HA3011 Advanced Financial Accounting | Merger of Houston Natural Gas

 

b) Concept of SPE and its application by the management of Enron for fulfilling financial objectives

 

Introduction

The establishment of Enron in 1985 was considered as a repercussion of merger of Houston Natural Gas and Internorth. Both the corporations were based on the operations of gas pipeline. The merger led to several changes pertaining to business environment of natural gas market in mid-1980s. There had been several consequences as a result of deregulation of prices which allowed separate arrangements among the pipeline operators and producers. This is mainly identified with increasing use of market transactions. In 1990s, there were more than 75% share coming from the gas sales pertaining to the spot prices. This was result of maintaining long-term contracts. In the same year, Enron stock increased to 311% which is only depicted with a slight increment as for the growth estimations of market index. Despite of this, the stock increased to 56% in 1999 and 87% in 2000. This is evident with fluctuation in the share price index (Pearce Dr 2015).

The current study will identify the activities of Enron along with the concerns for presentation of misleading financial reporting objectives. Moreover, it is also seen that there are several measurement methodologies pertaining to the financial statements of the company which is referred with Enron to critically examine the techniques incorporated within the company (Doe, Ndinguri and Phipps 2015).

Part A

a) Assessment of Mark to Market (MTM) accounting 

The understanding of MTM relates with the consideration of fair value measurement which is identified with several changes pertaining to assets and liabilities of the company. Such a concept is often evident with the implementation of accounting practices for noting down the PV of asset based on current market levels. For example, companies related to the financial services may decide to include several adjustments in the asset pricing which may be a resultant of non-repayment of loans. Henceforth, at the time of evaluating the financial statement, the financial entities mark such assets as bad. This results in lowering down the fair value associated with such assets. In a similar manner, the companies which are associated to offer discounts will also mark the current assets to a lower level for making the process of collecting Accounts Receivable swifter (Hatherly 2016).

The process of accounting for the natural gas entity was reliably done by Enron in the financial year 2000 and clearly shows its actual revenue and cost as a result of distributing the gas through pipelines. Despite of this progress, the company implemented MTM in the trading business. This required the company to make agreement as per PV of the future cash flows which are required for revenue recognition in addition to other expenses for adhering to the cost associated with the contract. The necessary challenges as per MTM approach was seen with estimation of market value of contracts. This resulted in identifying income as a portion of PV of the net future cash flows even after there was a serious concern for viability of these contracts along with the costs considerations (Christopher 2018).

b) Concept of SPE and its application by the management of Enron for fulfilling financial objectives

SPEs are defined as “bankruptcy-remote entity” and its main use is seen with the parent company for isolation and securitisation of their assets and showing the same as an off-balance sheet expense. SPE is identified as “bankruptcy remote entity” and “variable interest entities”. The consideration of such concept is based on the nature of the operations pertaining to financing and acquisition of specific assets by isolation of risk. Typically, companies are seen to form SPV/SPEs through limited partnerships and other entities. However, these may be also a result of designing defended ownership and projects suffering from operational or insolvency concerns (Omar 2016).

The present situation, Enron applied the technique of SPE to compensate for the risks associated with some of the assets. The company mainly relied on SPE for financing the acquisitions pertaining to gas reserve producers. Due to this, the investors in both Enron and SPE received a considerable amount of revenue from sales which was transferred to the results of the company. The aftermath of this incident resulted in Enron designing more than 200 controversial SPE in order to achieve its financial goals (Colon and Swagerman 2015). The incident of 1997 shows that the company made attempts to buy out the percentage of partners stake in one of the many JV deals. Despite of this, in the process of such an acquisition the company did not intended to show any debt pertaining to financing of debt in the sections of their balance sheet. Enron took the assistance of its SPE Chewco for falsely increasing the debt which was later on confirmed by the company after an investment of $ 383m in the JV. The transaction structure was made in such a manner that Enron was not required to consolidate its JV or SPE in its financial statement which led to acquisition of the company through partnership interest without recognition of the same in balance sheet and liability (Usikalu, Ogunleye and Effiong 2015).

c) Significance of stock options compensation scheme 

Agency theory is concerned with defining the connection of people and agents among business entities. The aforementioned theory is often used to resolute the concerns existing in the different components of principles and agents for achieving particular goals of the business (Wokukwu 2015).

It needs to be depicted that the dependency of Enron was considered in the stock options. Thus, a high usage of such stock options was associated to short term price evaluations. Such short-term price evaluation was mainly associated factors driving growth at Enron (Bhasin 2015). Moreover, implementation of agency theory was necessary to the business in terms of alignment of the goals which were to be achieved by the principles and agents. In the given scenario, agents of the business are seen with the management of Enron and principles are the shareholders. A number of occasions, Enron has suffered from acute accounting problem for short-term performance. Moreover, the overall experience of the company is also concerned with issues which are based on including stock compensation program for instigating the motives of executives and helping their short-term stock to perform in a better manner for generating long-term value to the firm (Bhasin 2016).

Part B

a) Case assessments pertaining to measurement methodologies from the annual report

The declaration of accounting procedures in 1998 was evident with the adherence of SFAS standards. This was a study concerned with recording the derivatives and hedging activities applied in balance sheet to either a liability or asset. It is also necessary for the consideration of fair value measurement to interpret whether hedges are able to qualify. Enron implemented SFAS 113 for recognising ATNL worth $ 5m. There are many more evaluations which are engaged with market risk evaluation based on continuously measuring the risk related to diverse products and markets. A considerable amount of evaluation pertaining to risk management is identified with investments done on a daily basis. The quantification of market risk is often implemented with considering the risks of diverse markets and credit risks (Okoye 2015). 

US organisation Broadcom Inc is referred with preparing the financial reports by implementing GAAP standards. This method is considered to be similar to the application of SFAS 113. The assumption for the current facts measured by Broadcom Inc was not considered with historical experience which resulted in poor decision-making. In addition to this, the revenue recognition estimates were traced from sales of the products based on delivery. Furthermore, the alliance of distributor credit also consists of price adjustments related to historical rate estimation and economic conditions associated with contractual terms. As per the present evaluation, company has claimed for difficult inferences pertaining to estimates and actual amounts. In addition to this, the reductions are recorded as per rebates and revenues for a particular financial period (Reiche et al. 2016).

b) Elements measured and beneficial decision making

The consideration of shareholders value is related to services of contract values. It is also discerned that Enron was involved in several nature of diagnostic measures which was effective in real-time monitoring of unusual changes. Furthermore, the application of “The Enron Intelligent Network (EIN)” was depicted with extensive reach in the US as it acted as a bridge between Asia and Europe. Moreover, the implementation of “SFAS No. 137” and “SFAS No. 138” has also proven its worth in substantial editor mining the liability and derivative instruments. The relevant allocation of the resources pertaining to the IBIT was considered as the main decision-making criteria for Enron (Nguyen 2016).

c) Recalling the techniques employed by company through a critical analysis

The trading operations at Enron is often based on implementation of complex business models which is having appropriate tenure for long-term contracts. Furthermore, the current accounting methodology is depicted with the use of PV framework which are evident with transactions consisting of future earnings. The application of important techniques by the company is evident with the MTM approach which is important with recognising the forecast of energy price and rate of interest which will take place in future. Additionally, Enron was depicted to extensively rely on financial transactions by using the SPEs. These transactions were often considered with shared ownership for cash flows which were often included outside the boundaries of lender and investor relationship. Henceforth, the regional accounting method was considered with arm’s-length transaction for the independent companies suffering from several problems associated with transactions. The accounting policy makers at Enron therefore the debated for using inappropriate tools of accounting for decades. On the contrary, the use of mechanical conventions for recording transactions often resulted in variations in actual accounting figures and fake portrayals. These conventions did not reveal the actual debt and liabilities incurred in FY 2000 (Micklethwait and Dimond 2017)

Conclusion

The study has shown how the accounting policies for conducting business in Enron was reliable during the initial years. As the business progressed Enron involved in adopting unscrupulous measures such as MTM. This was considered as turning point for war estimation of market values for long-term contracts. This also resulted in estimating the PV as per net future cash flows even though there was a serious concern of viability pertaining to the contracts along with costs. The use of SPE was evident by Enron with financing acquisition for gas reserves are slated to the producers. The company further used Chewco as its SPE for wrongly demonstrating its increased debt which was later on revealed. The investors were also unaware of Enron using its personal financial guarantees for carrying out stock out processes pertaining to hedging. Henceforth, there was no real protection associated to the shareholders of the company.

References

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Bhasin, M. L. 2016. The Untimely Demise of Satyam Computers Limited: A Revisit to the India’s Enron. International Journal of Management and Social Sciences Research, 5(5), 6-24.

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Colon, D., and Swagerman, D. 2015. Enhanced Relationship Participation Incentives for (Dutch) Multinational Organizations.

Doe, R., Ndinguri, E., and Phipps, S. T. 2015. EMOTIONAL INTELLIGENCE: THE LINK TO SUCCESS AND FAILURE OF LEADERSHIP. Academy of Educational Leadership Journal, 19(3).

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Micklethwait, A. and Dimond, P., 2017. Enron: Launch to Boom and Bust, 1985–2001. In Driven to the Brink (pp. 15-38). Palgrave Macmillan, London.

Nguyen, T. N. 2016. Insights from Science into Business and Economics: Roadmap to a Fiasco Prevention Theory.

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