Page 30 - DMGT104_FINANCIAL_ACCOUNTING

Financial Accounting

Notes 2.1 Generally Accepted Accounting Principles

Accounting principles are those rules of actions on the basis of which the transactions of the
business are recorded, classified and summarized. If the financial statements are not prepared
on the basis of these principles, there will be low acceptability and difficulty to understand
them, and the comparison will be impossible and unreliable. Therefore, the accountants
recommend that there should be common concepts and conventions of accounting so that the
above difficulties and problems may not occur. These common concepts and conventions of
accounting have become the basic accounting concepts and conventions as these are commonly
accepted by the body of the professional accountants all over the world to prepare the financial
statements, Therefore, they are termed as Generally Accepted Accounting Principles (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 field
of Accounting and finance, The industry, firms, business groups have to follow these, both
as legal provisions and as convenience.



Caselet 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 financial 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 firm—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,
Contd...

24 LOVELY PROFESSIONAL UNIVERSITY