In the lead up to the Blackstone initial public offering, The Wall Street Journal has a piece saying that it's shaping up as a test case of new fair-value accounting rules where profits can be booked years in advance of when the money actually comes in.

What makes it more difficult is that most of Blackstone's investments are in private companies. That makes them harder to value and could potentially give management far too much power in saying how much those investments might be worth.


"If Blackstone invested, say, $1 billion in a buyout of a company, it could determine that the fees it would generate when it sells the compay to be $200 million. Under such an assumption, Blackstone could book a portion of the $200 million upfront - and record higher fees later if it determines the value of the investment has risen,", the WSJ says.

"This method was once used by many companies, most notably Enron Corp, and led accounting rule makers a few years back to ban firms from booking immediate gains from certain transactions that didn't trade in active markets."

The comparison with Enron is spooky. Enron used so-called mark to market accounting to wildly inflate its books. Under this system, if Enron did a deal which might result in, say, $50 million profit in 10 years' time, it didn't have to wait until the money rolled in to put the profit on the books. Just doing the deal meant it put the estimated profit on its books even if the actual deal never turned a profit down the track. Indeed, many of the deals led to massive losses, but using mark to market and a string of other accounting tricks, Jeff Skilling and executives like Andy Fastow were able to constantly report growth in their quarterly results. It was a system that turned its books into fiction.

As Professor Paul Healy from Harvard Business School told me in this interview here, the fair-value rule will be abused.

No wonder Public Company Accounting Oversight Board member Charles Niemeier told the WSJ that it would "come back to haunt" the accounting rule makers.

You can read the entire WSJ piece here.