014) The Financial Times Guide to Using the Financial Pages. London: FT Prentice Hall

Viney, C. (2010)  McGrath’s Financial Institutions, Instruments and Markets, Sydney

Wesfarmer. (2017) Wesfarmer annual report and accounts 2017 [online]. Available from: https://www.wesfarmers.com.au/docs/default-source/default-document-library/2017-annual-report.pdf?sfvrsn=0 [Accessed 25 September 2018]