Enron Cases Essay

903 Words4 Pages
I. Analyze the case and answer the following question: (a) Discuss the earnings management technique employed by the management of Enron. Enron earned profits by providing services such as wholesale trading and risk management in addition to building and maintaining electric power plants, natural gas pipelines, storage, and processing facilities. When taking on the risk of buying and selling products, merchants are allowed to report the selling price as revenues and the products 'costs as cost of goods sold. In contrast, an "agent" provides a service to the customer, but does not take on the same risks as merchants for buying and selling. Service providers, when classified as agents, are able to report trading and brokerage fees as revenue, although not for the full value of the transaction. Although trading firms such as Goldman Sachs and Merrill Lynch used the conventional "agent model" for reporting revenue (where only the trading or brokerage fee would be reported as revenue), Enron instead elected to report the entire value of each of its trades as revenue. This "merchant model" approach was considered much more aggressive in the accounting interpretation than the agent model. Enron's method of reporting inflated trading revenue was later adopted by other companies in the energy trading industry in an attempt to stay competitive with the company's large increase in revenue. Between year 1996 to 2000, Enron's revenues increased by more than 750%, rising from $13.3 billion in 1996 to $100.8 billion in 2000. This extensive expansion of 65% per year was unprecedented in any industry, including the energy industry which typically considered growth of 2-3% per year to be respectable. For just the first nine months of 2001, Enron reported $138.7 billion in revenues. In Enron's natural gas business, the accounting had been fairly

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