need half page of word 16 Case prt sc Enron: The Revenue Recognition Principle S
ID: 2422535 • Letter: N
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need half page of word
16 Case prt sc Enron: The Revenue Recognition Principle Synopsis In its 2000 annual report, Enron prided itself on having "metamorphosed from an asset-based pipeline and p and logistics company whose biggest assets are its well-established business approach and its innovative people."1 Enron's strategy seemed to pay off, in 000 it was the seventh largest company on the Fortune 500, with assets of $65 billion and sales revenues of $100 billion. From 1996 to 2000, its rev enues had increased by more than 750 percent, which was unprecedented in any industry. Yet just a year later, in December 2001, Enron filed for bank ruptcy, and billions of shareholder and retirement savings dollars were lost. Background Enron was created in 1985 by the merger of two gas pipeline companies: Houston Natural Gas and InterNorth. Enron's mission was to become the leading natural gas pipeline company in North America. As it adapted to changes in the natural gas industry, Enron changed its mission, expanding into natural gas trading and financing and into other markets, such as electricity and other commodity markets. In the process, Enron made significant changes to several of its accounting pro- cedures. For example, Enron began using mark-to-market (MTM) accounting for its trading business. Firms in the financial services industry typically used MTM Enron 2000 annual report, p. 7. 2 Joseph F. Berardino, Remarks to U.S. House of Representatives Committee on Financial Services December 12, 2001 3 Bala G. Dharan and William R. Bufkins, "Red Flags in Enron's Reporting of Revenues and Key Financial Measures," March 2003, prepublication draft (www.ruf.rice.edu/-bala/files/ dharan-bufkins_enron_red_flags_041003.pdf), p. 4 25Explanation / Answer
Answer for Question 1
The question ,when a company have to recognize its income or expenses plays a very important role in preparation of the financial statements. At the Intermediate Accounting, it states that “the revenue recognition principle provides that firm should recognize its revenue when it is realized or realizable and when it is earned.” According to this statement, there must be two conditions met when a company is allowed and must record its revenue:
condition one
(1)when the company receives payment;
condition two
(2) when the company has earned that payment.
The importance of the revenue recognition principle to users of financial statements is very high. If this principle is not followed, all stakeholders of that company can be misled into believing a company is profitable when in actuality it might be losing money. This misstatement in the financial statement would lead investors astray and they would invest in a company that they wouldn’t ordinarily.
Answer for Question 2
Did Enron violate the Revenue Recognition Principle?
I could say that, Enron’s associates did not have sufficient controls set in place to monitor or govern their decisions. According to GAAP, in order for revenue to be recognized, it must have been earned by the company. In the present context, Enron used MTM accounting to allow for the recognition of the present value of the stream of future inflows as revenues on its contract with Sithe Energies. However, the application of MTM (in this context) clearly violates the revenue recognition requirements under GAAP. They tweaked or bent the principle to suit their needs and at first no violations were made: the SEC gave permission for Enron to use Mark to Market accounting for natural gas contracts. In Enron: The Rise and fall, Fox defines mark to market accounting as amethod that “takes all the trades and contracts extending out into the future and figures out what their values would be based on current market prices.” (Fox, 40)This type of accounting method is easy to calculate for securities like stocks, but for the future valueof a gas contract several factors went into determining the true value.
Answer to question No : 3
According to paragraph #14 of Auditing Standard #5, “effective internal control over financial reporting provides reasonable assurance regarding the reliability of financial reporting and the preparation of financial statement for external purposes.
If there is one or more material weaknesses exist, the company's internal control over financial reporting cannot bec onsidered effective.”In the Appendix of Auditing Standard no. 5, paragraph no.A5 provides that more specifics about the definition of an internal control system. According to this paragraph, this a system is “a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP and includes those policies and procedures that “Internal controlis a process—effected by anentity’s board of directors, management, and other personnel—designed to provide reasonable assurance regarding the achievement of objectives in the following categories: (a) reliability offinancial reporting, (b) effectiveness and efficiency of operations, and (c) compliance with applicable laws and regulations.” In the light of the above case study and eith the principal mention i could say that Enron had not properly established an effective system of internal control over financial reporting related to the contract revenue recorded in its financial statements
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