Okeana State Bank Okeana State Bank (OSB) is a small state-chartered bank in the

Question

Okeana State Bank

            Okeana State Bank (OSB) is a small state-chartered bank in the village of Okeana, Ohio. 90% of the stock in OSB is owned by members of the Fieher family. The bank was founded by the current presidents great grandfather, and most stock is passed from one family generation to the next.

            In recent years the banking industry has seen increasing consolidation. This has occurred for four reasons. First, the banking industry has largely been deregulated. Previous to deregulation, the government prohibited banks from getting too large. Second, there are large economies of scale in the industry, particularly with respect to information technology, which small banks simply do not have the funds to take advantage of. Third, due to consolidation in other industries (e.g., agriculture), the size of the average loan banks primary source of income - has grown and smaller banks do not have available the necessary funds to make the size loans necessary to meet customers needs and stay in business. Lastly, the financial crisis of 2008/2009 left many small banks insolvent (bankrupt) due to inadequate reserves and they were forced to sell out to larger banks.

            OSB has determined that it will soon no longer be financially viable as a separate bank. However, the Fieher family does not wish to give up its family banking tradition or lose control of the bank founded by their ancestors. Accordingly, they have worked out the following affiliation arrangement with Banco Uno of Ohio:

Banco Uno will provide OSB $20 million in working capital (primarily cash). There will be no required principal or interest payments on these funds unless the affiliation agreement (see below) is canceled.

In return for a proportionate share of the interest income and subject to the approval of Banco Unos loan committee, Banco Uno will provide any funds needed to make loans that exceed OSBs lending ability. (The Federal Reserve typically limits the total value of the loans a bank may make based on their size.)

If any member of the Fieher family chooses to sell their stock in OSB, Banco Uno has the right of first refusal (i.e., the stock must be sold to Banco Uno if they wish to buy it).

OSB will be described as an affiliate of Banco Uno on all OSB documents and advertising

Banco Uno will fill all of OSBs information technology needs at a price equal to Banco Unos direct costs (i.e., without overhead allocation).

The agreement may be canceled with one years notification by either party

If the agreement is canceled by Banco Uno, OSB will have 5 years to repay the $20 million working capital provided by Banco Uno. Commencing on the date that the agreement is canceled, interest will accrue on those funds at the rate of 3% per year.

If the agreement is canceled by OSB, OSB will have 5 years to repay the $20 million of working capital provided by Banco Uno. OSB will pay Banco Uno interest on the funds from the date of the original affiliation agreement. The interest will be paid at the rate of 8% per year, the rate at which OSB could currently borrow funds from another bank.

Required:

            How should the $20 million of funds be reported on OSBs balance sheet? As debt or stockholders equity? Why?

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Hint:    What is in this deal for the two parties involved? What does each want to happen? This question is intended to help you think about the substance of this transaction I do not necessarily expect you to explicitly answer it in your write-up.

             All GAAP that needs to be referenced in this case will have been coved at least one week before the case due date.

Expectations for Case Write-ups

Substantive expectations

1.   No more than three pages of double-spaced, typewritten text. Detailed calculations, journal entries, financial statement presentation, etc., may be put in appendices / exhibits at the end of the paper and thereby not count as part of the three pages of text.

2.   Begin by succinctly (1 paragraph) identifying the facts and issues of the case.

3. Succinctly (1 or 2 paragraphs) outline relevant GAAP guidelines / concepts. In the best case scenario the standards will relate directly to the type of asset, liability, etc. at issue. If such standards do not exist, or are ambiguous, you will then need to rely on the more general standards such as the conceptual framework.

4. Discuss possible alternatives and their appropriateness in light of GAAP, the purposes and objectives of financial statements (e.g., users' needs), and the facts of the case. Include both arguments for and against the alternatives.

5. Select and justify one of the alternatives; your justification should include refutation of the acceptability of the alternatives.

The requirements for 4. and 5. Will generally result in some redundancy in the case.

Note that as accountants your objective should be to fairly represent what is actually happening. You should not use as part of your criteria what will / will not make someone look good, help stockholders, maximize share price, etc.

If you find something in the Standards that you think tells you the right answeryou still need to evaluate it and tell me why you agree or disagree with that method.

The bulk of your paper should consist of parts 4. and 5. What I am looking for is whether or not you can apply GAAP to situations which are NOT explicitly covered by the current authoritative literature and, as accountants are frequently required to do, justify your choice of accounting methods.

Hint: Whenever you make a statement in your case to the effect that something should or

should not be done, does or does not meet some criteria (such as being an asset), make sure you have explained why you said that.

Explanation / Answer

It will be shareholder's equity. Unless the the agrrement cancelled, company need not to pay interest or principle. It will be like no fixed payment as in the case of debt where you have to pay fixed some every year(interest). As it is mentioned in the agreement, It is a bilateral agreement and it can be terminated by either party at any point of time. There will be only interest rate difference in the payment terms.

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