Making money by moving a bad or doubtful asset ("dead donkey") off the balance sheet. Enron Balance Sheet (anticipated), 12/31/199x Doubtful Asset 1,000,000 Owners' Equity 1,000,000 (a) Mr. Fast Bow contemplates the above balance sheet, and is concerned that the asset may be worth zero. If that is true, and nothing else happens, what would Enron's Income Statement and Balance Sheet look like at the end of 199y? (b) S. Killer advises Mr. Fast Bow to sell the doubtful asset for 3,000,000 to a Special Purpose Entity (set up by Fast Bow and buddies). What is the journal entry (in Enron's books) to record this sale? If this works out, what will its income statement and balance sheet look like on 12/31/199y? What will be the return on assets, and will this impress financial analysts? Exercise 2 -How the SPE raises 3 million for the 'dead donkey'. Pass journal entries for the following accounting events in the books of the SPE, and prepare its balance sheet. (i) SPE starts with $1 capital put in by Mr. Fast Bow. (ii) SPE raises $3,000,000 cash from Lazy Banks to help finance the purchase of Enron's bad asset. But why were the banks willing to lend 3 million to finance purchase of a bad asset? (one sentence) Exercise 3 - Issue of stock against promises to pay (Notes Receivable). Give journal entries for the following stock issue transactions in the books of Enron. (i) if Enron had issued stock for cash of 10 million. (ii) alternatively, for Enron's issue of stock to Fast Bow for his promise to pay 10 million. Question: Can stock be issued for consideration other than cash? For notes receivable? Exercise 4: List in correct time order the sequence of steps involved. Write each step in words, using a brief phrase. (This will help you for the more analytical questions later.) Conclusion: 1. What was Enron's gamble? You should now be able to see what whistleblower Sherron Watkins meant (in her testimony to Congress) by 'using stock to improve the income statement is plain illegal'. 2. Review the exercises for the conditions all of which were necessary for the scam to be successful for as long as it was. Explain why each condition is necessary. 3. Describe the ethical problem if any faced by any of the professionals involved - auditors, lawyers, bankers, analysts? For concreteness, you may assume that you were a mid-level employee in a bank that lent money to Enron