Table Of Content

00 Ketz FM 5/21/03 9:58 AM Page i Hidden Financial Risk Understanding Off–Balance Sheet Accounting 00 Ketz FM 5/21/03 9:58 AM Page ii 00 Ketz FM 5/21/03 9:58 AM Page iii Hidden Financial Risk Understanding Off–Balance Sheet Accounting J. Edward Ketz JOHN WILEY& SONS, INC. 00 Ketz FM 5/21/03 9:58 AM Page iv ∞ 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. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA01923, 978-750-8400, fax 978-750-4470, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, e-mail: [email protected]. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993 or fax 317-572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com. 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 10 9 8 7 6 5 4 3 2 1 00 Ketz FM 5/21/03 9:58 AM Page v For Charity and Benjamin 00 Ketz FM 5/21/03 9:58 AM Page vi 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. vi 00 Ketz FM 5/21/03 9:58 AM Page vii 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 vii 00 Ketz FM 5/21/03 9:58 AM Page viii 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 viii 00 Ketz FM 5/21/03 9:58 AM Page ix 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 ix

Description:

What went wrong and how to fix it "This is a book that well represents the skeptical, probing, and doubting spirit of the time. Professor Ketz explores the ways corporate management and auditors can ‘spin’ financial reporting to misinform investors. It is written so that the individual investor