Off-Balance Sheet Financing and Balance Sheet Fraud Essay

 

Off-Balance Sheet Financing is an accounting process that is associated with debts that are non reported on the balance sheet of a company. Aboagyea? Otchere and Agbeibor ( 2012, p. 197 ) is against the usage of off sheet balance coverage, in the fiscal records of companies. This is because fiscal statements, which are prepared through this manner of fiscal coverage usually, fail to give a true representation of the economic value or substance of the company. This is because of the legitimate failure to describe some assets and liabilities. This paper provides a treatment to the extent to which this statement is true.

In run intoing the aims of this paper, the research worker will place illustrations of off balance sheet coverage. This is to assist in understanding this construct. Thereafter, the research worker will explicate how this construct helps in helping balance sheet fraud. This paper will besides incorporate a instance survey on companies that failed because of the usage of this type of fiscal coverage. This paper has a decision, which is a sum-up of the major point’s references in it. A good illustration of off-balance sheet coverage is the unconsolidated subordinate.

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Under the rules of unconsolidated subordinate, a parent organisation may non be mandated to consolidate or describe the activities of its subordinates in their fiscal records or statements ( Stickney and Brown, 2007, p. 81 ) . However, it is of import to explicate that the company has an duty to pay any unconsolidated liabilities, of its subordinate companies ( Lemieux and Limonad, 2011, p. 35 ) . Operating rental is another illustration of an off balance sheet financing/ coverage. These are usually entered for intents of utilizing the rentals on a short period of clip, comparative to their overall utile lives.

Brigham and Houston ( 2004, p. 27 ) explain that an operating rental does non affect the transportation of any hazards or wagess of ownership. Based on this fact, it is non possible to describe them on the balance sheet of an organisation that has entered into the rental understanding ( Chorafas, 2000, p. 114 ) . Other illustrations of off balance sheet coverage includes, take or pay contract, sale of histories receivables, etc ( Caracuzzo, 2009, p. 373 ) . It is of import to hold a consideration of these off-balance-sheet fiscal agreements, because they can hold an impact on the fiscal stableness of a company.

For illustration, if an organisation defaults on the rental payments, that is required because of runing a rental, so the lease giver can reclaim the assets of the company. Off Balance Sheet Reporting and Balance Sheet Fraud: One of the major grounds given, as to why Off Balance Sheet coverage does non denote the true value of an organisation, is the fact that it encourages balance sheet fraud ( Petrick and Scherer, 2003, p. 43 ) . Balance sheet fraud usually occurs when an organisation gives an inaccurate study on their liabilities and debts ( Elliott and Elliot, 2005, p. 60 ) .

Normally, this happens when the company provides an inaccurate low figure of their liabilities and debts. One of the off balance sheet strategies aimed at inaccurately cut downing the liabilities of a company is the misclassification of a capital rental. In every bit much as capital rentals are usually recorded as liabilities under international accounting regulations, it is non a demand to describe runing rentals as a liability. Some fiscal experts usually misclassify capital rentals as operational rentals, therefore avoiding enlisting them in the balance sheet ( Ketz, 2003, p. 1 ) .

Through this action, the fiscal experts have managed to enter a low figure of their liabilities. This therefore fails to supply the true value of the company, because of an understatement of its liabilities. The Lehman brother was accused of a false misclassification of its capital rentals, thereby misdirecting investors on the true value of the concern organisation ( Paramasivan and Subramanian, 2009, p. 51 ) . Doran ( 2012, p. 44 ) . Failure to record accrued disbursals as another balance sheet offense, made possible through the rules of off balance sheet coverage.

Accountants usually use this method for intents of minimizing the liabilities of the company, hence increasing its income ( Lander and Auger, 2008, p. 35 ) . Prior to its autumn in 2001, the main executives of Enron used this method at exaggerating its fiscal public presentation. This made investors to believe that the company was executing good, merely to surprisingly hear that the company was registering for bankruptcy. The usage accounting records of their unconsolidated subordinates, for intents of hiding liabilities is another off balance sheet activity that contributes to fraud.

This is a method that is largely used by shell companies, in a command to avoid revenue enhancements, or launder money ( Rogers, 2005, p. 41 ) . Shell companies are little private companies, which do non hold a physical reference. They are usually formed as stock keeping companies, or for intents of keeping and pull offing the intangible assets of other companies ( Doran, 2012, p. 42 ) . Enron was accused of utilizing its shell subordinate companies to offload its fiscal liabilities, to these companies ( Petrick and Scherer, 2003, p. 39 ) . This had an consequence of neglecting to bring forth a true and accurate fiscal place of the company.

Doran ( 2012, p. 12 ) explains that the usage of sophisticated fiscal minutess to take liabilities from the balance sheets of a company has an impact in inaccurately increasing the grosss of a company. Lehman brothers developed their ain fiscal system referred to as Repo 105, whose chief purpose was to conceal the liabilities of the company, for intents of increasing its grosss. Repo 105 refers to a short term loan, where the company is able to sort short term loans as gross revenues, and utilize these “sales proceeds” for intents of cut downing the debts or liabilities of the company ( Hines, Kreuze and Langsam, 2011, p. 7 ) .

Case Study Examples: WorldCom is a company that was accused of utilizing the rules of off balance sheet describing for intents of blow uping its net incomes, by a humongous 3. 8 billion dollars ( Laing and Perrin, 2011, p. 44 ) . The company was accused of capitalising certain costs, which were supposed to be treated as disbursals. This was able to let the organisation to distribute its assorted disbursals over a period of many old ages ( Clikeman, 2009, p. 31 ) . This is every bit opposed to entering these costs as disbursals in their current periods.

Such a recess of costs was able to let the company to describe a low disbursal, therefore blow uping their incomes ( Elliott and Elliott, 2008, p. 19 ) . The comptrollers of the company were able to misclassify their disbursals, taging them as long-run beginnings of gross ( Clikeman, 2009, p. 37 ) . The company besides had undocumented computing machine related disbursals, numbering to 500 million dollars, which were seen as assets. Another company is called Health-South. This is a company with its central offices in Birmingham ( Clikeman, 2009, p. 33 ) .

The company was accused of intentionally utilizing the rules of off balance sheet coverage to blow up its income, so that it may run into the earning criterions and outlooks of Wall Street. This deceitful activity began in the twelvemonth 1996, upon which, the true fiscal value of the company was 1. 7 billion dollars ( Holtzman, 2008, p. 31 ) . In the twelvemonth 2003, the directors of the company were charged for willing exaggerating its hard currency sedimentations by 300 million dollars and exaggerating the entire assets of the company by 800 million dollars ( Clikeman, 2009, p. 9 ) .

However, grounds presented during the test of this company indicated that it used legitimate accounting methods in supplying fiscal studies to its stockholders. Another company accused of utilizing off balance sheet coverage to perpetrate fraud was Olympus Corporation. Olympus is a Nipponese multi-national corporation, and it was accused of concealing its losingss and liabilities to assorted subordinate companies that were under its control ( Wolny, 2013, p. 19 ) . These subordinate companies were unconsolidated fiscal organisations.

Furthermore, the company recorded these losingss at value that exceeded their just values. Subsequently on, the company was able to categorise these losingss as costs which were incurred because of the acquisition of other entities, or fiscal consultative costs. Enron is another company responsible for utilizing the rules of off balance sheet coverage to conceal its losingss and liabilities. Through subordinate organisations, and complex fiscal coverage, the company was able to conceal its losingss and liabilities.

Decision: As illustrated through the illustrations contained in this paper, it is possible to asseverate that off balance sheet coverage does non give a true value of the company. In fact, this technique of fiscal coverage makes it easier for companies to prosecute in deceitful activities. This is by exaggerating their assets, and cut downing their liabilities. Companies such as World Com, and Health South managed to take advantage of the commissariats of off balance sheet coverage to perpetrate fraud in their balance sheets.

This is by neglecting to account for the legion disbursals and liabilities that the companies incurred. Based on these facts, the companies managed to portray an inaccurate fiscal place, therefore misdirecting its stockholders, and other interest holders of the organisation. This made them to lose 1000000s of dollars. Based on these facts, it is hence prudent for a company to utilize the on balance sheet fiscal coverage. This would assist in placing the true value of an organisation.