Hidden financial risk: understanding off-balance sheet accounting

313 Pages·2003·1.76 MB·English

by  J. Edward Ketz

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Hidden Financial Risk
Understanding Off–Balance Sheet Accounting
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Hidden Financial Risk
Understanding Off–Balance Sheet Accounting
J. Edward Ketz
JOHN WILEY& SONS, INC.
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∞
This book is printed on acid-free paper.
Copyright ©2003 by J. Edward Ketz. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey
Published simultaneously in Canada
Copyright 2002 SmartPros Ltd. www.smartpros.com. Reprinted with permission.
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Library of Congress Cataloging-in-Publication Data
Ketz, J. Edward.
Hidden financial risk : understanding off-balance sheet accounting / J. Edward Ketz.
p. cm.
Includes bibliographical references and index.
ISBN 0-471-43376-4 (CLOTH)
1. Accounting—Case studies. 2. Accounting firms—Corrupt
practices—Case studies. 3. Business ethics—Case studies. I. Title.
HF5635 .K43 2003
658.15′5—dc21
2003003952
Printed in the United States of America
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For Charity and Benjamin
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About the Author
J. Edward Ketz is MBAFaculty Director and Associate Professor of Accounting at the
Penn State Smeal College of Business. He has been a member of the Penn State faculty
since 1981. He holds a bachelor’s degree in political science, a master’s degree in
accountancy, and a Ph.D. in business administration, all from Virginia Tech.
The teaching and research interests of Dr. Ketz focus on financial accounting,
accounting information systems, and accounting ethics. He has published numerous
academic and professional articles, and he has written seven books. Also, he is coeditor
of Advances in Accounting Education.
Dr. Ketz writes two columns about financial reporting issues. Accounting Todaypub-
lishes “Accounting Annotations,” while “Accounting Cycle: Wash, Rinse, and Spin”
appears on SmartPros.com. He has been cited in the popular and business press, includ-
ingThe Wall Street Journal,The New York Times,The Washington Post,Business Week,
and USAToday, and he has served as an accounting commentator on CNNfn.
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Contents
Preface xi
PART I My Investments Went Ouch! 1
1 What? AnotherAccounting Scandal? 3
Accounting Prophets: “They Have No Profits” 4
ARash of Bad Accounting 5
Debt? What Debt? 11
Summary and Conclusion 15
Notes 30
2 Balance Sheet Woes 33
Investment Risks 34
Some Ratios That Index Financial Risk 34
Financial Leverage and its Effects 36
Stock Prices and Financial Leverage 41
Bankruptcy Prediction Models 43
Bond Ratings Prediction Models 45
Cost of Lying 46
Summary and Conclusion 47
Notes 48
PART II Hiding Financial Risk 51
3 How to Hide Debt with the Equity Method 53
Brief Overview of Accounting for Investments 54
Equity Method versus Trading-Security
and Available-for-Sale Methods 55
Boston Chicken 57
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CONTENTS
Details about the Equity Method and Consolidation 58
Hiding Debt with the Equity Method 63
Summary and Conclusion 70
Notes 71
4 How to Hide Debt with Lease Accounting 73
Present Value 74
Brief Overview of Lease Accounting 83
More Details about Lease Accounting 90
Adjusting Operating Leases into Capital Leases 91
Summary and Conclusion 101
Notes 101
5 How to Hide Debt with Pension Accounting 103
Definitions and Concepts Underlying Pension Plans 105
Brief Overview of Pension Accounting 111
Adjusting Pension Assets and Liabilities 117
Summary and Conclusion 122
Notes 123
6 How to Hide Debt with Special-Purpose Entities 125
Special-Purpose Entity Landscape 126
Securitizations 131
Synthetic Leases 137
Accounting for Special-Purpose Entities 141
Preliminary Corporate Responses
about Special-Purpose Entity Accounting 142
Summary and Conclusion 143
Notes 144
PART III Failures that Led to Deceptions 149
7 Failure of Managers and Directors 151
Failure of Managers 152
Failure of Directors 155
Business Ethics: As Oxymoronic as Corporate Governance? 161
Culture 164
Summary and Conclusion 167
Notes 168
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Contents
8 Failure of the Auditing Profession 173
Securities Laws and the Auditing Profession 174
Evolution of Underauditing 177
Changing Nature of the Big, Independent Auditor 180
Serving the Public Interest 185
Andersen Verdict 187
Young Model: AReprise 188
Summary and Conclusion 190
Notes 191
Appendix Sutton’s Critique of Serving the Public Interest 195
9 Failure of Regulation 213
Failure of the Financial Accounting Standards Board 214
Failure of the Securities and Exchange Commission 219
Failure of Congress 223
Failure of the Courts 227
Summary and Conclusion 227
Notes 228
10 Failure of Investors 233
Failure of Financial Governance 234
More Accounting 235
Enron—AReprise 238
Rules for Investing 242
Summary and Conclusion 247
Notes 247
PART IV Making Financial Reports Credible 251
11 Andersen Has the Solution—Really! 253
Arthur Andersen Forgets its Roots 255
Purpose of Financial Reporting 256
Socialization 262
Andersen’s Accounting Court 263
Summary and Conclusion 265
Notes 267
Bibliography 269
Index 291
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