"Long-Term Liabilities" Discuss bonds 2. "Off Balance Sheet Financing" Harold Walker is CEO and Owner of...

"Long-Term Liabilities" Discuss bonds 2. "Off Balance Sheet Financing" Harold Walker is CEO and Owner of Walker Enterprises (WE), a company that has shown strong and consistent growth over the years. However, WE is struggling with cash flow issues and Harold is looking for a loan and/or line of credit to bolster his company. The problem is that the company’s debt to equity ratio is already high and he knows it will be challenging to find a bank willing to lend him additional funds. Fred, his CFO, has come up with an idea. A large portion of the company’s debt is tied up in the mortgage of their five-story office building. Fred has suggested moving this debt to “off balance sheet” by creating an SPV (Special Purpose Vehicle) that owns the building on behalf of the company and then leases it back. This results in WE entering into an operating lease off the balance sheet and recording only the relatively small monthly “rent” as an operating expense. Fred says this will significantly increase the company’s liquidity and present a balance sheet that will be much more attractive to any potential lenders. Fred has assured Harold this is legal and common. This arrangement does not feel right to Harold. What additional information should Harold request? What additional reservations or concerns would you have?

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Expert Solution

Due to this arrangement there is decline in depreciation and increase in operating expenses in the name of lease Rent.

Also company have to to create Right over Asset in Use and Lease liability under Ind AS 116 or IAS 16 accounting standard.

However company have to disclose lease asset as well as lease liability in the financials of the company.CFO view that it will be off balance sheet is not proper.

To avoid showing it on the Balance sheet company should reduce lease period less than 1 year and every year Renew the lease to avoid applicability of IAS 116.If lease period is more than year then Company have to disclose it.

This arrangement is seems good if Borrowed fund to be utilised in more efficient and managed way but if considering past trend company is continuously facing loss and funds are misutilsed then it is one of the Fraud/Insolvency Red Flags.

What company normally do they Borrow fund and utilise for their personal benefits without considering company interest or Shareholders interest.

Ultimately debt burden on the Company increases and it will be ultimately loss of the Bank or Shareholders if directors also default in case of Fraud/Insolvency.

ekkarill92 answered 1 year ago

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