Repo 105 and Repo 108 are accounting methods that are used by firms to leverage themselves against potential financial difficulties through short-term sale of liabilities at a discounted rate. However, it is done for a short period to avoid the impact of becoming reliant on debts. This paper presents an investigation as to whether the use of Repo 105 amounted to a fraudulent practice that contributed to its collapse.
Repo 105 represents an accounting trick that aims at leveraging a potentially broke company to use short-term loan as a sale, thereby gaining an upper hand in reducing its liabilities. In essence, the company invariably accesses the funds of other companies even though in a short period. However, in business world, this can help in bringing in a lot of unaccounted profits. According to Hines (2006), the borrower of the funds promises to repay the short-term loan with an agreed amount of interest and the guarantee typically never changes hands between the two companies. This lack of sharing agreement opens a loophole where companies can easily record the incoming cash as sales while the agreement’s assumption is that the cash was sold off and bought back later into the company.
Financial Statement Fraud
In the case of Lehman Brother, the firm increasingly paid interest to Ernst & Young over a period of seven years. This implicates that these payment were being illegally made. There are possibilities that the accounting officers at Lehmans were fully aware of this fraud but chose to perpetuate it for that period while enjoying kickbacks from Ernst & Young. Analysis of the use of Repo 105 at Lehman Brothers indicated a payment of over 50 billion dollars in an attempt to reduce the advantage on the balance sheet even after the earnings of the company were announced to the stakeholders. The use of Repo 105 by Lehman Brothers meant that for a period of seven years Ernest & Young were buying the liabilities that the firm had at a discount of 5%. In the spirit of the measure, this could not have caused the firm dearly were it implemented within a short period
Consequently, this made the impression of the company as being much dependent on debts, when the actual position was that the firm was collapsing under the weight of accumulated debt. Furthermore, the investors of the firm did not have access to this information and therefore continued to pump their money into the firm, while thinking they were making wise investment.
Since its use by Lehman Brothers, Repo 105 was a highly guarded secret; the investors did not have information of making decisions about the firm with confidence. Repo 105 itself is not a fraudulent accounting practice and it is being used by several companies that face difficulty in their financial status. However, it is a short-term measure because the assets return less than their actual value. Lehman Brothers used the principle for more than it was necessary; implying that the method was being used to fleece investors of their money. As such, the financial report by Lehman Brothers did not allow investors to differentiate among investment options available for them basing on their judgment in relation to the factual financial standing of their investment.
As such, the Lehman Brothers and Repo 105 stands as a fraud case given the fact that Lehman Brothers did this hastily without proper general acceptable principles of accounting. In addition, the Lehman Brothers did hide the actual standings of its financial status from investors. In essence, the company disguised its actual ineptness in handling financial reporting, instead opting for Repo 105 as a route to escape penalty. Thus, the firm went into bankruptcy as a result of payments that were being made to Ernst & Young for a period of seven years.
In conclusion, it is evident that the use of Repo 105 was a fraudulent measure in the case of Lehman Brothers as it failed to indicate to the investors that the firm was using the method to cushion them against the effects of short-term liabilities.