Page 27 - DCOM101_FINANCIAL_ACCOUNTING_I

Unit 3: Principles of Accounting

and problems may not occur, they are termed as Generally Accepted Accounting Principles Notes
(GAAP).

!
Caution There are various bodies, national and international, who from time to time
frame guidelines, define terms, formulate principles and standards to be used in the fi eld

of Accounting and finance, The industry, firms, business groups have to follow these, both

as legal provisions and as convenience.

Case Study Enron & Accounting Issues: Yawning GAAP
he Enron Corp imbroglio holds many lessons for Indian accounting professionals
most of whom are working in a country which fancies itself as a software sweatshop
Tand, therefore, have to deal frequently with tricky revenue recognition issues.
In fact, revenue recognition is so tricky that the Financial Accounting Standards Board
(FASB), which sets the global benchmark for private sector accounting, has tagged it
“the largest single category of fraudulent financial reporting and fi nancial statement

restatements”.
But what do revenue recognition issues have to do with Enron? The answer is... just about
everything.

Consider these facts: Between 1996 and 2000, the energy trading outfit reported an increase
in its sales from $13.3 billion to $100.8 billion. In one single accounting year, 1999-2000, it
doubled its reported sales. And said that it was set to double its sales again the following
year.
How was Enron able to claim this phenomenal increase in sales revenue? Very simple — it
exploited a loophole in accounting rules that allowed it to book revenue from energy-
derivative contracts at their gross — as against net — value.
The basic incongruity of this practice becomes apparent if you examine the way a Wall
Street fi rm — which is also in trading, although not energy trading — books its revenue.
Let’s say Wall Street Company X handles, on behalf of a client, the sale of 10,000 shares
worth $500,000 of Company Y. It would record as revenue its commission on the sale or
the spread between the bid price and the ask price — a few hundred dollars. But Enron (or
any other energy trader in the US, for that matter) handling an energy trade would book
the full $500,000.
According to Enron’s 2000 annual report, it was in the business of building “wholesale
businesses through the creation of networks involving selective asset ownership, contractual
access to third-party assets and market-making activities”. It seems to have used the term
“wholesale businesses’’ to mean trading, plain and simple. From which it made more than
90 per cent of its revenue....
To make matters worse, Enron bought and sold the same goods over and over again.
And all this trading — a good amount of which was being carried on with purportedly
independent partnerships which do not look very independent on examination — was
being booked as revenue at full value.

It got away with this fancy book-keeping because the FASB just could not make up its
mind about how energy contracts should be accounted for and, at some point or the other,
decided that each company had a “free option’’ to do what it wanted. Contd....

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