Market accounting Approach
This approach is also known as the fair value accounting approach and refers to an accounting method or technique that is used to value an asset belongs to a company to its current market level. In other words, it is used to determine the fair value of an asset or liability of a company or business on its current market prices (Lin, Pfeiffer & Porter 2017, p. 550). Therefore the company futures are always a subject to daily mark to market as well as cash settlements. In this case, the liquidation value for prospects is still zero in the margin calculated. However it is also important to note that market options are not subject to mark to market analysis and cash settlement is ever done when the constraints are expired (Sainati, Locatelli & Brookes 2015, p. 12). As a result, a company will incur mark to market loss if its market value falls from one business day to zero since the approach requires an asset value to be adjusted on a daily basis to reflect its market prices.
Misuse of the approach by the company or business management or the accountants can put the company in a rosy situation regarding offering an accurate reflection of its performance or profitability to the general public or the investors. It, therefore, misrepresents the real value of a business and hence may mislead investors who have no idea of what may be happening and are thrilled by the current business profitability which is a good indicator of the future profitability of the company (Haswell & Evans 2018, p. 35). As a result, they may invest their money in certain company assets or liabilities with the hope of gaining in the future only to experience significant loss as it was the case with Irons Management.
Enron business was founded in the year 1985 through a merger of two natural gas pipelines companies, Houston natural gas and the Internorth natural gas. The merger or the business came to a fall after it encountered very challenging and troubling questions on its financial reporting and disclosure problems as well as at the high market valuation of its stock (Walters 2015, p. 6). The fall is attributed to the failure of the company fund managers, the investment brokers who acted as the investment researcher and brokerages as well as the financial regulators in the financial markets. These capital markets intermediaries, regulators and governance experts were supposed to ensure the effective functioning of the stock market. According to the Financial Accounting Standards Board (FASB), a well-functioning capital market will create the appropriate linkages of information incentives between and governance between its managers and investors which was not the case in Eron Fraud which involved a collaboration of these experts to mislead the investors through financial reporting which did not reflect the true and fair value of the company stock in the capital markets as well as high market valuations of the company stock price (Busillo, Harvey & Hoffman 2016, p. 130). The disclosure problems and high market valuation of the company stock prices in the capital markets according to the Mark to market approach, therefore, led to the portray of a rosy picture of the company performance and profitability.
Special purpose entities (SPE) are also known as the special purpose vehicles (SPV) and refer to a subsidiary of company or business entity which is protected from the financial risks of the parent company (Blatt, Gulbin 7Officer 2018, 32). It is created as a legal entity for limited business acquisition and transactions, and therefore it can be used as a funding structure for company contracts. It has assets and liabilities as well as a legal status which is outside the obligations of the parent company (Campbell et a. 2017, p.78). Individual Purpose entities are therefore used for purposes of carrying out a specific business activity which is always outside those of the parent company and hence plays a crucial role of protecting the parent company from any possible risks such as bankruptcy and insolvency.
Enron Company successfully used the SPE to fund their contracts to achieve their specific financial objectives. This was accomplished by transferring a considerable number of what appeared to be their quickly rising stock to the SPE, and as a result, they received cash in return. The entity was then used for hedging purposes of the company assets held on the balance sheet. However, the management was critical regarding reducing the risk which led to Enron being guaranteed the SPE value. As a result of the capital market stock price fluctuations and the high valuation of Enron stock, the prices of the company stock significantly dropped which conversely affected the value of the SPE, and the guarantees were forced to establish ways of paying (Chowdhury & Chen 2017, p. 66). However, the company could not pay due to a large number of funds or capital it owed to both the company investors and the creditors a situation which led to a massive financial collapse of the Enron business. The investors and creditors despite the company disclosing its financial information on the balance sheet could not understand the gravity of the financial fraud situation that the company was facing.
Stock options compensation has been a lousy strategy that is employed by many companies as an incentive mechanism to motivate their top rank and file employees at largest companies to work harder. As a result, the companies end up paying them heavily despite the financial health of the company (Markham 2015, p. 18). Enron’s compensation strategy, therefore, followed such practices of rewarding the top executives with incentives which cost the company millions of dollars which were provided in the form of stock options. These stock options provide a guarantee to the senior employees of the right to buy a certain amount of company shares at a predetermined share price (Diebold & Y?lmaz 2014, p. 126). As a strategy, it can be very manipulative from the top management who despite the collapse of the business they were to be compensated and hence the failure of the Enron’s business. As part of their financial fraud mechanism, the high inherent incentives were among the factors which encouraged the top executives of Enron business to present very misleading financial information to their shareholders to inflate the stock prices to cash their stock options and walk away with millions of dollars from the company.
Elements of Financial statements Measurement as defined by International FRS conceptual Framework
The financial report is essential documents for any company and is used to portray of reflecting the business transactions or activities of a company by merely grouping them into different classes according to their economic characteristics (Gherai & Balaciu 2015, p. 36). The levels formed are therefore known as the elements of financial statements. Thus for any company, these elements can either be directly related to the financial position of the company or the balance sheet, or they can be connected to straight to the company performance as reflected in the income statement. The most identifiable elements related to the balance sheet are the assets, liabilities and equity while those related to the income statement include the income and expenses. Therefore, assets, liabilities, equity, income, and costs form the five elements of financial statements as provided under the IFRS conceptual framework for measurement (Azibi, Azibi & Tondeur 2017, p. 154). The measurements of these elements involve therefore the assigning of value or monetary amounts through which each feature is recognized. The international financial reporting standards, thus, have provided different methodologies under their conceptual framework in which these elements can be measured. The companies to varying degrees as well as in varying combinations to help the companies determine the true and fair value of the financial statements for effective decision making use these measurement basis or methods widely. To measure the above elements of financial statements then different companies utilize the use of Historical cost measurements, current costs methodology, the net realizable value as well as the present value methodologies to determine the fair and accurate measure of the elements. For instance, the Woolworths Company has successfully utilized the use of historical cost methodology in measurements of its financial statements according to the Annual financial report for 2017.
To understand how elements of the financial statements are measure we examine how Woolworths Group limited has employed the use of historical cost methodology to measure its assets in their annual financial report for 2017. The measurements of the company assets, liabilities, and equity from the company statement of financial position are done through the use of historical data and sell-through strategy (Ellul et al. 2014, p. 302). The 2017 cost of the assets is measured against the performance or the values of the assets in the previous years that are in 2016 and 2015 as reinstated in the 2017 annual financial report. The use of such historical cost measurement technique to measure the performance of the company assets in the current year provides a comparative analysis of assessment where the users of the financial statements can use the information to make essential or useful decisions. The comparisons give a clear picture of which assets have been performing better in the period presented as well as their trends and also help in determination of the assets which are performing poorly (Woolworths Group Annual Report 2017). Useful information, in this case, refers to the ability of the financial statements to provide the different users with information that is reliable and essential in making investment decisions with the company. The company is also able to analyze or measure the value of their different class of assets and hence the ability of the company to meet its short-term obligations using their assets. From their measurement, the total company assets at 25th June 2017, were valued at $ 44993 million which was a decrease from the previous year (2016) value of $ 50 367. The 2016 amount was an increase from the 2015 value of the total assets which was $ 42017 (Woolworths Group Annual Report 2017). Therefore, the use of historical cost measurement trend for the Woolworths group shows that the company experiences an increasing and decreasing cost strategy for the asset valuation and measurements. It is therefore projected that the company will a high value for their assets as at 25th of June 2018. Such cost measurement technique is essential in helping the management of the company to prepare adequately by taking appropriate strategies.
Woolworths Group has utilized some techniques or methodologies in assigning monetary amounts to specific elements of the financial statements. The use of historical cost methodology in measurement of the company assets is critical in that it provides a relative or more reliable measurement scare based the historical data for the company assets as compared to the use of the current cost technique which would be biased depending on various economic conditions and may not reflect a true and fair value of the company assets worth. But historical cost provides reliable data on the average costs measures for the assets (Zreik, Latouche & Bouveyron 2015, p. 170). Secondly the use of the net realization value in measurement of the company profitability as realized in the company income statement a more useful measure of the company performance as compared to the use of net present value technique which is subject to many assumptions and does not provide a record of the revenue when they accrue or are realized. The net current value measurements can be manipulated for various reasons since the income are accounted for in different times compared to when they have been achieved (Hubrich & Tetlow 2015, p. 105). Such measurement provides the company shareholders with the confidence that all the revenue recognized in a particular financial period have been accounted for and therefore reduces the chances for financial risks through fraud. The ability to combine different measurement techniques helps in assessment of the quality of the financial reporting for the company financial statements. It enhances its ability to produce financial statements which represent a true and fair reflection of the company performance and profitability (Woolworths Group Annual Report 2017). It also enhances the ability of the management and the investors to make appropriate and useful decisions which will promote the growth aspects of the company as well as support the interest of the shareholders and the investors at large.
In conclusion, therefore; financial reporting of company financial statements should be done according to the various international standards established in different countries. It is essential for all the experts involved in capital markets to work together by ensuring that there is effective functioning of the stock market and not for their selfish motives which saw to the collapse of the Enron Business. A well-functioning capital market markets will, therefore, create appropriate linkages of information incentives and governance between the managers and the investors to reduce financial fraud through selfish motives. However, it is critical for companies to ensure that their financial statements reflect an accurate and fair value judgment to avoid misleading the public and the potential investors through many auditing processes.
References
Azibi, J., Azibi, H. and Tondeur, H., 2017. Institutional Activism, Auditor’s Choice and Earning Management after the Enron Collapse: Evidence from France. International Business Research, 10(2), p.154.
Blatt, J., Gulbin, J. and Officer, C.F., 2018. Achieving IFRS Off-Balance-Sheet Treatment in Trade Receivables Securitizations. The Journal of Structured Finance, 23(4), pp.30-35.
Busillo, J., Harvey, T. and Hoffman, B., 2016. Mark-to-Market Accounting for United States Corporate Pensions: Implementation and Impact. Retirement System Risk Management: The New Regulatory Order. Oxford, UK: Oxford University Press, pp. 125-145.
Campbell, J.L., D’Adduzio, J., Downes, J.F., Utke, S., Cassell, T.C., Crawley, M., Dhaliwal, D., Ehinger, A., Gaver, J., Lee, J. and Rowe, S., 2017. Do Investors Adjust for Balance Sheet Risk that Should Be “Off Balance Sheet”? Evidence from Cash Flow Hedges.pp.78.
Chowdhury, A.N. and Chen, P.H., 2017. Special Purpose Vehicle (SPV) of public private partnership projects in Asia and Mediterranean Middle East: Trends and techniques. Institutions and Economies, pp.64-88.
Diebold, F.X. and Y?lmaz, K., 2014. On the network topology of variance decompositions: Measuring the connectedness of financial firms. Journal of Econometrics, 182(1), pp.119-134.
Ellul, A., Jotikasthira, C., Lundblad, C.T. and Wang, Y., 2014. Mark-to-market accounting and systemic risk: evidence from the insurance industry. Economic Policy, 29(78), pp.297-341.
Gherai, D.S. and Balaciu, D.E., 2015. From creative accounting practices and Enron phenomenon to the current financial crisis. Annales Universitatis Apulensis: Series Oeconomica, 13(1), p.34.
Haswell, S. and Evans, E., 2018. Enron, fair value accounting, and financial crises: a concise history. Accounting, Auditing & Accountability Journal, 31(1), pp.25-50.
Hubrich, K. and Tetlow, R.J., 2015. Financial stress and economic dynamics: The transmission of crises. Journal of Monetary Economics, 70, pp.100-115.
Lin, S., Pfeiffer, G. and Porter, D., 2017. Accounting Standards and Financial Market Stability: An Experimental Examination. The Economic Journal, 127(605), pp.F545-F562.
Markham, J.W., 2015. A financial history of the United States: From Enron-era scandals to the subprime crisis (2004-2006); From the subprime crisis to the Great Recession (2006-2009). Routledge.pp.18.
Sainati, T., Locatelli, G. and Brookes, N., 2015, June. Organisational forms in Megaprojects: Understanding the ‘Special purpose Entities’ An ontological analysis. Leeds.pp.12.
Walters, C., 2015. Recession to Depression: A Critical Disambiguation of the 2007/2008 Financial Crisis and a Model for New Age Securities Regulation.pp.6.
WoolworthsGroupAnnualReport;https://www.woolworthsgroup.com.au/icms_docs/188795_annual-report-2017.pdf
Zreik, R., Latouche, P. and Bouveyron, C., 2015. Clustering of dynamic networks through subgraphs: a study of the Enron scandal. JOURNAL OF THE SFDS, 156(3), pp.166-191.
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