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Chapter One 1. “Badly in Need of Repair,” Economist, May 4, 2002, pp. 66–68. 2. It is more than likely that the drop in stock prices had some adverse effects on the underlying real economy. For one set of estimates, see Carol Graham, Robert E. Litan, and Sandip Sukhtankar, “The Bigger They Are, The Harder They Fall: An Estimate of the Costs of the Crisis in Corporate Governance,” Brookings Policy Brief (August 2000). 3. “Rebuilding Trust—Before It’s Too Late,” Business Week, June 24, 2002, p. 164. 4. The Sarbanes-Oxley Act of 2002 formally gave the FASB the authority to establish accounting and auditing standards, subject to oversight by the SEC; all publicly traded companies and public accounting firms must follow the standards. The act also created the Public Company Accounting Oversight Board, which is charged with overall supervision of registered public accounting firms, which public companies must use as their external auditors. 5. E. S. Browning, “Where Is The Love? It Isn’t Oozing From Stocks,” Wall Street Journal, December 24, 2001, p. C1. 6. “FASB Finally Comes Up with SPE Rules,” Treasury & Risk Management, vol. 12, no. 7 (August 2002), p. 9. Notes 105 06-0890-NOTES 1/30/03 9:37 AM Page 105     ‒ 7. As we discuss in chapter 3, this outcome could be achieved either directly (by having explicit rules allowing firms listing on exchanges to choose the reporting standards) or indirectly (by allowing exchanges, each having their own associated disclosure system, to compete in different countries without restriction). 8. A good case can be made, however, in support of mandatory rotation of auditing partners within the same firm, as is now required by the Sarbanes-Oxley Act of 2002. Chapter Two 1. See, in particular, William Z. Ripley, Main Street and Wall Street (Boston: Little, Brown and Co., 1927). 2. As discussed in chapter 3, Congress and the stock exchanges moved in the summer of 2002 to ensure that corporate managers who were in a position to manipulate a firm’s financial statements would not also be responsible for hiring and firing the firm’s external auditors. 3. The AICPA has played a role in setting GAAP through its Accounting Standards Executive Committee’s Statements of Operating Positions (SOP) and its industry audit guides, when these are accepted by the FASB. However, the AICPA has announced that in the future only the FASB will establish GAAP. 4. An important exception is fair-value accounting for financial assets, which we examine later. 5. A key example is the expense associated with stock options, which is not currently reported as an expense in the income statement. We address this issue later in the chapter. 6. For firms that might liquidate, transaction costs reduce the values of most assets usually below their purchase price. 7. Managers should also distinguish between revenue earned from the operations of the enterprise and income derived from the sale and revaluation of assets and liabilities. This distinction is important because many users of financial statements (particularly investors) base their calculations of a company’s prospects on its past performance, as reflected by its revenue and net income from continuing operations. 8. At the time Enron declared bankruptcy, its reported assets were $63 billion . WorldCom reported assets of $107 billion when it went down. Until these two failures, the largest corporate collapse was Texaco, which had $36 billion in assets when it declared bankruptcy in 1987. 9. These restatements reduced previously reported net income to the following levels: 1997, $28 million (27 percent of previously reported $105 million); 1998, $133 million (19 percent of previously reported $703 million); 1999, 06-0890-NOTES 1/30/03 9:37 AM Page 106    ‒  $248 million (28 percent of previously reported $893 million); and 2000, $99 million (10 percent of previously reported $979 million). 10. “Report of Investigation by the Special Investigative Committee of the Board of Directors of Enron Corp.,” William Co. Powers, chair, Raymond S. Troubh, and Herbert S. Winokur Jr. (Houston, February 1, 2002). Our analysis here is based on the Powers Report and press reports and the analysis thereof in George J. Benston and Al L. Hartgraves, “Enron: What Happened and What We Can Learn from It,” Journal of Accounting and Public Policy, vol. 21, no. 2 (2002), pp. 105–27. 11. SPEs may take the legal form of a partnership, corporation, trust, or joint venture. 12. For a complete description of the accounting rules governing consolidation of SPEs and other...