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“Mark-to-Market” accounting and how Enron used it
Mark-to-Market is an accounting method that adjusts the valuation of a security or other asset to reflect current market values, with the paper gain or loss taken through the income statement. It relates to how a trader calculates their trading gains and losses, and how these gains and losses are reported on the trader’s income tax returns.
Enron started using the mark-to-market accounting for the contracts that had a predictable future cash flow which were treated as merchant assets. They got the approval from SEC to be allowed to mark these assets to the market and became the first company outside the financial sector to adopt this method. Use of this accounting method allowed Enron to take up front most of the anticipated profits on such contracts, and the requirement to write them down if their value diminished. This allowed them to show significant profits on their income statements (which were writton off in subsequent years) and overstate company’s financial position.
Why did the banks do inadequate due diligence with regard to the bank lending for SPV’s supported by Enron guarantees?
Enron’s solution to take off some assets and related debt from the balance sheet was to find some independent investors who are willing to take some risk through equity participation in separate entities, which, in turn, could borrow from third party lenders or investment bankers.
During the period, SPVs needed only 3% of capital investments from bankers or an independent invesor. Investments in an Enron SPV were not considered at risk by these banks because of the overvalued profits shown by Enron’s financial statements, backed up by their letters of credit and guarantees. These bankers added their investments in an Enron SPV to their high-return portfolios and did not hesitate in lending to an Enron SPV.
Main reasons for Enron’s collapse. Could it have survived?
Enron’s collapse resulted from the disclosure that it had reported false profits, using unusual accounting methods that failed to follow generally accepted procedures. Both internal and external controls failed to detect the financial losses disguised as profits for a number of years. Anderson also failed to bring these illegal policies and unethical party transactions to the attention of Enron’s Audit and Compliance committee. Enron’s managers, whose activities brought the company to the brink of ruin, escaped with millions of dollars as they retired or sold their company stock before its price plummeted. Enron could have survived if its attempt to merge with its local competitor, Dynergy, had been a success.
Role of Arthur Anderson play in the demise of Enron
Arthur Anderson had been Enron’s auditors since the company’s formation in 1985. They performed Enron’s internal as well as external auditing. They were able to discover the risky accounting practices of Enron, but silently sanctioned these unusual and illegal accounting policies that Enron adopted in fear of losing a large client. As financial auditors, they failed to follow the ethics of accounting and lead Enron to an eventual collapse.
What, if anything, could have been done to prevent the Enron scandal?
But what could have prevented so many individuals from losing their life savings? Is there any database application that could have prevented that? Probably not from a user perspective, but certainly from an auditing perspective. Data mining allows for the extraction of particular information based on defined goals. Once the attributes are created, the user can extract hidden predictive information from large databases. In the case of Enron’s auditing practices, perhaps a data-mining tool would have been able to unearth hidden information. Remember, data mining is data-driven, not user or verification-driven. A user formats a theory about a possible relation in the database and converts this hypothesis into a query.
Lieberman’s remark made it seem he is focusing on the question of whether the federal government could have acted to stop the collapse of Enron. His statement did not note these subpoenas could also produce information showing if and how Enron tried to use its political influence to win favorable policies and decisions from the Bush and Clinton administrations. Is Lieberman sidestepping this delicate matter–or being rhetorically restrained for strategic purposes?
The Wall Street Journal surmised that greed has always been around, but recessions have a way of flushing out the sinners and exposing the companies that are houses of cards. The New Republic voiced the perception that Enron was a scandal, but not a typical one — it wasn’t a matter of what someone did, it was a matter of what regulators, whistleblowers and politicians *didn’t* do that caused the problems. The Washington Post’s editorial page perhaps took the broadest view of the topic, sensing the political minefield for Republicans and Democrats alike who fed at Enron’s table, and viewed Enron’s woes in light of the ingering issue of campaign finance reform.
An article review from The Economist
The rich people of SA found it expensive to spend holidays abroad or import foreign cars. The poor saw an increase in food costs because of increasing prices of oil, transportation and imported grains. Tourism and export manufacturing sectors benefited as these became cheaper and more competitive in the world markets.
The currency jumped back up this year. There can only be one reason: more of the currency was demanded than supplied. The central bank of SA increased the interest rates, making it attractive for foreigners to invest in the country. The interest in South African Gold mines also attracted foreign investments. As a result, the rand was demanded more. Rand’s recovery is bad news for South African exporters and Tourism service sector as these become more expensive and less competitive. But investors like a stable currency more, as it makes business returns more predictable.
In contrast, the Indian government manages the value of the Indian rupee. Some say these foreign exchange controls should be liberalized now because of the current account surplus. India’s central bank was buying dollars to slowdown the appreciation of Indian rupee, there by making the exports more competitive and reduce the trade deficit.
Demand for the rupee is booming because of two different kinds of services exports. The boom in the value of rupee is mainly because of the software services provided by Indian companies to other countries and the business process outsourcing provided by Indian Data Centers
If the Indian government made the rupee convertible (by allowing anyone to sell it any time at any price), more rupee will be supplied to the world market which pushes down the value of the currency. This makes exports from India more cheaper and competitive in the world market. On the other hand, the imports become expensive.
