For insiders only.
For casual readers, this will probably go way over your head. If you’re a C suite executive of a publicly traded company, you’ve probably already heard about this. If not, get on the phone with your auditors and find out how this will affect your balance sheet. Then have a meeting with your in house experts to estimate the impact on your stock value.
It could be significant. It would have been for Enron. Of course Enron specialized in ways to hide liabilities from investors and regulators. We’ll give you the benefit of the doubt and assume your company isn’t.
“Off-balance-sheet’ issues in Enron’s financial reporting ate Arthur Andersen alive, it pains me to have to say that because AA is my alma mater. When I was with them they were the biggest and best, and they attracted the smartest people on the face of the earth. When I joined them, my entire freshmen class had graduated number one from their college or university. There were always two types at AA, the bright but thoughtful and the the type that were so smart they weren’t afraid of anything. The wrong element got into power at the wrong time. When Enron and a few bad apples drug them under, their consulting arm had just split away and become Accenture. But they were the largest CPA firm, Accenture was the largest consulting firm in the world and their new in house consulting firm was second largest. Plus, AA was the only real large accounting firm to grow on its own abilities. All the other big firms did it by forming associations. AA never even acquired another firm as far as I know. You may not realize this, but the entire Big Four are associations of individual firms. They grew by forming associations.
In any event, when the Enron debacle hit and AA’s shortcomings became public knowledge, Congress directed the SEC to investigate ‘off-balance-sheet’ issues and repot back. Four years later, the SEC issued a report condemning lease accounting as a ‘giant loophole’. Since then, the world’s two largest accounting rule makers, the FASB and the IASB have recommended wholesale changes to lease accounting. PwC, one of the four largest accounting firms, describes the resulting proposals to change all of this as the biggest accounting change ever.
Enron’s ‘modus operandi’ was to figure out ways to leave liabilities off the balance sheet. In many cases, including their’s, this resulted in leaving the assets tied to these liabilities off as well, even if the asset was worthless – which in Enron’s case it usually was. This can have the affect, as it did in Enron’s case, of greatly strengthening a company’s appearance to the financial markets.
For instance, if you are a reporting company who leased a big ship for which you still owe $40 million in lease payments, but the ship is now worthless and sitting in dry dock, other than for some notes disclosing limited data, this entire transaction is hidden from the public, the investors, and the regulators. This is the loophole the AICPA and the IASB are attempting to close.
This is a necessary change to the accounting rules. I remember when they were trying to figure out how to report for leases, we professionals called it the lease of the month club. They must have issued thirty opinions about leases. That’s how I remember it. It became a joke. The FASB ran off the tracks in those day and never really recovered. At least that’s my opinion. The were often guilty of overthinking. Which is what happened here. It certainly would have gone a lot better had they simply concentrated on the users of financial statements. Today the SEC plays a bigger role in accounting rule making than does the FASB. That’s what happens when you turn an important task over to a bunch of technocrats in green eye shades.
But, you can be certain, this will have a significant impact on financial reporting.