My last article was a book review of the The Smartest Guys in the Room. This book covered the Enron debacle and is part of the series of articles I have written on SOX Section 409 Real Time Disclosures.

The application of mark-to-market accounting was brought to the attention of the public immediately following Enron's filing for bankruptcy. Mark-to-market accounting is actually a fairly easy concept to understand if you break it down to its lowest common denominator.

Here is an example:

Let say I invent a machine that will rearrange the molecules in the fabric of a pair of jeans so that the jeans fit your body perfectly every time you wear them. I have a five-year contract with a merchandiser for the sale of this machine. My best guess is that my sales over 5 years will be 50 million dollars.

Instead of waiting to book the profits as the machine is sold, under mark-to-market I can book the entire 50 million at the time the contract is signed with the merchandiser.

Ok, you might be wondering, why would I want to do this? What would be the purpose, as the 50 million was just my best guess - a figure I wrote down on a napkin at the local Starbucks while drinking a cup of coffee.

High ranking employees at most publicly traded corporations are rewarded by methods other than their agreed upon salary. This reward system allows for millions of dollars of incentive payments and stock options to be given to those employees as they deliver faster and faster revenues and earnings growth.

Meeting and exceeding revenue projections only has one effect on the price of stock as traded on the open market - the price goes up. This will have a direct effect on the amount of money I would make when I exercise and sell any stock options tied to an incentive plan.

It can be a shell game as new ideas must be constantly generated and theoretical profits booked to keep the action in process.

This is what happened at Enron. Mark-to-market accounting treatment was a condition of Jeffrey Skilling accepting employment at Enron. Enron's accounting firm, Arthur Anderson, signed off on the treatment and the SEC approved it. Unfortunately for the lower ranking employees at Enron, Enron's grandiose revenue streams never came to fruition thus leading to Enron's eventual bankruptcy.