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Chapter 9. Goosing, Stuffing, and Faking... > Red Flag 11: If Companies Use Their ...

Red Flag 11: If Companies Use Their Own Assumptions to Assess the Value of Contracts

We have already seen that there is plenty of room for tweaking revenue and profit figures depending on accounting methods used, but in the energy trading sector, use of the word “tweaking” would be an understatement. One of the issues that arose over the disintegration of Enron was the wildly optimistic assumptions that went into the energy merchant’s assessment of profits and revenues from long-term energy contracts. The contracts, often stretching many years into the future, were not traded on an exchange, so companies made their own assumptions about their worth. This practice, of course, left plenty of room for manipulation and deception. It is very difficult for an investor to decide whether the delivery of electricity or natural gas in 2007 is being priced fairly within a company’s accounts. In October 2002, accounting rulemakers appeared to close the door on some of these practices by declaring that on some types of contracts, energy traders will only be able to record the revenue and income from the contracts at the time of delivery and billing. However, many derivative contracts can still be valued based on a model that might have little to do with their eventual value.


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