Understanding Financial Accounting 3rd Canadian Edition by Christopher D. Burnley solution manual
LO 2,5 BT: C Difficulty: H Time: 120 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting
RI1-6 Answers to this question will depend on the company selected.
LO 5 BT: AN Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001, cpa-t005
CM: Reporting and Finance
CASE SOLUTIONS
C1-1 Enticing Fashions Ltd.
Memorandum
To: CEO, Enticing Fashions Ltd.
From: Accountant
Re: Bank’s Use of Financial Statements
As the company is seeking financing from its bank to support its expansion plans, it is understandable that the bank will be taking a greater interest in the company’s financial reporting. Prior to approving any loan, the bank will use Enticing’s financial statements to assess the following:
The company’s ability to service a loan
The bank will use the financial statements to determine if Enticing has the earnings and cash flow to service the loan (i.e. pay interest on the loan and repay the loan principal).
Specifically, the bank will review the statement of income to assess the profitability of the company’s operations. If the company does not have a track record of profits, then it unlikely a loan will be granted. If the company is not profitable, it will not be able to pay interest or repay loan principal.
The bank will use the statement of cash flows to evaluate the amount of cash the company is generating from its operating activities. It will be these cash flows that Enticing will use to pay interest and repay principal. While it will look at the company’s financing and investing cash flows, the bank’s primary focus will be on those generated from operations.
C1-1 (Continued)
The extent of assets that the company has available that could be provided as security in the event of loan default
The bank will also want to ensure that it has adequate loan security. This will normally involve them taking a charge over some of the borrower’s assets. For example, they may want a charge over the Enticing’s accounts receivable and inventory, meaning these assets would revert to the bank for collection or sale to repay the loan if Enticing defaulted. They may also wish to use the property, plant and equipment of the company as security. This would involve the bank having a charge over Enticing’s equipment, buildings, land, etc. The bank could then seize and sell these assets to repay the loan in the event of default.
The bank will use the statement of financial position to determine what assets the company could provide as security. The bank would know that, for many assets, the values on the statement of financial position represent their historic cost rather than their fair values. As such, the bank may ask Enticing to obtain appraisals for these assets prior to agreeing to accept the assets as loan security.
I hope that this enhances your understanding of how the bank may use Enticing’s financial statements in the context of approving the company’s loan application. Please don’t hesitate to contact me if you wish to discuss this matter in greater detail.
Sincerely,
Accountant
LO 2 BT: C Difficulty: M Time: 35 min. AACSB: Communication CPA: cpa-t001 CM: Reporting
Legal Notice
Copyright
Copyright © 2022 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.
The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence.
The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.
MMXXI xii F1