The Nature of the Enron Scandal: Mark-to-Market Accounting
When Skilling joined Enron, he immediately called for change in the accounting method from the traditional “historical cost” to “mark-to-market cost”. This innovative change is so inherently tied to Skilling and his arrival at Enron that his employment with the company was actually conditioned upon the change. Mark-to-market accounting allows an asset to be valued at its current market value as opposed to the actual cost paid for it. This method works best in more liquid markets where the value of the asset is easily discernible. Enron’s markets, however, did not have assets of such easily-discernable value – thus allowing for wide latitude in the application of “mark-to-market”. This is where Enron truly flourished; albeit falsely.
Enron had developed valuation methods that would enable the company to consistently beat even the most optimistic Wall Street estimates by fraudulently manipulating this non-traditional accounting format and creating wholly malleable figures on their books. Initially, the mark-to-market accounting left valuations to be based solely on the assumptions and predictions of Enron’s executives. Conveniently, these assumptions and the “proprietary methods” used to make them, were predicated on nothing more than their own greedy imaginations. As the nation later discovered, the actual value of Enron’s assets were well-below their actual cost; leaving a vast chasm between the accounted figures and the actual value of the assets. Notably, at the time Enron initially employed this new accounting method, it was by not considered a fraudulent act on its face in the eyes of US regulators. In fact, the change was approved and sanctioned by the Securities and Exchange Commission. In the end, however, it was not the accounting method(s) that perpetrated this fraud, but the people who used it to grossly and dubiously manipulate the company’s financial statements. Ironically, this method not only went unquestioned by both those within the company and outside observers, but it was ultimately lauded as a brilliant financial innovation worthy of praise in the larger business community.