Solution
David answered on
Dec 23 2021
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OFF BALANCE SHEET FINANCING
ENRON CASE
Part 1
Off-Balance Sheet Financing is that situation when a company does not disclose its large
capital expenditure in the balance sheet by putting them under different categories or
classification, through various methods. This is done by the companies just to make sure that
their leverage and debt to equity ratios low. These are actually the contrasts to loan, equity
and debt, which are not shown in balance sheet of the company.
Operating Lease is one of the most common examples of off-balance sheet financing. In this
particular, the asset is not shown in the balance sheet of the lessee. The main asset is shown
in the balance sheet of the lessor. And on the other hand, the lessee is required to disclose just
the rental payment made by him for the usage of the asset. Generally Accepted Accounting
Principles (GAAP) has given certain rules and regulations to determine whether a particular
lease should be capitalised pr expensed in the financial statement. Many companies have used
this phenomenon to create a spam and have been included in fraudulent activities. An entity
can actually use the asset either by taking the rights to use the same or simply buy it. On the
other hand, the entity also can buy the same for its usage. Whether the capital expenditure
done by it will be shown in the balance sheet or not greatly depends upon the nature of the
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agreement made for the asset. There are many commercial reasons to explain the use of off
alance sheet financing. The commercial reasons are required because off balancing
financing can actually lead to various scams and frauds as in the mentioned case of enron
corporation. The leverage and the interest coverage can be flattered with the help of this
facility. Therefore, it highly recommended by the accounting authorities to make sure that the
entities and the companies have a strong reason to proceed with off balance sheet financing.
Any company that uses off balance sheet financing does not show the true picture of the
company as many of the items are not included in the balance sheet. It is the liability which is
not actually shown in the balance sheet of a company.
Off balance sheet financing is often conducted in research and development partnership, joint
ventures, and at times in consignment also. “Common off balance sheet financing
mechanisms include consignment stock, sale and repurchase (or leaseback) a
angements,
debt factoring, securitisation, creation of special purpose entities, and leasing”
(http:
lexicon.ft.com/Term?term=off-balance-sheet-financing). The off balance sheet
financing at times creates a flattering expression of the balance sheet. These gave a false
impression of the balance sheet ratios and leverage. Along with this, the return on equity also
does not give us the proper impression of the company.
Off Balance sheet financing has been one of the major concerns for the Accounting
Authorities since the Enron case. The basic problem related to off balance sheet financing is
the fact that the people are unable to see the true and actual picture of the company. The
financial ratios which are generally utilised to know the cu
ent position of the company will
not be able to provide the people with actual status of the company. As the liability portion is
not disclosed, the financial ratios will give the result which is unfair. The ratios, being the
most important factor for an investor to make its decision, will itself show an unfair result.
http:
lexicon.ft.com/Term?term=off-balance-sheet-financing
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In today‟s market the companies look to gain a competitive advantage over
other companies. This is one of the major reasons for them to get succeeded in this field.
With this particular aspect, the effectiveness of the companies increases which ultimately
helps them in gaining a competitive advantage over other companies of the same industry.
Because of this factor, many companies have gained a lot of goodwill of the investors.
Because of this reason, the company can show a better and a stronger impression and will
attract the investors to make an investment in the company. “The major issue in off-balance-
sheet financing which is transparent to the lender, but can have significant accounting
implications is whether the lease will be considered a capital lease or an operating lease.”
(http:
www.iveybusinessjournal.com/topics/strategy/off-balance-sheet-financing-and-trusts-
a-competitive-advantage#.UgUd7pI_v-U). The accounting prospect is harmful as the true and
fair picture of the company is not visible which may create an issue for the investors and for
the clients of the company. As the leverage and other ratios of the company will be shown
efficiently, the company will be able to gain more and more an investors which will
obviously work in the favour of the same. Generally, all the investors make an investment in
the company after having a true and fair picture of the company. But with this off balance
sheet financing, the proper and the fair picture of the company could not be seen by the
investors and wrongful decisions can be made by them. This has been one of the major
problems for the investors. Though the company shows the transparent pictures of the
financial statements, yet the ratios and the leverage of the company cannot be worthy enough
to trust. Some of the companies hide billions of debts that they have in order to ca
y on the
usiness. The main reason for hiding the debts of the company is the fact that the investors of
the company will be least interested in making an investment in the activities of the company.
Therefore we can conclude that off balance sheet financing is one of the
major ways as used by companies in order to not to disclose the amount of debt factor in the
http:
www.iveybusinessjournal.com/topics/strategy/off-balance-sheet-financing-and-trusts-a-competitive-advantage#.UgUd7pI_v-U
http:
www.iveybusinessjournal.com/topics/strategy/off-balance-sheet-financing-and-trusts-a-competitive-advantage#.UgUd7pI_v-U
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company. As it helps in hiding the amount of debt taken by a company, the true picture
cannot be seen, that is why GAAP has given the rules and regulations which are to be
followed by the company in order to determine whether the following expenditure is to be
shown in the balance sheet or not.
Part 2
AN OVERVIEW OF THE ENRON OFF BALANCESHEET FRAUD
CASE
BACKGROUND
The Enron scandal is one of the biggest fraud cases of all time which left the entire American
economy in shackles as the company was hiding billions of dollars of debt incu
ed by it.
This scandal was eventually revealed in October 2001 that resulted into bankruptcy of the
Enron Corporation. Enron Corporation (once the seventh largest company in America) is an
American based energy company situated in Houston, Texas. The organization came into
existence in 1985 when it was founded by Kenneth Lay by merging the two companies called
Houston Natural Gas and Inter North. Basically the fraud was a result of the loopholes in
USA‟s accounting policies, improper and poor financial reporting and with...