Reference no: EM132976653

Question - Enron made a deal in 1992 to supply Sithe Energies, a New York utility, with 195 million cubic feet of gas per day for 20 years for its new plant in upstate New York. The estimated value of the contract was $3.5 to $4 billion. Therefore, in 1992, Enron recorded about $3.5 billion in revenue and profits on its income statement based on the proceeds from a 20-year contract. In other words, Enron recognized revenue all at once on this kind of long-term sales contracts. Enron went bankrupt nine years later. Thus, over half of the revenue booked in 1992 from the Sithe Energies sales contract was never earned.

Required -

1) Discuss why the above-mentioned Enron's revenue recognition practice violated the accounting standards. You should form your discussion based on the revenue recognition criteria- which criteria are violated and why do you think they are violated.

2) Discuss the incentives of Enron's management team to record revenue this way. You should form your discussion based on what we have learned about earnings management-what's the impact of this accounting practice on Enron's financial statement and why do you think Enron's management would do it.