Question

How did Enron use market to market accounting to commit fraud? When is appropriate for market to market accounting to be used?

Answer 1

Enron Company employed accounting method, mark-to-market (MTM) accounting to “cook its books”. This method allows the company to record their assets at the fair market value rather than their book values. Moreover allows the company to list it's profits as projections instead of the actual numbers. Enron used the mark-to-market accounting to write unrealized future gains from few trading contracts into current income statements, and thus provided an illusion on the higher current profits for the company.

Also the troubled company operations were transferred to special purpose entities (SPEs) that were essential limited partnerships created with outside parties. Although majority of the companies distributed assets among the special purpose entities, however Enron misused the practice for its troubled assets by using SPEs as dump sites. The transfers of assets to SPEs allowed Enron’s books to making its losses to look less severe than they really were.

The company should use market to market accounting to be used during the periods of declining markets. A decrease in the asset value on the left-hand side of company's balance sheet will cause an equal fall in the company's retained earnings and equity capital on the right-hand side of company's balance sheet.