Repo 105, among others
Tuesday, March 16, 2010
Well. Most of my blog readers have passed through the stage of deciphering accounting case studies during their course work. So I here I bring you the latest topic which I am sure will be the staple of ethics and accounting classrooms in the future - repo 105. Gone are the days of Enron and Arthur Anderson. Usher in Lehman and Ernst & Young (if they are found guilty of not raising the flag on time).
In simple terms, repo 105 is a accounting practice followed by Lehman to move assets off balance sheet. In a normal repo (repurchase agreement), the assets are swapped for a certain amount with a promise to buy them back later and the assets stay on the balance sheet. If the cash received for these assets is such that the asset value is over 105% of cash received, then the transaction can be claimed as sale of assets and can be taken off balance sheet, which is what Lehman did, while failing to report these transactions in its financial statements. Read more of this here. The benefit of repo 105: it understates the leverage ratio (indication of amount of debt held) and lo, haven't we seen many companies tring to lower their leverage ratios for various reasons - to improve credit ratings, to get easy access to credit, to meet debt covenants, to get favorable market reviews, among others.
I can see this being the most talked about accounting practice in the future.
2 comments:
Munni, I am very much new to this REPO business. Currently working with the Monetary Operations dept of a Central Bank.
Your statement
"If the cash received for these assets is such that the asset value is over 105% of cash received, then the transaction can be claimed as sale of assets and can be taken off balance sheet,"
means that the accounting entries posted for the REPO were recorded as sale and not booked in REPO related accounts and with Accounts Payable showing some out-standing.
Correct me if I am wrong.
If yes, then the auditors are sleeping over by not vetting the Chart of Accounts properly and tracking cash in flows and out flow.
This also applies to the other side, who gave this short loan without verifying the value of the asset and did not book the REPO into proper accounts to facilitate future tracking for recoveries.
Requires two hands to clap!!!
Honestly I am not sure of the ledger entries in this case. I agree, any oversight by the counterparty can lead to misuse of the system
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