This quotation shows how arbitrary MTM can be. Simply by terming Enron's cash shortage a sa minority interest as opposed to the proper term for it, debt, Enron was able to manipulate MTM to prevent such a sizeable loss from appearing on its balance sheet. Moreover, MTM's role in this transaction allowed Enron to repair its problem of a cash flow shortage since it credited $500 million via its sale of Treasury securities. The relative short duration in which Enron was able to take out a loan and repay it indicates how effective MTM was in providing Enron a favorable balance sheet, and in singled-handedly dancing around the reality of its shortages. Additionally, it also kept others (shareholders, stakeholders, not to mention its hard working employees) to know how tenuous an economic position the company was actually in.
In discussing Enron's MTM approach to accounting and the considerable role it played in the facilitation of greed and immorality on the part of its upper level management, it is crucial to analyze the sort of valuation it utilized to monetize its assets. Originally, Enron used the most acceptable form of valuation, the public quoting of price information, to properly evaluate the worth of its natural gas commodities. Still, it is crucial to note that of the two forms of evaluation of MTM (publicly quoted prices and management prognosis in the event of a lack of the former), the vast majority of Enron's MTM utilized the former. Again, it is noteworthy to mention that this fact alone reveals that these aspects of business were inappropriate for MTM. Also, this fact reveals that back in 1991, the SEC actually was not complicit in Enron's later nefarious practices, since it only sanctioned MTM for natural gas commodities. However, the highly subjective nature of Enron's MTM accounting for assets that had no publically quoted prices reveals that a fair amount of this blame falls not only on the company itself, but on its accounting firm, the once renowned Arthur Andersen.
Still, it would be unfair to issue the degree of culpability of Enron's asset and commodity appraisals to solely lie with Andersen. Other firms, such as Houston's KMG consulting, were also utilized for the purpose of valuation. The interest that such firms had in providing favorable estimates, however, seems to be well aligned with their own interests in terms of profiting from Enron's alleged financial prowess. Such a statement certainly appears to be of true Andersen, which had a longstanding, confidential relationship with its top client. Regardless of ulterior motives, however, Enron's valuation for its MTM accounting did utilize some sound financial practices, such as employing outside entities to assist in the process. Both directly through its own upper level management and through the aforementioned consultants, Enron also employed statistical analysis as a means of determining asset worth when there was a dearth of publicly quoted prices. One of the more frequently used tools is known as Monte Carlo systems analysis, which is used to "simulate probable outcomes given a set of variables. Through multiple iterations of simulations, the probable outcomes will cluster around a normal bell curve distribution table" (Batson, 2003, p. 34).
The probable with such statistically sound measures is the fact that most of Enron's MTM reflected future earnings that were highly difficult to gauge, regardless of what means of statistics was used. The company had a propensity to determine potential gains and losses (the latter of which there were not too many) immediately after conceiving of any number of far flung ideas that it believed would generate earnings up to 10 years in advance. There are a number of specific examples that proves that much of Enron's MTM valuation was based on future activity. One of the most egregious of these is the deal that Enron established with Blockbuster in 2000 in which it attributed $53 million in earnings, despite some considerable setback and developments that were to take place in the future -- and which never did. The Blockbuster deal was based on the notion that the pair would service direct to television movies to people at home. However, Enron never had the technology to facilitate such a move, and Blockbuster itself did not have the rights to movies to carry out this transaction. Still, these circumscriptions did not prevent Enron from selling a portion of its subsidiary that it set up for this transaction to its Hawaiian securitization company under Federal Accounting Standards rule 140 -- which accounted for its allgeged $53 million.
There are several dubious factors in the confluence of events that led to Enron's recording of profits via MTM in this particular business venture, not the least of which the Hawaiian securitization structure was merely an extension of Enron itself. However, what is most egregious about this particular act of duplicity involving MTM is Arthur Andersen's valuation of this transaction. As Enron's primary accounting firm, representatives at Andersen were well aware of the fact that Enron lacked the technology and the rights to major motion pictures (as did Blockbuster) to actually accomplish its objective of streaming movies to television sets. Yet that did not stop the accounting magnate from making some pretty bizarre assumptions in evaluating the net worth of this future venture including a growth rate of digital subscribers by 70% in 2010, a growth rate of digital subscriber lines by 80% in 2010, a market of 10 metropolitan areas in its first 12 months of operation with 1.6 million people which was projected to expand to eight additional metropolitan areas until 2010, and the fact that Enron would capture 50% of the market share (Batson, 2003, p. 30).
To refer to some of these calculations, which are little more than predictions, as ambitious would not be an understatement -- especially since the particular of this matter, such as movie rights and the proper technology were not procured. One would think that attaining both of these crucial components would have some sort of cost associated with them which would negate potential earnings. Andersen's numbers then, especially those based on the purported success of an operation that was little more than a figment of the imagination at the time such MTM accounting was calculated, certainly seem inflated and would appear to be based in part on the firm's own ulterior motives. The figures reflecting the market growth certainly seem to be assuming a degree of success that appears to be hard to substantiate -- especially since Enron terminated its agreement with Blockbuster for the proposed project a year later.
To Enron's credit, however, it and the various firms it employed did make efforts to account for the fact that these profits that were projected for years down the line were future, and as such were subject to some degree of fluctuation. In that respect, then, its MTM methodology did employ a discounting of cash flows due to the fact that they were future projections. For instance, the cash flows recorded in the MTM accounting for the Blockbuster transaction were discounted approximately 33% to allow for the fact that they had not yet occurred (p. 31). The discounting of future cash was regularly employed by the company and its affiliates to determine MTM accounting. Sometimes the discounting of cash rates would be based on stock and bond prices, as was the case during the Eli Lilly Transaction. Therefore, measures of prudence utilized in Enron's MTM included using statistical analysis tools such as Monte Carlo simulation analysis and discounting cash flow rates.
Finally, it should be noted that Enron's liberal usage of MTM in inappropriate situations and the biased valuation that it, Arthur Andersen, and other consultants provided was considerably aided by an abuse of FAS 140. Under the auspices of this mandate, Enron was able to set up additional companies that merely allowed it to shift debt and profits back and forth to its own advantage. What was crucial about this practice of the energy company is that when it would, say, sell 30% of its share in its venture with Eli Lilly to its Hawaiian FAS 140 entity, it could record this as a profit yet still retain control over the latter entity. Thus, Enron could best maintain its own benefits and risks in such a venture, and readily record profits which were dubious in the first place.
In conclusion, Enron was able to manipulate MTM accounting along with a host of other illicit business practices to misrepresent itself on paper and support its burgeoning stock. Again, it is crucial to note that MTM in and of itself is not a negative financial practice. The abuse of it, however, certainly is. What Enron was actually guilty of was ludicrously determining the market value of its assets-as well as quite liberally using the term assets and commodities to include ventures that could never be accounted for in public quotes. As such, the company could rely on its accounting and consultant…