The Business Book

(Joyce) #1

154


O N L Y W H E N T H E T I D E


G O E S O U T D O Y O U


D I S C O V E R W H O ’ S B E E N


S W I M M I N G N A K E D


OFF-BALANCE-SHEET RISK


See also: Play by the rules 120–23 ■ Accountability and governance 130–31 ■
Who bears the risk? 138–45 ■ Leverage and excess risk 150–51

T


he balance sheet is a
snapshot of a company’s
assets and liabilities and
should show any financial risks that
a company is facing. Yet in reality,
not all of the company’s liabilities
appear there. This means that when
calculating the debts of a business,
it may not be possible to account for
everything. This was the case when
Enron failed in 2001, and it was also
true for the Western retailers and
banks that struggled from 2007–08.
Operating off balance sheet
was at the heart of the 2011 scandal
at Japanese camera company
Olympus. To hide poor management
decisions, such as overpaying in
takeover bids, the board set up
unconsolidated subsidiaries to hold
the transactions that were causing
losses. As unconsolidated losses, the
figures did not have to appear in the
its annual accounts. Analysts and
auditors should have spotted that
something was wrong when profits
appeared “healthy” while cash was
draining out of the business. But
nothing was spotted until new CEO
Michael Woodford blew the whistle.

Off-balance-sheet finance has been
increasingly used by governments
in recent decades. In China, the
National Audit Office has warned
that local government may have as
much as three times its official debt
of $600 billion in off-balance-sheet
unofficial debt. This will add
greatly to future interest charges—
and may carry significant risk if
China experiences a credit crunch
similar to that in the US and
Europe from 2007–08 onwards. ■

Enron used off- balance-sheet
accounting to hide overvalued assets
in subsidiary businesses. Its financial
records continued to look perfect even
as it spiraled toward bankruptcy.

IN CONTEXT


FOCUS
Financial risk

KEY DATES
1992 Terry Smith publishes
Accounting for Growth, an
insider exposé of accounting
practices in big businesses.

2001 The spectacular collapse
of Enron shows that practices
such as off-balance-sheet
accounting are not just
obscure talking points.

2010 Lehman Brothers bank
is revealed to have used “Repo
105” and “Repo 108” repurchase
transactions to temporarily
remove some loans and
investments from its balance
sheet for 7 to 10 days, creating
a misleading picture of its
activities and value.

2011 UK care provider
Southern Cross collapses due
to off-balance-sheet debts to
the value of $8 (£5) billion.
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