Forensics Journal - Stevenson University 2015 | Page 11

FORENSICS JOURNAL

third party confirmations from each lessor to discuss and verify the
accuracy of lease terms for a better understanding of the corporation’s
lease accounting practices. It is imperative to ascertain whether
the lease amounts and footnote disclosures in the corporation’s
financial statements are accounted for in accordance with FASB
Statement No. 13.

positive net amount; however, financial statement readers should be
able to identify the assets as well as the liabilities separately, in order to
make sound financial decisions.
A study conducted by the SEC revealed “…defined-benefit pension
plan obligations and assets reported by the population approximate
$1.320 trillion and $1.119 trillion, respectively… pension plans for
the population may be underfunded by approximately $201 billion
on a net basis” (United States Securities and Exchange Commission
[SEC], 2005, p. 55). The FASB permits corporations to net pension
assets against pension liabilities; however, the netting of the pension
assets against the pension liabilities can mislead financial statement
readers to believe that the assets will be there to cover the pension
liabilities. As noted by the SEC’s study on the United States
population, pension assets and pension liabilities should be
reported separately, so creditors and investors can determine the
corporation’s pension fund status. To obtain a true representation
of the corporation’s pension costs, a prudent creditor and investor
must adjust the prepaid pension cost or accrued pension cost account
on the balance sheet to separate the projected benefit obligations
from the pension plan assets (Ketz, 2003, p. 123). In reviewing
a corporation’s pension costs, financial statement readers use a
corporation’s balance sheet by allocating pension assets to the
assets section and pension debts to the liabilities section. In addition,
estimates of interest rates must be evaluated for reliability, since these
factors of measurement can be easily manipulated.

There are two types of pension plans offered by employers: the
defined contribution plan and the defined benefit plan. A defined
contribution plan allows an employer and an employee to contribute
funds to the pension plan in which the funds are then used to make
investments until the employee retires (Ketz, 2003, p. 106). In the
defined contribution plan, the employee contributes funds to the
plan, which the employer may match depending on the agreement
between the employer and the employee. Conversely, in a defined
benefit plan, an employer guarantees to pay the employee an agreed
amount once the employee retires, wherein the employer is burdened
with this long-term obligation (Ketz, 2003, p. 107). Based on the
agreement between the employer and employee, the amount paid
after retirement is determined at the employer’s discretion.
In the book Hidden Financial Risk: Understanding Off-balance-sheet
Accounting, Ketz warns “…we cannot believe the pension costs that
most corporations report, for the FASB engages in some fairy-tale
magic” (Ketz, 2003, p. 117). Corporations may exercise greater
flexibility in accounting for a defined benefit plan than a defined
contribution plan because they determine the funding amount, and
measure the present value of the projected benefit obligation paid
after retirement as well as the service costs for the annual impact on
the pension commitments. In addition, the employer must calculate
the interest cost and expected return on plan assets for the net pension
cost (annual service cost plus interest cost minus expected return on
plan assets), which is reported on the income statement. The net
amount (previous balance minus net pension cost plus funding)
is reported on the balance sheet as either an asset account, prepaid
pension cost (if positive), or a liability account, accrued pension
cost (if negative). The net amount should also equal the plan assets
(previous balance plus the expected return on plan assets plus any
additional funding) minus the projected benefit obligation (Ketz,
2003, pp. 107-113). Accordingly, corporations may employ creative
accounting practices for a defined benefit plan by manipulating the
net amount reported on their balance sheet as a prepaid pension
cost or accrued pension cost and/or estimating a higher interest rate
to calculate the projected benefit obligation and expected return on
plan assets. This will lower the corporation’s liabilities and hide its
pension debts (Ketz, 2003, p. 118). A corporation is permitted to
report a net amount on the balance sheet however the corporation’s
assets may exceed its liabilities, and a positive amount will result in
an overfunded pension plan; wherein this amount is only an illusion,
because the corporation is permitted to avoid reporting the liability
on its balance sheet. Assets often exceed liabilities resulting in a

Established in 1970, special-purpose entities (SPE) are another
method for a corporation to hide debt, wherein a separate entity
is created and operated for a specific purpose such as financing
(Ketz, 2003, p. 126). SPEs have evolved over time and assumed
different values within the business community. A corporation may
create and structure a SPE to obtain credit at a cheaper price, decrease
its income tax liability, or avoid consolidating its liabilities on the
balance sheet (Ketz, 2003, pp. 127-128). Critics believe SPEs are a
new mechanism to conquer deception in order to mislead creditors
and investors, while advocates argue SPEs aid in hedging risk. Ketz
states, “…the government’s pension fund known as social security is
a massive SPE that the federal government maintains for the express
purpose of hiding the debts from its citizens” (Ketz, 2003, p. 128).
Consolidation is the key issue when accounting for SPEs. In
comparison to accounting for equity investments, a corporation
that controls another entity’s operations must apply the consolidation
method when accounting for an SPE. In recent times, concerns
regarding SPE consolidation were elevated by investors, the SEC,
and the President’s Working Group on Financial