In 1984, Houston Natural Gas Corporation, a pipeline operator have merged with Internorth, another pipeline company. After thir merger, the merged company’s name changed to Enron. Enron Corporation has significant growth and become one of the biggest companies in USA at 90’s. But, this company suddenly announced its bankruptcy in late 2002. This condition makes everybody distracted. Why? On the previous year, this company still recorded revenue US$ 100 billion! Enron stock was originally priced at $ 90 per share but then fell sharply to US$ 45 cents per share. What happened? This question continues to dominate the economic and business analysts in the United States in that period to be headlines everywhere.
After some investigation and examination, management of Enron supposed had been practicing what we called as window dressing. The manager has been manipulated (mark up) Enron's revenues amounted to US$ 600 million and hid its debts totaling US$ 1.2 billion. Mark up at this amount certainly cannot be done easily, this manipulation required expert tricks to hide the high number.
How can the big corporation like Enron do this such failure? After some researches, supposed that they (the manager) had manipulated Enron's revenues and hid its debts with that such big number by misapplying mark to market accounting system. This system makes the managers of Enron can adjust their account with their intended amount.
What is mark to market system? It is one of accounting approaches to record and adjust some money market’s instrument value as its fair value, or based on market value. Enron should just use mark-to-market accounting for the instruments utilized in trading activities. Unfortunately, mark-to-market accounting was also used in cases where the market value had to be estimated rather than observed. This practice introduced an excessive amount of arbitrary and subjective evaluations into the income and asset measures.
Enron, after the merger, try to diversified and expand their business. The great investment to transportation and distribution segment, wholesale services and also broadband was made. The managers of course hope that their investment will result as their expectation, but it was not happened. Income from their expansion was too little compared with their investment before, even some segment suffered loss.
After some lobbying process with Securities Exchange Committee, Enron are allowed to use this accounting approach, because their primary business is about natural resources (natural gas) that its value likely changes everyday. To count market value from the contract, Enron forecast the future price from the trading commodities under contract. Used this forecasting they can increase the expected cash flow theoretically, set the discount rate and count its net present value. The net present value then recorded as real value of the contract. If net present value is higher than contract value, the differences will recorded as income in income statement. Enron had over predicted the contract the future cash flow and under applied discount rate. So that, they served high income to the investor. That was moral hazard on Enron’s management.
These values were Enron’s dreams, not money in the bank. Today, brokers and dealers in marketable securities and commodities use mark-to-market. They can look in the Wall Street Journal or on Bloomberg to get values. (OK, if one had to dump a large holding, that could push the price down, but that is a relatively small glitch in the scheme of things.) In contrast, Enron made up its own numbers! And this was the SEC in the Clinton Administration.
Besides that, mark to market should used just to adjust trading assets. But, the moral hazard appeared again when the manager used it to non-trading assets, because of unexpected result of their investment and because there are some conflict of interest (the managers is some people who have many stock at the company, so, they have to increase their stock value). With mark to market, Enron has led their stakeholders to misleading financial statement.
At the extreme case of certainty and complete objectivity, Mark to market accounting tends to supply better information than cost-based accounting. But as the amount of uncertainty and the amount of subjectivity are increased, the positive aspects of mark to market accounting are reduced and it may actually be less useful than the old-fashioned cost-based accounting.
Enron adjusted almost all of their assets value by used mark to market system. The gain of their adjustment make they can mark up their revenues till US$ 600 million. Beside that, the management of Enron has done some insider trading to make people thought that Enron’s financial statement was fair. They sold some assets based on market value. This condition make people thought that the asset’s value written in financial statement was fair. But the fact showed that the buyer of this trading was their own subordinates company.
The misleading financial statement of Enron because of fraud using mark to market system make many people suffered much loss. The manager’s moral hazard not only caused the stockholders but also the customers, the employees, the managers and other stakeholders suffered loss. From this scandal we can see that the practice of clean and transparent business will help the com-any to be more sustainable. The principles of good corporate governance (corporate governance) must be preserved and maintained. Management system should be transparent, fair, accountable, and maintain environmental balance. Ignoring the code of professions ethics conduct will create many disadvantages for us and others. (Quoted from various sources)
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