Reference no: EM132965441

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:

Problem 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.

Problem 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.