Posts Tagged ‘repurchase agreements.’

Lehman Brothers used an accounting gimmick to increase a key percentage in its balance sheet, thereby appearing to be better off that it actually was.  This accounting gimmick was used to hit certain target numbers in an attempt to (1) keeping stock prices from dropping, and (2) forestall regulators from stepping in and forcing bankruptcy at an earlier date.

In the end, it was not enough to save the company.

Lehman capitalized on a “bad” accounting rule that allows what is called off-balance sheet financing.  Specifically, Lehman was able to remove liabilities from the balance sheet, thereby reducing leverage (the relative percentage of financial liabilities) and increasing the relative percentage of capital (or stockholders equity).

Was it an attempt to deceive?  Obviously, but activities that fudge some number happen every day in every company.  Was it material, or large enough to deceive?  At first glance the numbers involved are pretty small.  I’ll walk you through the analysis, but you have to go through a lot to find any percentages boosted a material amount.  But materiality is a judgment call, and Ernst & Young might not have reasoned the Repo 105 use was material (I’ll explain how to justify E&Y’s position).


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