Sue Alejandro, president of Tobago Enterprises, applied for a $300,000 loan from

Question

Sue Alejandro, president of Tobago Enterprises, applied for a $300,000 loan from First National Bank. The bank requested financial statements from Tobago Enterprises as a basis for granting the loan. Sue has told her accountant to provide the bank with a balance sheet. Sue has decided to omit the other financial statements because there was a net loss during the past year. Answer the following questions: 1. Is Sue behaving in a professional manner by omitting some of the financial statements? 2. What types of information about their businesses would owners be willing to provide bankers? What types of information would owners not be willing to provide? 3. What types of information about a business would bankers want before extending a loan?

Explanation / Answer

Answer:1 Sue is not behaving in a professional manner by omitting some of the financialstatements, and I doubt the bank would even consider granting her loan. Sue is in factbehaving unethically from the perspective of the accountant, since accounting should be ameans of communicating with honesty and transparency. From a more legal standpoint,Sue is abiding by the standards of neither the GAAP (in the U.S.) nor the IFRS(international standards; the U.S. GAAP states that disclosures for the four differentstatements (balance sheets, income statements, statements of retained earnings, andstatements of cash flow) for the current year and prior two years, while the IFRS requiresthese statements for the current and previous year. By withholding key information abouther company that would provide lenders with the necessary information to evaluate thereliability of Tobago to repay its loans (with interest), Sue is not being honest with thebank nor with herself. In fact, as one student mentioned on the discussion board, anyprofessional creditor would realize some of Sue’s statements have been omitted, thereforedecreasing his/her trust in Sue’s company and ultimately Sue’s chances at receiving a loan. (Plus, if Sue feels at all unsure if she can repay the loan plus interest, then the mostlogical move would be to not ask for a loan).

Answer:2 According to the GAAP, a business should provide “relevant, reliable, andcomparable” information to bankers via general-purpose financial statements such asbalance sheets,income statements, statements of retained earnings, and statements ofcash flow. Income statements and statements of retained earnings are important becausethey report an organization’s net income/loss, while balance sheets offer insight as towhere a company stands at a particular moment in time. A statement of cash flows elaborates on the flow of cash within an organization, which would help a bank betterunderstand how effectively an organization spends money. Managers would not bewilling to provide managerial internal reports, as they relate to the particular needs of theinternal users. These reports include transactions within an organization that may or maynot alter the accounting equation (assets= liabilities + equity) and therefore are notusually of much use to investors or lenders.

Answer:3 Bankers (lenders) search for information about a company that would give insightinto how likely it is to repay its loan (with interest!) before granting the request for a loan.In other words, bankers want to know whether or not granting a loan to a company is agood investment: will the money loaned be used effectively and efficiently? Answers tothis question regarding a business’s reliability would be found in an organization’sgeneral-purpose financial statements, which include current balance sheetsas well asincome statements, statements of retained earnings, and statements of cash flow.

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