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COLLEGE OF BUSINESS

BKAF 3123
ANALYSIS AND USE OF FINANCIAL STATEMENTS
GROUP A
TUTORIAL 10
Credit Analysis
MEMBERS NAME:
TAN YUE WEI

213782

MOHAMMAD AMEER BIN RUSLEI

213826

MUHAMMAD ANUAR BIN ABIDIN

214016

LECTURERS NAME

: PROF MADYA DR AZHAR BIN ABDUL RAHMAN

DATE OF SUBMISSION: 02.DECEMBER.2014


GROUP NO

: 8

Question 1036
What is off-balance-sheet financing? Provide one or more examples.
Off-balance sheet financing are attempts by management to structure transactions in such a
way that debt and the related assets can be excluded from the balance sheet. This is usually
done by emphasizing legal accounting form over substance. Examples of such transactions
include certain sales of receivables, inventory repurchase agreements, and take or pay
contracts.

Exercise 10-4
The management of a corporation wishes to improve the appearance of its current
financial position as reflected in the current and quick ratios.
Required:
a. Describe four ways in which management can window-dress the financial statements
to accomplish this objective.
Window dressing is a set of actions or manipulations with financial or other information in
financial documents (financial statements, reports, etc.) to make this information look more
attractive to its users. Even though window dressing can occur at any time, it is commonly
used at the end of a period.
Methods to window dress financial statements to improve appearance of its performance or
liquidity:
1. Sell fixed assets for cash or short-term notes. This would increase current assets, but
decrease only fixed assets. Thus, the current and quick ratios would improve.
2. Borrow cash by incurring long-term liabilities (notes or bonds). This would increase cash,
but would not affect current liabilities, since the purpose is to make them long-term liabilities.
3. Defer incurring various expenses, such as advertising, research and development, and
marketing, along with reducing capital expenditures.
4. Keep the cash receipts books open longer, in an effort to show higher receivables or
collections. This method is a highly irregular and manipulative device.

b. For each technique you identify in (a), describe the procedures, if any, you can use in
your analysis to detect the window-dressing.
1. Contracts and invoices might be examined to see when they were entered into and when
they were recorded.
2. The procedures for investigation of excessive borrowing at year-end are the same as those
for excessive investments of equity funds (2. above). Also, the contracts should be studied to
determine if they are bona fide loans.
3. The purchase journal and cash disbursements journal should be examined to compare
expenses incurred towards the end of the year with expenses at the beginning of the following
year, and the reasons for large differences.
4. To determine if the books are being kept open too long, the analyst would study such
documents as the underlying invoices and cancelled checks to determine their actual dates,
and to compare this with the dates recorded. S/he might also confirm material accounts with
customers as of the year-end.

Problem 10-6
As lending officer for Prudent Bank you are analyzing the financial statements of ZETA
Corporation (see Case CC2 in the Comprehensive Case Chapter for data) as part of
ZETAs loan application. Your superior requests you evaluate ZETAs liquidity using
the two-year financial information available. The following additional information is
acquired (in $ thousands): Inventory at January 1, Year 5, $32,000.
Required:
a. Compute the following measures for both Years 5 and 6:
Ratio
1. Current ratio

Year 5: $61,000/$40,000 = 1.5


Year 6: $84,000/$54,000 = 1.6

2. Days' sales in receivables

Year 5: ($20,000 / ($155,000/360) = 46


Year 6: ($25,000 / ($186,000/360) = 48

3. Inventory turnover

Year 5: $99,000/ [($32,000+$38,000)/2] = 2.83


Year 6: $120,000/ [($38,000+$56,000)/2] = 2.55

4. Days' sales in inventory

Year 5: $38,000/ ($99,000/360) = 138


Year 6: $56,000/ ($120,000/360) = 168

5. Days' purchases in accounts payable

Year 5: $23,000/($105,000* /360) = 79


Year 6: $29,000/($138,000* /360} = 76

* Purchases
Cost of sales
+ Ending inventory
Goods available for sale
- Beginning inventory
Purchases

Year 5

Year 6

$ 99,000

$120,000

38,000

56,000

137,000

176,000

32,000

38,000

$105,000

$138,000

6. Cash flow ratio

Year 5: $7,700 / $40,000 = 0.19


Year 6: $6,400 / $54,000 = 0.12

b. Comment on any significant year-to-year changes identified from the analysis in (a).
Based on the calculation, most of the liquidity measures of ZETA do not reveal any
significant changes from Year 5 to Year 6. However, there is some deterioration in the
inventory turnover. This deterioration is even more evident in the days' sales in inventory
measures. Moreover, the liquidity index also suggests that the liquidity position of ZETA has
deteriorated from Year 5 to Year 6. Also notice that because of a lower level of operating
cash flows, the cash flow ratio shows a significant decline. Still, due to the short time span of
this analysis, one would want to examine another year or two to see if these changes reflect a
longer-term trend in liquidity.

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