Ethical Decision Making: A Real$-$Life Example

In February $19,2004,$ press release, the 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 is 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 of Merrill Lynch$.$

Although Enron reported this transaction as a sale in its income statement, 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 $17,2002,$ Michigan Senator Carl Levin

declared, $"($T$)$he case of the Nigerian barge transaction was, by any definition, a loan."

Required:

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? What aspects of the transaction are similar to a loan? Which aspects suggest that the four criteria for revenue

recognition $($summarized near the end of Chapter $3)$ were not fulfilled?

The income statement effect of recording the transaction as a sale rather than a loan is fairly clear: Enron was able to boost its

revenues and net income. 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.

How would the two different statements of cash flows $($described in your response to requirement $2)$ affect financial statement users?