Corporate shennanigans and the real deal

I’ll freely admit that one of the lessons I learned in many years of running a couple of corporations was that I should do what I know (exploration, planning, marketing, etc.) and rely on experts for the stuff I don’t know (accounting might be a good example). So, when it came up this afternoon, I had to concede that I couldn’t begin to supply an answer.

At hand was a discussion of the Enron debacle. Originally, the story of their accounting black hole centered on their off-balance-sheet partnerships.

Now, simple me, having left accounting maneuvers in the hands of those professionals, had thought that the balance sheet was supposed to encapsulate the whole story, i.e., everything in the company’s financial history has a place on the balance sheet.

So, I admit I do not wholly understand; are there legitimate off-balance-sheet activities?

What would those be?


Yes, there are legitimate off-balance sheet activities. For example, a company could set up a securitization of its accounts receivable to secure debt. This often involves (and may always - I have not done an in-depth study) setting up a seperate company that is not a part of the parent company. That company then “owns” the accounts receivable as well as the debt and neither amount is reported on the balance sheet.

What you will find is that these types of accounts should (especially after the last year) be closely scrutinized by the external auditors, to ensure that they are legitimate operations, and these items, will probably be referred to in the companies annual report and/or 10K reporting.
That’s about the best I can do - although I worked in internal audit, I was not closely involved with any debt securitization/accounts receivable, focusing mainly on operational issues.

Certainly. Think about your personal finances. Suppose you own one share of Microsoft stock, and Microsoft has a billion shares outstanding. Now suppose you are preparing your personal income statement and balance sheet. You don’t count one billionth of Microsoft’s assets, liabilities, and income as your own. You’d value the stock as an asset at its share price, recognize no liability, and count any dividend as income and share price appreciation as a capital gain. Your share of Microsoft is an “off-balance sheet activity”.

When one business owns a stake in another, the same principle applies. Microsoft itself owns stakes in many other businesses. When they own a small stake, they treat it just like you’d treat your one share of stock–“off balance sheet”. When they own a large stake, with effective control of the smaller company and some responsibility for its liabilities, the line can become difficult to draw.

In Enron’s case, they not only failed to draw the line but went fifty yards beyond it. They set up shell subsidiaries, with Enron retaining close to 100% ownership, complete control, and explicit responsibility for the subsidiary’s debts–but then took them “off balance sheet” for the purpose of deceiving investors.