Question

You work as a commercial loan officer in a local bank.  The president of a small-to-medium sized fast-food restaurant chain, with 250 employees in five locations, comes into your bank and asks for a business loan of $400,000 to help fund his expansion plans for building two additional restaurant locations Question(s): What would be your concerns as the loan officer? What questions would you ask and what financial documents might you request of him/her? Discusses differences between Accrual basis and Cash basis accounting; and why Accrual basis accounting is important to practice.  Explain the importance of Accrual basis accounting and how you might possibly verify that this company is following Accrual basis accounting.

Answer 1

Q.1 What would be your concerns as the loan officer?

1. As the loan officer, you must ensure this restaurant earns a reasonable profit.
2. He must see that whether enough capital has been invested by its proprietor/partners.
3. He must see the amount of existing borrowings in the business.
4. He must see any fixed asset/s or current asset/s are mortgaged or hypothecated for the existing borrowings of the firm.
5. If it is so, he must see any other fixed or current assets remain there in the firm to be mortgaged or hypothecated for the loan being applied.
6. He must see how many times, the firm’s profit covers the interest payment which is to be paid by the firm after getting this loan.
7. He must see the location of the business and sales history to estimate the future sales of the firm.
8. He must see the credit score by letting some credit rating agency to analyse the company’s financial statements and previous credit history.

Q.2 What questions would you ask and what financial documents might you request of him/her?

• Questions to be asked to the applicant of the loan:

1. How long have you been in the business?
2. What is the annual turnover?
3. What is the profit for the last financial year and of previous years?
4. In which bank do you maintain your current account?
5. Do you do business in your own land and building or at rented one?
6. What is the total investment in your business?
7. What is the existing borrowed capital?
8. What is the repayment schedule of your existing loan?
9. What are the assets mortgaged or hypothecated for the existing loans?
10. Is your concern is a sole proprietor/partnership/ private limited company or public limited company? (get their Registration certificate, Partnership Deed or Memorandum of Association and Aritcles of Association (if it is a company))

• Financial documents you might request of him/her?

1. Profit and Loss account for past five years.
2. Balance Sheet for past five years
3. Projected sales and profit for two following years.
4. The bank statement for the last six months of current accounts of the concern.
5. The statement of personal net worth (private assets and liabilities) of proprietor/partners/directors.
6. The bank statements of personal account of proprietor/partners/directors for the last six months.
7. Statement of accounts of the loan accounts existing.
8. Statement of accounts of the interest expense

Q.3 Differences between accrual basis accounting and cash basis accounting

Accrual basis	Cash basis
Expenses or income are recorded when they become due irrespective of the fact they are paid/received or not.	Expenses or income are recorded when they are actually paid or received.
It recognizes the expense or income when the expense is incurred or the income is earned.	It recognizes the expense or income when they are actually paid or received.

Q.4.Importance of Accrual basis accounting:

1. If you want to know the accurate profit or loss of a business, you must follow accrual basis accounting because it takes into account all the expenses incurred to earn the revenue of the year and all the income earned in the year. The actual payment or receipt may be in the same year or in the next year or in the previous year.
2. As this method considers all the expenses incurred to earn the revenue of a particular period, it properly matches revenue and expenses incurred to earn that revenue.
3. As it takes into account the expenses and income accrued in a period, it shows the unpaid expense as a liability of the period and accrued income as an asset of the period. It becomes accurate and rational method of accounting. Because it reminds the expenses due and income to be received.
4. In turn, it shows the accurate assets and liabilities of the business.

Q.5. How might you verify that this company is following Accrual basis of accounting.

1. Get to know the fixed expenses of the company like salary, rent, taxes etc. per month.
2. Calculate that expense for 12 months.
3. See whether the whole amount of the expense for the year is debited to profit and loss account or not.
4. Get to know the fixed income of the company like rent, dividend, interest, commission etc.
5. Calculate that income for 12 months
6. See whether the whole amount of those income for the year is credited to profit and loss account or not.
7. If the whole amount of expense for the year is debited and the whole amount of income is credited to profit and loss account, it proves this company follow accrual basis of accounting
8. You can see the balance sheet and verify that there is any outstanding expense in the liability side and accrued income in the asset side. If they are there, it proves this company follows accrual basis of accounting.
9. If the company shows in their credit side of profit and loss account the credit sales for which amount is still outstanding from the customers, this proves this company follows accrual basis of accounting.