Enron Corporation was a major U. S. energy company. Its executives engaged in a systematic accounting fraud that resulted in the company’s bankruptcy in 2001. In a February 19, 2004, press release, the U. S. Securities and Exchange Commission described a number of fraudulent transactions that Enron executives concocted in an effort to meet the company’s financial targets. One particularly well- known scheme was called the “ Nigerian barge” transaction, which took place in the fourth quarter of 1999. According to court documents, Enron arranged to sell three electricity-generating power barges moored off the coast of Nigeria. The “ buyer” was the investment banking firm Merrill Lynch. Although Enron reported this transaction as a sale in its statement of earnings, it turns out this was no ordinary sale. Merrill Lynch didn’t really want the barges and had only agreed to buy them because Enron guaranteed, in a secret side deal, that it would arrange for the barges to be bought back from Merrill Lynch within six months of the initial transaction. In addition, Enron promised to pay Merrill Lynch a hefty fee for doing the deal. In an interview on National Public Radio on August 17, 2002, Carl Levin, a Senator from Michigan, declared, “[ T] he case of the Nigerian barge transaction was, by any definition, a loan.”
Required:
1. Discuss whether the Nigerian barge transaction should have been considered a loan rather than a sale. As part of your discussion, consider the following questions. Doesn’t the Merrill Lynch payment to Enron at the time of the initial transaction automatically make it a sale, not a loan? Which aspects of the transaction are similar to a loan? Which aspects suggest that the criteria for revenue recognition (discussed in Chapter 3) were not fulfilled?
2. The effect of recording the transaction as a sale rather than a loan is fairly clear: Enron was able to boost its revenues and net earnings. What is somewhat less obvious, but nearly as important, are the effects on the statement of cash flows. Describe how recording the transaction as a sale rather than as a loan would change the statement of cash flows.
3. How would the two different statements of cash flows (described in your response to (2)) affect financial statement users?