Accounting Case Assignment Paper

Accounting Case

Case 2: Review of Introductory Accounting

Introduction

As we move into Intermediate Accounting, it can be very helpful to take time to review some of the basic principles from our introductory financial accounting class. This case is designed as a review for some of the most important topics you covered in those classes.

In addition, recent ethical scandals have rocked the financial markets.  While people blame many different sources for these scandals, the real reason is that a group of individuals chose to manipulate the markets for their own benefit.  In other words, the scandals occurred because of a breakdown in ethics, which unfortunately was not caught by the checks and balances used at the time. The final portion of this case will help you to think about these scenarios and how you can react to avoid the poor choices that have caused so much consternation to the capital markets and the employees of the companies affected.

Case Questions

Please read the attached case, “To Adjust or Not to Adjust: The Case of BNB Credit Union.”  As you read the case, think about each of the individuals involved and their choices.   What is the main dilemma facing these individuals?  What options do they have and what are the consequences of each action?  Who would be affected (positively or negatively) by each choice?  Which option do you think they will choose and why?  These questions are just for you to consider.  You do not need to formally answer them.  You only need to answer the question in the case.

Do NOT try to answer the questions in one long essay.  You should answer each question individually.  Each answer should be clear and concise and should flow easily from one thought to the next.

Personal Ethical Code

Now that you have read and thought about an ethical scenario and the motives and incentives that lay behind it, take a minute to think about your own code of ethics.  You might want to consider the following:

• What do you consider to be right and wrong?
• What is your priority in life?
• How far are you willing to go to make money?
• How do you wish to treat others?
• How do you wish to be remembered someday?

Write up your ethical code (1 page max).  This part of the assignment is meant to encourage personal reflection, so it will be graded based on your thought and effort not on what you have decided to be right or wrong.  If you wish, you may use quotes from books, journal articles, or established ethical codes as part of your personal code as long as you give any sources you use appropriate credit.

Formatting

Your paper write up should be written in standard font (Times New Roman 12 pt or similar) with 1” margins.  Please single space your paper with blank lines between paragraphs (similar to the format of these instructions).  The title page should contain the assignment name, the course number and section, my name, your name, and the due date.  All of your work, including that in Excel, must be submitted as one file to BBLearn by 11pm on the due date in the syllabus. It is very easy to paste from Excel to Word, so please DO NOT attempt to upload multiple files.

This is not an English class, so I will accept any paper than shows at least a minimal level of editing (i.e. running spell check and grammar check, reading through the paper at least once, following the formatting instructions above, etc.).  Papers returned because of editing problems can still be turned in late for partial credit (see the policy on late work in the syllabus).

Your entire assignment, including title page, should NOT be more than six (6) pages long.  Include the question as the header for each of your answers.  You should also include a header for your personal ethical code.  Please leave an extra line between questions or emphasize heading in some way.  Please put your answer to question 5 and the ethical code on separate pages at the end of your paper (in other words, make sure that they could each be handed to someone separately from the other parts of the case).

Please note that you will lose points for each formatting omission.  As a final note, make sure that your paper size is set to standard letter size (8.5” x 11”).  Papers formatted for legal size CANNOT be printed for the grader and, therefore, WILL NOT be graded!

Grading

Your answer to the first four (4) questions will be graded based on the quality of your work (30 points) and your logic in defending your answer (10 points).

Your answer to question 5 from the case will be graded using the ethics rubric posted in BBLearn (20 points possible – I expect you to be in the 4 range, so 5’s will give you extra credit).

The remaining points (10 points possible) will be based on the effort and thought you put into your personal ethical code.  The grading will be broken down as follows:  Exceptional, 10 points; Good, 8; Acceptable, 6 points; Marginally acceptable, 4 points; Not acceptable, 2 points; No effort, 0 points.

Extra Credit (5 points possible): DSO’s original Statement of Cash Flows is included in the financial statements for the company. The adjustments required in the case don’t change total cash, but they do affect the Statement of Cash Flows. Provide an updated Statement of Cash Flows along with your other financial statements.

To Adjust or Not to Adjust:  The Case of BNB Credit Union

Background Information

BNB Credit Union was founded by the Beiterman family over 100 years ago in the small town of West Klirk, GA.  Since its founding, BNB has served the local population with mortgage, auto, and small business loans, as well as other banking services.  Because of West Klirk’s remote location, BNB was the only bank used by most of the members of the community.  In the last twenty years, BNB has struggled to maintain its position as the primary bank of the local community.  Online banking services, heavy marketing by large banks in nearby towns, and a small branch office opened in West Klirk by a national banking chain have all served to reduce BNB’s profits.

In order to improve their shrinking deposits and loan portfolio, BNB’s management was forced to increase the interest rate paid on savings accounts, and to reduce interest rates charged on several types of loans.  These measures further dipped into BNB’s profit margin, but allowed the credit union to retain most of its customer base.  Friendly customer service and less stringent regulations for credit unions also helped.

The situation changed with the banking debacle in 2009.  The local branch of the national bank closed in early 2010, and lending limits and new restrictions on many of BNB’s competitors have allowed BNB to slowly improve profit margins.  However, BNB still hasn’t fully recovered.  The Beiterman family has offered the management team significant bonuses if they can improve profits during the upturn without exposing the credit union to too much risk.  The current manager, Sam Oliver, has been pushing his team to do just that.

Introduction

Two weeks ago DSO, Inc., a local manufacturing firm, approached Judy Intersan, one of BNB’s loan officers, for a $1,000,000 loan to expand their facilities.  The company was seeking funds to expand production on its most successful line, which had experienced record growth in the past six months.   Following BNB’s credit policies, Judy requested DSO’s adjusted trial balance and financial statements (see Figures 1-3).   In order to assess the company’s overall risk and credit worthiness, she computed the financial ratios required by the credit union’s loan department.  The financial ratios revealed that DSO had met the targets on four (4) of the six (6) required ratios in BND’s risk analysis.  While the credit union generally requires all 6 ratios be met for a small business loan, loan officers can override this requirement in certain cases.  Judy felt that DSO had a sound business model, good governance practices and the product line showed continued potential for growth.  Based on these considerations, Judy decided to approve the loan.

<< DSO’s adjusted trial balance and financial statements are at the end of the case and as a template on BBLearn>>

 

 

Present

Upon arriving at work, Judy had a message from Jim Terrle, DSO’s owner, requesting a meeting about the loan.  Given the size of the potential loan and Judy’s recommendation to approve the loan with special consideration, Judy immediately rearranged her schedule to accommodate Jim’s request.  Shortly after the meeting started, Judy became increasingly concerned about her decision.

Jim nervously explained to Judy that the financial information he had provided with DSO’s loan application had been unaudited, but that he had assumed that the information was accurate.  Previous audits had never raised any concerns.  This year, BNB had hired a new auditor and the audit had uncovered several issues that needed to be addressed.

First, the auditor felt that DSO was depreciating some assets over lives that were too long.  The auditor’s recommendation was to increase depreciation expense by $75,000.   Second, the company had included in sales revenue $60,000 of cash received as a deposit for product not yet shipped.  Third, the company had misclassified a $50,000 loan due the following year as a long-term liability.  Finally, DSO had neglected to accrue salary expense of $15,000.

“I just hired a new accounting manager, and I assumed that he knew what he was doing.  I guess I was wrong,” Jim admitted.  “I’m not sure if I’m going to replace him, but I assure you that we will be much more careful in the future.”

Judy sighed as she considered the conversation. Jim promised to send her the corrected financial statements as soon as they were completed.  She didn’t think that Jim had intentionally tried to trick her or lie to her.  If so, he certainly wouldn’t have volunteered the information about the changes from the auditor so quickly.  He could have waited until the loan was fully processed.  At that point, there wouldn’t have been anything she could do about it.  Still, even if he wasn’t lying, his financial position was completely different now.  She glanced again at DSO’s risk analysis (see Figure 4).

<< BNB’s Ratio Threshold Table is the last page of the case>>

These changes will affect the ratios she had calculated as well as the financial statements.  Since the loan documents were making their way through final processing, she decided it would be best to involve her manager in the discussion on how to proceed with DSO’s loan application given this new information.  She sighed and headed towards Sam’s office.

 

 

Meeting between Judy Intersan and Sam Oliver

“Judy.  How are you doing?” Sam asked as he waved Judy into his office.

“I’m very concerned at the moment,” Judy answered as she came in and sat down.

“What’s the problem?’ Sam asked.

“I just got through talking with DSO’s owner, Jim Terrle.”

“DSO?  Isn’t that the company that just applied for a $1M loan to expand their business?  I looked over their financial statements.  I thought they looked like a solid investment.”

Judy nodded.  “I felt the same way, until I talked with Jim today.  It turns out the financial statements they gave us were unaudited.”

“I don’t see that as a problem, as long as there aren’t any surprises after the audit.”

“Unfortunately, there were a few issues raised by the audit.  The auditor found some significant transactions that DSO had not handled properly.

Sam frowned.  “That’s never a good sign.  Was it fraud?”

Judy shook her head.  “I don’t think so.  I think they were honest mistakes, but I’m still a little concerned that they weren’t more careful before applying for such a large loan. I’m also concerned about some of their ratios given the corrected financial statements.  Remember, they were border line in my original risk analysis.  They only met four of six required thresholds.  That was enough under our guidelines, but I fear they will be short of even more requirements now.  Honestly, I don’t think we should approve the loan.”

“I can see your point, but why should we stop them from getting the loan?  We could increase the interest rate on the loan to compensate for the additional risk.  That would give us an additional loan on the books, which the owners will like, and lead to increased revenues, which the owners will like even more.”

“But,” J   udy argued. “They now appear to be a risky company, and I don’t think that the owners want us to increase our loan base or our interest revenue on risky loans.  They want us to grow safely.”

“But, slowly,” Sam interrupted.  “Look, Judy, I appreciate your concerns.  I really do, and I want to see the new numbers and the new ratio analysis.  However, I really want to see that big bonus in my Christmas paycheck.  Let’s just let this one go, enjoy the bonus, and work with DSO very carefully to ensure that the company makes its payments on time.  The owners will never even know.”

With that, Sam ushered Judy out of his office.  “I’m your manager, Judy, and I say we approve the loan.  They aren’t that much more risky now than they were this morning.  Just let it go, and I’ll make sure I’m not the only one that enjoys a good bonus at the end of the year.”

Case Requirements

1. Update DSO, Inc.’s adjusted trial balance to reflect the audit changes.

 

2. Using the adjusted trial balance completed in requirement #1, generate DSO’s updated Income Statement and Balance Sheet.

 

3. Update the risk analysis table for DSO by recalculating the following:
   1. Current Ratio
   2. Quick Ratio
   3. ROA
   4. ROE
   5. Debt-to-Equity
   6. Profit margin

 

4. Based on your ratio analysis and the updated financial statements, do you think that BNB should approve DSO’s loan application? Defend your answer.
5. Sam wants to approve DSO’s application, while Judy feels that the risk is too great based on the updated numbers. Using your knowledge of GAAP, BNB’s business goals, the principles of business ethics, and your answers to questions 1-4, do the following:

 

1. Assume you are Sam, what would be the reasons and rationalizations for approving the loan?
2. Assume you are Judy, what would be the reasons and rationalizations for rejecting the loan?
3. What arguments do you think Judy should use to convince Sam to agree with her position?
4. Based on the scenario and your responses to a through c, do you think the loan will be approved?

 

 

DSO Inc.
Adjusted Trial Balance
As of 12/31/Year 2
	DR	CR
Cash	$60,000
A/R	$160,000
Allowance for Bad Debts		$20,000
Inventory	$520,000
Land	$440,000
Building	$320,000
Equipment	$1,120,000
Accumulated Depreciation		$480,000
Accounts Payable		$459,375
Salaries Payable		$70,000
Unearned Revenue		$100,000
Loan Payable		$100,000
Notes Payable		$560,000
Common stock		$400,000
($1 par, 1,000,000 authorized, 400,000 outstanding)
Additional Paid-In capital		$120,000
Retained Earnings		$116,000
Dividends	$46,000
Sales Revenue		$4,000,000
Cost of Goods Sold	$2,776,000
Advertising Expense	$75,000
Bad Debt Expense	$154,000
Depreciation Expense	$80,000
Sales Force Salaries Expense	$215,000
Shipping Expense	$32,750
Executive Salaries Expense	$256,000
Insurance Expense	$6,000
Miscellaneous Admin. Expenses	$4,000
Rent Expense	$14,500
Utilities Expense	$30,000
Rent Revenue		$12,500
Interest Expense	$25,500
Income Tax Expense	$103,125
	$6,437,875	$6,437,875

 

 

 

 

 

DSO Inc.
Multi-Step Income Statement
For the Year Ended December 31, Year 2
Sales Revenue		$4,000,000
Cost of Goods Sold		$2,776,000
Gross Profit			$1,224,000
Operating Activities
Selling Expenses
Advertising Expense	$75,000
Bad Debt Expense	$154,000
Depreciation Expense	$80,000
Sales Force Salaries Expense	$215,000
Shipping Expense	$32,750
Total Selling Expenses		$556,750
Administrative Expenses
Executive Salaries Expense	$256,000
Insurance Expense	$6,000
Miscellaneous Admin. Expenses	$4,000
Rent Expense	$14,500
Utilities Expense	$30,000
Total Administrative Expenses		$310,500	$867,250
Income from Operations			$356,750
Other Gains and Losses
Rent Revenue		$12,500
Interest Expense		($25,500)	($13,000)
Income from Continuing Operations before Taxes			$343,750
Income Tax Expense			$103,125
Net Income			$240,625
EPS			$0.60

 

 

 

DSO Inc.
Balance Sheet
As of 12/31/Year 2
	Year 2	Year 1
Assets
Current Assets
Cash	$60,000	$76,000
A/R	$160,000	$120,000
Allowance for Bad Debts	($20,000)	($60,000)
Inventory	$520,000	$560,000
Total Current Assets	$720,000	$696,000
PPE
Land	$440,000	$280,000
Building	$320,000	$320,000
Equipment	$1,120,000	$520,000
Accumulated Depreciation	($480,000)	($400,000)
Total PPE	$1,400,000	$720,000
Total Assets	$2,120,000	$1,416,000
Liabilities and Stockholders’ Equity
Current Liabilities
Accounts Payable	$459,375	$240,000
Salaries Payable	$70,000	$40,000
Unearned Revenue	$100,000	$60,000
Total Current Liabilities	$629,375	$340,000
Long-term Debt
Loan Payable	$100,000	$120,000
Notes Payable	$560,000	$320,000
Total Long-term Debt	$660,000	$440,000
Total Liabilities	$1,289,375	$780,000
Stockholders’ Equity
Common stock	$400,000	$400,000
($1 par, 1,000,000 authorized, 400,000 outstanding)
Additional Paid-In capital	$120,000	$120,000
Retained Earnings	$310,625	$116,000
Total Stockholders’ Equity	$830,625	$636,000
Total Liabilities and Stockholder’s Equity	$2,120,000	$1,416,000

 

 

 

DSO Inc.
Statement of Cash Flows
For Year Ended 12/31/Year 2
Cash Flow from Operations
Net Income		$240,625
Adjustments:
Change in A/R	($80,000)
Change in Inventory	$40,000
Depreciation	$80,000
Change in A/P	$219,375
Change in Salaries Payable	$30,000
Change in Unearned Revenue	$40,000	$329,375
Net Cash Flow from Operations		$570,000
Cash Flow from Investments
Purchase of Land	($160,000)
Purchase of Equipment	($600,000)
Net Cash Flow from Investments		($760,000)
Cash Flow from Financing
Repayment of Loans	($20,000)
Issuance of Notes Payable	$240,000
Payments of Dividends	($46,000)
Net Cash Flow from Financing		$174,000
Net Increase (Decrease) in Cash		($16,000)
Cash, January 1, Year 2		$76,000
Cash, December 31, Year 2		$60,000

 

 

 

BNB Credit Union
Ratio Threshold Table*
Small Manufacturing Firms
Ratio Amounts
	Thresholds
Ratio	Excellent	Good	Acceptable	Poor
Current Ratio	2.2 – 2.8	1.7 – 2.2	1.1 – 1.7	< 1.7 or > 2.8
Quick Ratio	> 0.5	0.3 – 0.5	0.1 – 0.3	< 0.1
ROA	> 0.25	0.15 – 0.25	0.05 – 0.15	< 0.05
ROE	> 0.34	0.22 – 0.34	0.10 – 0.22	< 0.1
Debt-to-Equity	< 1.0	1.0 – 1.6	1.6 – 2.2	> 2.2
Profit Margin	> 0.11	0.07 – 0.11	.03 – 0.07	< 0.03
Decision Guidelines
	Minimum # of Ratio Values in Each Category
Loan Balances	Excellent	Good	Acceptable	Poor
Greater than $5M	3	3	0	0
$2M – $4M	1	3	1	0
$1M – $2M	1	3	2	0
$0.5M – $1M	0	3	3	0
Less than $0.5M	0	0	4	2
Loan applications that do not meeting these guidelines must include a letter of support from the local branch manager.