OBSF Problem Paper Single Spaced, 10 p, 5-23-07

OBSF Problem Paper Single Spaced, 10 p, 5-23-07 -...

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OFF-BALANCE-SHEET FINANCING Kenneth E. Stone , University of Central Missouri Ronald D. Niemeyer , University of Central Missouri INTRODUCTION Accounting and business events that have occurred since the year 2001 have especially highlighted the problem of off-balance-sheet financing (OBSF) as a technique used to artificially enhance the reported Statement of Financial Position (Balance Sheet) of many business entities. The OBSF problem has been in existence for many years; however, it has recently been perceived as a heinous technique because of many prominent business failures of seemingly well-off companies such as Enron, WorldCom, Tyco, etc. The OBSF problem has been perpetuated by (1) poor accounting standards; (2) unethical and sometimes fraudulent behavior of executives; and (3) extreme pressures on company executives to meet expectations for earnings and financial position in order to maintain stockholders’ wealth. In this paper, the authors examine some of the many techniques used to create OBSF, and make suggestions for reducing or eliminating the OBSF problem and improving financial reporting. REVIEW OF RELATED LITERATURE The Securities and Exchange Commission (SEC) issued a report in 2005 regarding off-balance sheet financing as it relates to the quality of financial reporting (Miller and Bahnson 2005). The report targets the current method of accounting for defined-benefit pension plans and other post-retirement benefits (OPEBs). The SEC questions why the assets and liabilities of such plans are not included with the other assets and liabilities of the parent (sponsoring) company. The report also indicates dissatisfaction with management’s unwillingness to do more than is required by generally accepted accounting principles (GAAP) for financial reporting. The SEC would like for preparers to be more concerned with providing appropriate and transparent reporting to investors instead of being obsessed with meeting only the minimum requirements of current accounting rules. The absence of pension plan assets and liabilities from the balance sheet tends to withhold valuable information from both investors and management. Merton (2004) reports that managers tend to take only amounts reported on the balance sheet into account when calculating their company’s weighted average cost of capital (WACC). Therefore, omission from the balance sheet of the assets and liabilities associated with pension plans may cause managers to materially misjudge the related risks and incorrectly calculate the company’s WACC. Simulated calculations of the WACC for four large companies indicate that the omission of pension plan related risks in the determination of the WACC lead these companies to overestimate the WACC. Therefore, these companies would very likely reject some investment opportunities that should be accepted. Bauman (2003) reports on the equity method of accounting as a technique for providing off-balance-sheet
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This note was uploaded on 09/08/2010 for the course ACCT 3600 taught by Professor Stone during the Spring '10 term at UCM.

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OBSF Problem Paper Single Spaced, 10 p, 5-23-07 -...

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