Prepared Bay Ateref Melaku WM0057/12

Individual Assignment, Financial and Managerial Accounting

1. Dawit, manager of Bambuu Agro forestry applied for a birr 75,000,000 loan from
Development Bank of Ethiopia. The bank requested financial statements from Bambuu Agro
forestry as a basis for granting the loan. Dawit has told his accountant to provide the bank
with a balance sheet. Dawit has decided to omit the other financial statements because there
was a net loss during the past year.

Required: Discuss the following questions:

A. Is Dewitt behaving in a professional manner by omitting some of the financial

statements?

No: Because the bank needs all financial statements of the company to make accurate
decision.

B. What types of information about the businesses would manager be willing to provide
bankers?
The Company Manager wants to provide part of financial statement which shows only
the balance sheet to see how a company's management is putting its resources to work, its

long term & Capital investment. Owners or Company Mangers are generally willing to
provide bankers with information about the operating and financial condition of the
business, such as the following:

Operating Information:

 Description of business operations

 Results of past operations
 Preliminary results of current operations
 Plans for future operations
 Financial Condition:
 List of assets and liabilities (balance sheet)
 Estimated current values of assets
 Owner’s personal investment in the business
 Owner’s commitment to invest additional funds in the business

C. What types of information would manager not be willing to provide?

The company manager is trying to hide its Cash flow statements & Income statement because
cash flow statements displays statement details the sources of cash inflows as well as
outflows. Cash in and outflows during a particular financial period may be consequences of
actions taken a long time ago. The repayment of a loan taken out years ago will result in a
significant cash outlay and is featured prominently in the cash flow statement. However, it is
Prepared Bay Ateref Melaku WM0057/12
Individual Assignment, Financial and Managerial Accounting

neither a profit nor a loss and will not be found in the income statement. The bank therefore
has to carefully consider how the company used its cash resources to understand if it will
have the cash to repay the loan.

Owners & company Managers are normally reluctant to provide the following types of
information to bankers: Proprietary Operating Information. Such information, which might
hurt the business if it becomes known by competitors, might include special processes used
by the business or future plans to expand operations in to areas that are not currently served
by a competitor.Personal Financial Information. Owners may have little choice here because
banks often require owners of small businesses to pledge their personal assets as security for
a business loan.

D. What types of information about a business would bankers want before extending a loan?

Before extending a loan to a borrower, banks consider all major financial statements of a
company. The balance sheet, the income statement and the statement of cash flow are all
studied carefully by the bank's loan office to assess the company's ability to repay the loan. In
addition to the capability to honor the payments, the bank also considers the likelihood of
loan recovery if the borrower goes into bankruptcy.

D. What common interests are shared by bankers and business manager?

 Risk – Both bankers and businesses agree that risk is a bad thing. This is especially true when
you consider the idea of needless risk. If a business can’t convince a banker, and through him
the bank, that the business is a solid investment with a good chance of success then the
chances are good that the business won’t be able to get help from that bank.
 Success — one common interest that bankers and business owners have in common is that
both parties want a business to succeed. If a business owner succeeds, then he can afford to
pay back the loans that a bank may give him. The business owner will then be in a good
position to get another loan to help extend his business. Successful businesses make both
their owners and their bankers happy.
 Contacts — Bankers and business owners who have a good relationship can share a pool of
information. For instance, if a business owner needs additional help with supplies or
advertising, his banker may have other clients that could assist him by providing necessary
services. If a banker needs a larger client base, a satisfied business owner is likely to funnel
other business owners and potential business owners to the banker.

2. The now defunct Enron Corporation, once headquartered in Houston, Texas, provided
products and services for natural gas, electricity, and communications to wholesale and retail
customers. Enron’s operations were conducted through a variety of subsidiaries and affiliates
Prepared Bay Ateref Melaku WM0057/12
Individual Assignment, Financial and Managerial Accounting

that involved transporting gas through pipelines, transmitting electricity, and managing
energy commodities.

Enron’s Three Major Violations under Generally Accepted Accounting Principles (GAAP)

b) Enron’s Off-Balance Sheet Method

The three major violations under Generally Accepted Accounting Principles (GAAP) that
preceded the collapse of the Enron Corporation were: (1). The off balance sheet arrangements,
(2). The role of mark-to market, and (3). The manipulation of derivatives. The creation of the
off-balance sheet method (OBSEs) served its specific purpose in Enron’s corporate accounting
scandal. In addition, the specific purpose of the Enron Corporation (as cited in e.g., Anson 1999;
Evans, 1996) was to increase financial flexibility, decrease the cost of borrowing from creditors,
reduce the tax portion, maximize profitability, and adequately improve the financial health of the
company as noted by (Angbazo, 1997; James, 1989; Shevlin, 1987). Moreover, the legitimate
financial purpose of Enron’s utilization of the off-balance sheet was to hide losses and debt from
auditors, investors, financial analysts, and regulators. Furthermore, in November, 2001, the
Enron Corporation announced plans to consolidate the financial statements by restating $586
million in earnings prior to the period by following the accounting principles of hiding losses and
debt under the applicability of the off-balance sheet method as mentioned in the research work of
(Kahn, 2002; Henry, 2002). The Wall Street Journal then published seven negative articles
concerning the way Enron Corporation was using the off-balance sheet method. Therefore, the
Enron Corporation’s failure to disclose billions of dollars in debt held by the off-balance sheets
(OBSEs) prompted auditors to require additional disclosure in the financial statements (Chandra,
Ettredge, & Stone, 2006).

c) Enron’s Mark-to-Market Method

The mark-to-market method and the special purpose entity were important to the Enron
Corporation as an accounting fraud principle. Additionally, the EnronCorporation was subject to
external governance because Enron had to report to organizations such as government regulators,
private entities, audit analysts in the equity sector, and some other agencies. Moreover, Jeffrey
Skilling and Andrew Fastow were the pioneers in adopting the mark-to-market method in the
Enron Corporation by pumping up the stock price and covering major losses while continuing to
attract major capital investment, which was both illegal and immoral.

As a result, the U.S. Securities and Exchange Commission (SEC) allowed the Enron Corporation
to use the mark-to-market accounting method. For example, Enron’s unrealized gains (as cited in
Thomas, 2002) were $1.41 billion reported as a pretax profit in 2000 and one-third was reported
as a pretax profit in
Prepared Bay Ateref Melaku WM0057/12
Individual Assignment, Financial and Managerial Accounting

1999. Therefore, one of the major causes of Enron’s fall was the U.S. Securities and Exchange
Commission (SEC) allowing Enron Corporation to use at best capacity the mark-to-market
accounting method (Li,

2010).

In conclusion, the unprecedented financial event of the Enron Corporation demonstrated that
major corporate organizations in the gas and utility industry were manipulating the company’s
financial statements.