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Unit 2: Principles of Accounting

contractual access to third-party assets and market-making activities”. It seems to have Notes
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 bookkeeping 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.
However, looking on the positive side of things, all this number-pumping without any
basis in good accounting ensured that the Enron bankruptcy, in the words of the US
Treasury Secretary, Mr Paul O’Neill, had no “spill-over effect.”
The downside, of course was that it did not do anything for its profits because of the steady
erosion in its trading margins (caused, ironically enough, by the entry of many players
into a market created by Enron) from 5.3 per cent in 1998 to less than 1.7 per cent in the
third quarter of the current year.
In retrospect, it would seem that the company made frantic attempts to keep up its profits
in spite of diminishing margins through various methods, including the setting up of
several off-the-balance sheet entities represented as independent of Enron to which it sold
assets or portfolios of assets.

It created so-called special purpose entities (SPEs) like the Chewco and JEDI partnerships
to get assets like power plants off its books. Enron was able to do this because, under
standard accounting, a company is allowed to spin off its assets—and related debts—to an
SPE if an outside investor has put up capital worth at least three per cent of the SPE’s total
value.
These methods also stretched across the lumping of assets into its trading business and the
booking as operating revenues the proceeds of the sale of fixed assets.

Gaps, it would seem, abound in GAAP....
Source: http://www.thehindubusinessline.in/2002/01/20/stories/2002012001470100.htm
Self Assessment

Fill in the blanks:
1. Accounting records all the transactions which can be expressed either in …………………….
2. Every financial transaction of the business has …………………… and recorded at two
places.

2.2 Classification of Accounting Principles

Accounting principles are broadly classified into three categories, these are:
 Basic Assumptions

 Basic Principles (Concepts)
 Modifying Principles (Conventions)

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