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Back in June, when headlines were screaming about the coming increase in student loan rates, we told you not to worry. We had full confidence that Congress would devise a scheme to keep the loans rolling for another year. And Congress actually exceeded our expectations. You see, they can’t control spending, even in a budget crisis.
But this time, even I was taken aback by the brazen accounting trick they devised. Congress found a way to claim they were getting revenue as they spent more tax dollars. And here’s how the scheme works.
Congress writes the rules for government accounting. So they’ve required federal accountants to book 100% of the future interest paid by a borrower in the year the loan is made. If a borrower is going to pay $5,000 in interest over the next decade, all the revenue is booked today.
In fiscal year (FY) 2013, for example, the government projects that student loans will generate a profit of $36 billion dollars. They’ve also ordered accountants to book all of the costs of the program immediately, thinking that this will balance the books.
Originally posted by roadgravel
This is the Enron style of accounting. Books all future potential profits now. Looks good on paper - we saw how it worked in real life.
In issuing student loans, the federal government incurs a large up-front cost (the loan given to the student) and then receives revenues (the student’s gradual repayments of the loan) over a period of several years. The government budgets for these transactions by taking the initial cost of the loan and subtracting all the projected repayments to create a single cost figure.
So far, so good. But things start to get complicated when we remember that students sometimes default on their loans, meaning that the average loan repayment is going to be less than what taxpayers are owed. So the government estimates an “expected” repayment and uses that lower figure to calculate future revenues.
Enron instead elected to report the entire value of each of its trades as revenue. This "merchant model" was considered much more aggressive in the accounting interpretation than the agent model. Enron's method of reporting inflated trading revenue was later adopted by other companies in the energy trading industry in an attempt to stay competitive with the company's large increase in revenue.
Between 1996 and 2000, Enron's revenues increased by more than 750%, rising from $13.3 billion in 1996 to $100.8 billion in 2000. This extensive expansion of 65% per year was unprecedented in any industry, including the energy industry which typically considered growth of 2–3% per year to be respectable. For just the first nine months of 2001, Enron reported $138.7 billion in revenues, which placed the company at the sixth position on the Fortune Global 500.
However, when Skilling joined the company, he demanded that the trading business adopt mark-to-market accounting, citing that it would represent "... true economic value." Enron became the first non-financial company to use the method to account for its complex long-term contracts. Mark-to-market accounting requires that once a long-term contract was signed, income is estimated as the present value of net future cash flow. Often, the viability of these contracts and their related costs were difficult to estimate. Due to the large discrepancies of attempting to match profits and cash, investors were typically given false or misleading reports. While using the method, income from projects could be recorded, although they might not have ever received the money, and in turn increasing financial earnings on the books.