The Enron Company Commission - Case Study Example

Case analysis Name Institution Case 1: EU defers accounting standards Background This case presents the resolution by the EU commission to cave in to lobbying from bankers as well as the French government to postpone new derivative accounting standards following the Enron affair. Enron Company, one of the largest natural gas extractors and sellers in the united states collapsed under a bankruptcy fixture which made the company become the world’s largest audit failure. The company executives, led by Kennedy Lay had successfully managed to hide losses that the company made amassing into billions of dollars from failed ventures and risky projects. The exposure of the fraud in this company led to a global concern pertaining the auditing process that companies engage themselves in. This led to the EU insisting on application of measures to come up with new accounting standards and methods that would lead to the control of how companies report and the accuracy of their auditing process. The trust and faith of the auditors and the process of auditing was thoroughly shaken, leading to investors losing their confidence in many of the giant corporations in the world. The EU commission backdrop in this case The EU commission wanted to impose measures upon companies to force them to account for all the derivative losses or gains in their books of account. This would imply that those companies would no longer present incorrect accounts to deliberately sway the decisions of the investors in these companies. Most companies only quote the costs that they have incurred in the buying of derivatives and other financial instruments but they never report these in their books of accounts. The result is that companies often hide the losses of the gains they make from these transactions. Following such issues is a hard thing and this often leads to the undermining of the investor’s confidence. According to the EU commission, it is vital to ensure that companies present a correct deposition of their financial situation. This goes a long way in aiding the investors in making informed decisions and choices pertaining their investment modes. Graham and Meridith (1937, p. 1) state that often, investors make their decisions on whether they will invest or not invest in a particular venture following their outlook on the balance sheets of the companies they are interested in investing. Sometimes, as this case shows, even these balance sheets can be misleading. Some factors of a company’s financial situation may not be presented forth in a balance sheet. In a typical case like this one, Enron succeeded in keeping off their risky speculative affairs from the books of account. This led to a lot of financial loss not finding their way into financial books. Though the situation was described as a situation where there occurred actual and deliberate misleading of the shareholders and other potential investors, the losses that resulted were momentous. According to the EU commission, it would have been apparent that Enron management knew that they were swindling the investors through giving them misleading information. This is viewed as a total breach of ethics. The introduction and application of the new derivative standards was aiming at ensuring that companies gave out information that was correct, honest and depicting a true financial standing of the company (Penner 2013, p.77). Following the Enron saga, the EU commission was forced to come with measures that were designed to ensure that a repetition of the same did not occur. From their argument, the new accounting standards would incorporate the costs and the gains that companies received through derivatives and speculative business activities. Salehnezhad (2013, p.1) argues that in any given financial transactions, companies should always ensure that they provide all the proponents of these transactions so that the users of the financial information may be able to have a true reflection of the financial health of the business. According to the EU commission, the new accounting for derivatives standards that the commission aimed at implementing would ensure that various companies would not be able to shift their underperforming assets into private corporations or private partnerships as Enron did, resulting into losses amounting into billions of dollars. According to Alberti-Alhtaybat et al (2012, p. 78), a company should place a market value for all its assets to enable the investors evaluate its performance. The view from the bankers and other lobbyists There was an agreement on the fact that companies need to provide accurate and timely financial information so that the relevant parties may have the chance to review these information and make informed decisions. However, the contention lay in how this was to be implemented. The bankers and other lobbyists were against the decision of the EU commission to implement new derivative for accounting standards after the collapse. The bankers argued that the accounting standards that have been implemented by the IASB and the IFRS are enough to steer companies into reporting that would give a truthful depiction of their financial standings. It is important to ensure that the financial and accounting reporting is not complicated as this would only lead to a confusion of the various accounting parameters in a company (Santos 2013, p. 3). The stakeholders of the company do not have to be bothered with every intricate detail of the transactions that the company engaged in. rather, the concept of ensuring that each company’s professionals’ ethics and standards are adhered to completely becomes a major factor here. Enron as a company collapsed mainly because the professionals in this company were not ethical in their capacity as managers. As such, the bankers and other lobbyists argued that the mistakes that one company created should not be used as a standard for punishing other companies. From their arguments, companies should b allowed to have these private partnerships to handle some pressure from the business. The main idea is to ensure that the ethic measures are well handled so that issues such as those followed the Enron collapse would not reoccur. Case 2: Foster’s: Less goodwill, higher earnings Background Foster company has been recording favorable profit values. Analysts however, argues that the company would record increases in the value of earned profits if the company gets rid of the goodwill in its books of accounts. According to these analysts, good will amortization charges would be done away with leading to an increase in the figure of the recorded profits. Others argue on the contrary. They show how the concept of goodwill under the new standards of accounting would only lead to an increment in the levels and standards of reporting. Basically, the increment in profit levels will not be substantiated with the removal of the good will. These different stands on the issue and the new standard has been analyzed in the ensuing discussion. Foster’s stand Foster’s management were keen on accepting the new standards. From their perspective, the standards would go a long way in cementing the confidence that the investors have on the company. In financial reporting, company management is inclined to welcome any move that would in one way or the other lead to the portray of the company in a brighter financial light (Carlin and Finch 2010, p. 4). In other words, most companies prefer to report more earnings and profit scales as this endears the company to investors. With this view in mind, any move that would subvertently allow for the reduction of factors and externalities that lead to the minimization of the profits of the company is welcome. Foster company defends the standards of the removal of good will stating that this will allow the company to record high levels of profitability before taxation. Goodwill occurs when a company’s assets are valued at a higher level than the current market value bearing in mind that it is an intangible asset. Technically, goodwill leads to a disposition of various factors in the company’s earnings. Goodwill results in the over-valuation of a company in some cases (Li and Sloan 2009, p. 2). The removal of good will reduces the costs that the company incurred through the annual amortization of the same. The charges that these companies used to incur through the amortization process go down and are translated into profits for the company (Jerman and Manzin 2008, p. 218). Foster company recorded an increment in the volume of profits after the goodwill was removed under the new standards. Removal of goodwill translates to the reduction of the base assets levels. The implication is that a high level of return from the same assets would be now realized. There are also other reasons why the new standards are becoming endearing to many corporations. One of the reasons is that it will make it very easy for companies to be able to offer an analysis and comparison of the company’s performance to others in the market (Bennet 2007, p. 5). Investment analysts have the capacity to know the exact proponents of a company’s earnings from the balance sheet and other financial reports and compare them to other companies in the market, even on a global scale (Beatty and Weber 2006, p. 258). For instance, Foster can be compared to other wine makers very easily using this concept. This comparison will ensure that the investors have a true identification of the company’s financial undertakings and performance. At a glance, they are in a position to identify whether a company is under-performing, over-performing or hitting expectations. Argument against the new standards There is a concern among various investment analysts and channels that the adoption of the new standards will lead to companies offering misleading reports on their performances. Companies will be inclined to offer incorrect figures of their profits. They will also become reluctant to predict the future profits of their companies following uncertainties in some aspects of these standards. Another issue in this case would be the problem of the determination of the way that credit ratings will react to such swings in the balance sheets of these companies. Credit rating agencies apply the concept of consistency in their capacity to be able to assign a particular credit scale to various companies. Variations in the figures resulting from good will removal may cause a chaos in these accounting concepts. Furthermore, the companies had not been given enough time to be able to have a transition from one standard to the new one. This would only result into overloading of data among various clients. The time-frame given for this transitions was not enough to offer a smooth transit from one form of system to the other. This calls for a lot of data analysis and preparation within a very short period of time and analysts argue that it will only result into data overload. In addition, the application of the new standards and concepts might take awhile leading to the creation of confusion among the current stream of investors. References Alberti-Alhtaybat, Khaled et al 2012, “Mapping corporate disclosure theories", Journal of Financial Reporting and Accounting, Vol. 10, no.1, pp.73 – 94 Beatty, A & Weber, J “Accounting Discretion in Fair Value Estimates: An Examination of SFAS 142 Goodwill Impairments”, Journal of Accounting Research, Vol. 44, no.2, pp. 257-288. Bennett, J 2004, "Accounting for Goodwill," Undergraduate Review: a Journal of Undergraduate Student Research, vol. 7, pp. 25-28. Carlin, TM & Finch, N 2010, "Resisting compliance with IFRS goodwill accounting and reporting disclosures: Evidence from Australia", Journal of Accounting & Organizational Change, Vol. 6, no. 2, pp. 260 – 280. Graham, B and Meridith, P 1937, “ The interpretations of financial statements- the classical 1937 edition”, retrieved from http://www.safalniveshak.com/wp-content/uploads/2011/11/interpretation-financial-statements.pdf Jerman, M & Manzin, M 2008, “Accounting Treatment of Goodwill in IFRS and US GAAP”, Organizacija, vol. 41, no. 6, pp. 218-225. Li, K & Sloan, RG 2009, “Has Goodwill Accounting Gone Bad?” Retrieved from http://faculty.haas.berkeley.edu/kli/research/Has%20Goodwill%20Accounting%20Gone%20Bad-Li%20%26%20Sloan.pdf Salehnezhad, SH 2013, “A Study Relationship between Firm Performance and Dividend Policy by Fuzzy Regression: Iranian scenario”, International Journal of Accounting and Financial Reporting, vol. 3, no. 2, pp.70-74. Santos, NE 2013, “An Interview-Based Study of Individual and Institutional Preparedness for Teaching IFRS”, International Journal of Accounting and Financial Reporting, vol. 3, no. 2, pp. 1-9 Penner, J 2013, “Long-Lived Asset Impairments in the Shipping Industry and the Impact on Financial Statement Ratios: Comparing U.S. GAAP and IFRS Standards”, International Journal of Accounting and Financial Reporting, vol.3, no.2, pp. 79-90. Read More