Loan purpose and accounting based debt covenants

2019 ◽  
Vol 18 (2) ◽  
pp. 321-343
Author(s):  
Daniel Gyung Paik ◽  
Timothy Hamilton ◽  
Brandon Byunghwan Lee ◽  
Sung Wook Yoon
Keyword(s):  
Multinomial Logistic Regression ◽  
Balance Sheet ◽  
Accounting Information ◽  
Contract Design ◽  
Financial Ratios ◽  
Debt Covenants ◽  
Content Type ◽  
Debt Contract ◽  
Income Statement ◽  
Debt Covenant

Purpose The purpose of this paper is to investigate the association between the purpose of a loan and the type of debt covenants, separated into balance sheet-based and income statement-based covenants. Design/methodology/approach Using private loan deal observations obtained from the DealScan database over the period between 1996 and 2013, the authors classify the sample loan deals into three categories based on the purpose of borrowing, namely, borrowings for corporate daily operating purposes, financing purposes and acquisition and investing purposes. The authors conduct multinomial logistic regression analysis to test the relationship between the choice of financial ratios in a debt covenant and the purpose of a loan, controlling for financing constraints and other factors that have been identified as important to debt covenant analysis in prior studies. Findings The results provide evidence that the purpose of the loan is significantly associated with the type of debt covenants, suggesting that the lender and the borrower have considered the loan purpose when structuring their debt agreements. More specifically, the results indicate that the loans borrowed to fund acquisitions or long-term investment projects are more likely to have income statement-based covenants and less likely to have balance sheet-based covenants. In contrast, the loans borrowed for corporate daily operating purposes or financing purposes are more likely to contain balance sheet-based covenants relative to income statement-based covenants. Research limitations/implications The authors show that loan purpose is significantly associated with the choice between income statement-based and balance sheet-based covenants. This result further illustrates ways in which accounting information improves contracting efficiency. The results are limited to the US market with its institutional structure. In future studies, it would be interesting to perform similar investigations on firms in other countries. Practical implications The findings contain important and economically significant implications indicating that loan lenders and borrowers agree to include different types of accounting information (that is, income statement- versus balance sheet-based financial ratios) in their loan covenants for different purpose loans. Social implications Overall, the results provide important evidence regarding the connection between debt covenant structure and loan purpose. In doing so, it contributes to the literature on debt contract design (Dichev and Skinner 2002; Chava and Roberts 2008; Demerjian 2011; Christensen and Nikolaev 2012). Despite much interest in debt contract design, Skinner (2011) argues that there still exists incomplete knowledge of the economic factors that structure debt contracts. Income statement-based covenants depend on measures of profitability and efficiency and act as trip wires that transfer control rights to lenders when borrowing firms’ performance deteriorates. On the other hand, balance sheet-based covenants rely on information about sources and uses of capital and align interests between borrowing firms and lenders by restricting the borrower’s capital structure. The authors show that loan purpose is significantly associated with the choice between income statement-based and balance sheet-based covenants. This result further illustrates ways in which accounting information improves contracting efficiency. Originality/value This study is the first to identify differences in trends over time for the use of income statement- and balance sheet-based covenants as it relates to different loan purposes. The authors build on prior research to examine the degree to which loan purpose is associated with the choice between income statement-based and balance sheet-based covenants.

The Relation between Accounting Information in Debt Covenants and Operating Leases

2015 ◽  
Vol 29 (4) ◽  
pp. 969-996 ◽  
Author(s):  
Daniel Gyung H. Paik ◽  
Joyce A. van der Laan Smith ◽  
Brandon Byunghwan Lee ◽  
Sung Wook Yoon
Keyword(s):  
Balance Sheet ◽  
Accounting Information ◽  
Debt Covenants ◽  
Debt Contracts ◽  
Debt Contracting ◽  
Income Statement ◽  
Operating Leases ◽  
The Impact ◽  
Accounting Ratios ◽  
Lease Accounting

SYNOPSIS Proposed changes by the FASB and the IASB to lease accounting standards will substantially change the accounting for operating leases by requiring the capitalization of future lease payments. We consider the impact of these changes on firms' debt covenants by examining the frequency of income-statement- versus balance-sheet-based accounting ratios in debt covenants of firms in high and low Off Balance Sheet (OBS) lease industries. Based on debt contracts from the 1996–2009 period, our results provide evidence that lenders focus on balance sheet (income statement) ratios in designing debt covenants for borrowers in low (high) OBS lease industries. Further, the use of balance-sheet- (income-statement-) based covenants falls (rises) faster in high OBS lease industries than in low OBS lease industries as the use of OBS leasing increases. This evidence indicates that OBS operating leases influence lenders' use of accounting information in covenants, suggesting that creditors consider the impact of OBS leases when structuring debt agreements. These results also suggest that the proposed capitalization of OBS leases may not result in firms violating loan covenants but will make the balance sheet a more complete source of information for debt contracting by removing the need for constructive capitalization of OBS leases.

Are leases substitutes or complements to debt? Insights from an analysis of debt covenants

2020 ◽  
Vol 19 (3) ◽  
pp. 339-361
Author(s):  
Daniel Gyung Paik ◽  
Joyce Van Der Laan Smith ◽  
Brandon Byunghwan Lee ◽  
Sung Wook Yoon
Keyword(s):  
Financial Constraints ◽  
Balance Sheet ◽  
Counterparty Risk ◽  
Debt Covenants ◽  
Risk Profiles ◽  
Content Type ◽  
Operating Leases ◽  
Study Support ◽  
Debt Covenant

Purpose The purpose of this study is to investigate the relationship between off-balance-sheet (OBS) operating leases and long-term debt by analyzing firms’ debt risk profiles measured by the constraints on firms in the financial ratios in their debt covenants. Design/methodology/approach This study determines debt risk profiles using three measures: the ex ante probability of covenant violation (Demerjian and Owens, 2016), firms in violation of debt covenants and firms close to covenant violations. Findings High-risk firms according to all three measures, on average, have a significantly lower level of operating leases, indicating that these firms use OBS leases as a substitute for long-term debt. Interestingly, for firms operating in industries in which leases are widely available, firms with a high probability of covenant violation have a significantly higher level of operating leases, indicating that these firms use OBS leases as a complement to long-term debt. Further analysis indicates that lease financing is less costly than debt financing for these firms. Research limitations/implications Overall, evidence of this study indicates that firms facing financial constraints may attempt to lease more of their assets, but the availability of leasing is constrained by their debt covenant obligations and the strength of the leasing market in its industry. Originality/value This study identifies states in which risky firms may treat leases as either complements or substitutes for long-term debt, implying that the leasing decision relates to the availability of an active leasing market for a firm’s assets and the firm’s financial constraints. The findings of this study support recent research showing that debt and leases are complementary in the presence of counterparty risk providing insight into the paradoxical relationship identified in prior research between leases and long-term debt.

The “need to know” and the lack of online transparency among political parties

2015 ◽  
Vol 9 (1) ◽  
pp. 85-103
Author(s):  
Beatriz Cuadrado-Ballesteros ◽  
Luis Andrés Vaquero-Cacho
Keyword(s):  
Political Parties ◽  
Graphical Representation ◽  
Balance Sheet ◽  
Public Information ◽  
Financial Information ◽  
Content Type ◽  
Income Statement ◽  
Robust Control System ◽  
Political Foundations ◽  
Management Report

Purpose – This paper aims to analyse the level of informative transparency among Spanish political parties and political foundations, according to general and descriptive information (e.g. contact, ideas and values, electoral programmes, members, etc.) and economic, governance and financial information. Design/methodology/approach – The situation of the parties in each year is represented by a biplot, which is a graphical representation of a multivariate sample. The data for this analysis were obtained from the reports published by Fundación Compromiso y Transparencia (Foundation for Integrity and Transparency) for 2011 and 2012. Findings – This paper evidences the existence of serious problems of opacity, especially in relation to financial information (balance sheet, income statement, annual accounts and audit report) and information on the fulfilment of goals and programmes (management report and compliance report). Originality/value – This is the first attempt to analyse statistically the level of transparency of political parties and foundations, showing the need for a robust control system and for mechanisms to penalise conduct that limits citizens’ access to public information.

scholarly journals Cash flow disaggregation and prediction of cash flow

2017 ◽  
Vol 18 (4) ◽  
pp. 464-479 ◽  
Author(s):  
Ehsan Khansalar ◽  
Mohammad Namazi
Keyword(s):  
Cash Flow ◽  
Balance Sheet ◽  
Cash Flows ◽  
Prediction Errors ◽  
Content Type ◽  
Balance Sheets ◽  
Income Statement ◽  
Aggregated Model ◽  
Flow Components ◽  
Future Cash Flows

Purpose The purpose of this paper is to investigate the incremental information content of estimates of cash flow components in predicting future cash flows. Design/methodology/approach The authors examine whether the models incorporating components of operating cash flow from income statements and balance sheets using the direct method are associated with smaller prediction errors than the models incorporating core and non-core cash flow. Findings Using data from US and UK firms and multiple regression analysis, the authors find that around 60 per cent of a current year’s cash flow will persist into the next period’s cash flows, and that income statement and balance sheet variables persist similarly. The explanatory power and predictive ability of disaggregated cash flow models are superior to that of an aggregated model, and further disaggregating previously applied core and non-core cash flows provides incremental information about income statement and balance sheet items that enhances prediction of future cash flows. Disaggregated models and their components produce lower out-of-sample prediction errors than an aggregated model. Research limitations/implications This study improves our appreciation of the behaviour of cash flow components and confirms the need for detailed cash flow information in accordance with the articulation of financial statements. Practical implications The findings are relevant to investors and analysts in predicting future cash flows and to regulators with respect to disclosure requirements and recommendations. Social implications The findings are also relevant to financial statement users interested in better predicting a firm’s future cash flows and thereby, its firm’s value. Originality/value This paper contributes to the existing literature by further disaggregating cash flow items into their underlying items from income statements and balance sheets.

scholarly journals Issues surrounding the classification of accounting information

2011 ◽  
Vol 12 (3) ◽  
pp. 353-369 ◽  
Author(s):  
Huibrecht Van der Poll ◽  
Daan Gouws
Keyword(s):  
Balance Sheet ◽  
Accounting Information ◽  
Financial Statements ◽  
Classification Theory ◽  
New Classification ◽  
Second Nature ◽  
Classification Framework ◽  
Income Statement ◽  
Current Classification

The act of classifying information created by accounting practices is ubiquitous in the accounting process; from recording to reporting, it has almost become second nature. The classification has to correspond to the requirements and demands of the changing environment in which it is practised. Evidence suggests that the current classification of items in financial statements is not keeping pace with the needs of users and the new financial constructs generated by the industry. This study addresses the issue of classification in two ways: by means of a critical analysis of classification theory and practices and by means of a questionnaire that was developed and sent to compilers and users of financial statements. A new classification framework for accounting information in the balance sheet and income statement is proposed.

An IFRS-based taxonomy of financial ratios

2019 ◽  
Vol 32 (1) ◽  
pp. 20-35 ◽  
Author(s):  
Thomas Zeller ◽  
John Kostolansky ◽  
Michail Bozoudis
Keyword(s):  
Cash Flow ◽  
Financial Reporting ◽  
Manufacturing Sector ◽  
Balance Sheet ◽  
Financial Statements ◽  
Component Analysis ◽  
Financial Ratios ◽  
Reporting Standard ◽  
Content Type ◽  
Country Differences

Purpose This study aims to identify a taxonomy of financial ratios derived from financial statements prepared using International Financial Reporting Standards (IFRS). The work first empirically establishes and then statistically validates the taxonomy of financial attributes captured in financial ratios. In 2005, the European Commission required that publicly traded companies in the European Union use IFRS as the basis for financial reporting. In the same year, Australia adopted IFRS as a basis for financial reporting. Since then, 120 countries and reporting jurisdictions have adopted IFRS as the basis for financial reporting. Given that IFRS predominate in the financial reporting world, it seems essential to establish and validate IFRS-based ratio attributes. Only then can reliance upon and comparability of these ratios be warranted (Altman and Eisenbeis, 1978). Using principle component analysis, the authors empirically identify nine stable attributes (factors) for ratios drawn from IFRS-based financial statements from 84 counties. The findings provides an empirical basis to formulate testable hypotheses regarding the predictive and descriptive utility of financial ratios draw from IFRS-based financial statements. Design/methodology/approach The paper begins with a broad category of IFRS-based financial ratios, 50, found in practice and research, including income statement, balance sheet, cash flow, profitability and liquidity measures. Then, a sample of companies from the manufacturing sector is segmented using IFRS as a basis of financial statement reporting. Next, principal component analysis, a method of factor analysis, is applied to empirically identify factors and financial attributes captured in financial ratios used in research inquiry and financial analysis. Findings The authors find that the financial attributes captured by IFRS-based ratios go well beyond the traditional measures of profitability, liquidity and solvency. The authors identify nine factors that are interpretable and stable over the period, 2011-2015: asset relationship, asset turnover, capital structure, expense insight, fixed asset usage, inventory turnover, liquidity, profitability margin and performance return. Interestingly, the authors did not find a separate cash flow factor. Most importantly, the results corroborate that IFRS-based ratios are consistent and comparable, despite innate country differences that have been shown to influence the application, interpretation and use of IFRS. Research limitations/implications The efforts are limited to the manufacturing sector. The financial attributes may be different in service, distribution and retail sectors. Also, limiting the effort are the ratios selected in this study. A broader range of ratios may widen the identification of unique stable factors over time. Practical implications The findings provide a basis for research and analysis efforts regarding the validity, comparability and stability of IFRS-based financial ratios. Most importantly, the results corroborate that IFRS-based ratios are consistent and comparable, despite innate country differences that have been shown to influence the application, interpretation and use of IFRS. The findings should be of interest to international and national financial reporting standard setters, investors and analysts. Originality/value An empirically evidenced classification system for IFRS-based financial ratios has yet to be determined based on a financial statements across a wide breadth of countries and reporting jurisdictions. Identification of stable interpretable factors, financial attributes, has been limited. The first is that inquiry has been limited to domestic-based, such as US Generally Accepted Accounting Principles, financial ratios. The second is inquiry has been limited to IFRS-based financial ratios within a specific country.

The relationship between managerial entrenchment and accounting conservatism

2021 ◽  
Vol 19 (5) ◽  
pp. 612-631
Author(s):  
Mahdi Salehi ◽  
Ebrahim Ghanbari ◽  
Saleh Orfizadeh
Keyword(s):  
Corporate Governance ◽  
Fixed Effects ◽  
Balance Sheet ◽  
Accounting Conservatism ◽  
Content Type ◽  
Managerial Entrenchment ◽  
Conservative Accounting ◽  
Income Statement ◽  
Study Results ◽  
The Relationship

Purpose This study aims to assess the relationship between managerial entrenchment and accounting conservatism in Iran. Design/methodology/approach To test hypotheses, all listed companies on the Tehran Stock Exchange during 2013–2018 (six years) that qualified were selected. Given the defined limitations of the study, a total of 120 firms with 720 year-observations was selected. After collecting data and figures, they were analyzed using EViews software. Having presented the inferential model tests, the panel data with fixed effects model is chosen. Findings The study results indicate a positive and significant relationship between managerial entrenchment and unconditional conservatism presented in the income statement. Moreover, the authors find a meaningful relationship between managerial entrenchment and unconditional conservatism about the balance sheet. Practical implications Managers will be more aware of the positive consequences of employment optimal corporate governance such as conservative accounting. Such corporate governance is likely to serve their interest in the long run by providing positive signals to the equity owners and board of directors. Originality/value By assessing conservatism’s literature in Iran, we observe many studies on this concept. Still, no investigation is carried out on the relationship between conservatism in accounting and managerial entrenchment. The present study is innovative because it evaluates the relationship between managerial entrenchment and two types of conservatism, namely, balance sheet and income statement conservatism, which have never been investigated by prior studies, notably in emerging markets.

Effectiveness of Book Closing Using Web Based Accounting Online System 2.0 to Know the Company's Financial Ratios

2017 ◽  
Vol 1 (1) ◽  
pp. 56-60
Author(s):  
Euis Sitinur Aisyah ◽  
Maimunah Maimunah ◽  
Aris Martono
Keyword(s):  
Cash Flow ◽  
Balance Sheet ◽  
Financial Statements ◽  
Relevant Information ◽  
Financial Ratios ◽  
Web Based ◽  
Online System ◽  
Income Statement ◽  
Long Time ◽  
A Company

Financial ratios are very important in a company, because it is the most effective way to find out financial data on a company by comparing the current financial statements of the company with the previous one. To facilitate this comparison, book closure can be done. Closing the book itself is useful to determine the company's financial position before closing, by looking at the final results of the profit and loss. It is known that the process of closing the book takes a long time with extra precision. However, this has become easier by using WBAOS (Web Based Accounting Online System) 2.0, because companies are more flexible in preparing financial statements, starting from the lane balance sheet, income statement, to the periodic cash flow, where this cash flow provides relevant information regarding cash in and out of the company.   Keywords: ​WBAOS, Financial Ratios and Book Closure.

The Impact of Materiality Decisions on Financial Ratios: A Computer Simulation

1997 ◽  
Vol 12 (2) ◽  
pp. 125-147 ◽  
Author(s):  
Jerry L. Turner
Keyword(s):  
Balance Sheet ◽  
Distribution Patterns ◽  
Error Distribution ◽  
Financial Statement ◽  
Financial Ratios ◽  
Standard Normal Distribution ◽  
Income Statement ◽  
Standard Normal ◽  
The Impact ◽  
Profitability Ratios

This study examines the extent to which immaterial uncorrected errors may combine to affect specific financial ratios. A simulation is performed in which three balance sheet accounts and three related income statement accounts are seeded with immaterial errors. The magnitudes of the errors are controlled so the financial statement account balances are materially correct both individually and in the aggregate. The study examines six materiality heuristics for each of three industry classifications and three different error distribution patterns. For each heuristic/industry combination and error distribution pattern, a 95 percent confidence interval is generated for nine financial ratios. Results indicate that immaterial errors may combine to create substantial variances in some ratios. Profitability ratios based on income statement accounts display wide confidence intervals, while solvency ratios based on balance sheet accounts display relatively narrow intervals. Comparison between a standard normal distribution and a nonsymmetrical error distribution indicates that ratio variances are substantial and sensitive to error patterns even when errors are immaterial. Tests for equality of variances identify significant differences between heuristic methods and between industries. When making the decision regarding requiring entry or waiving discovered errors, the auditor should consider the impact of such errors not only on financial statement balances, but on the ways users may combine those balances.

Following beginning farm income and wealth over time

2017 ◽  
Vol 77 (1) ◽  
pp. 22-36 ◽  
Author(s):  
James M. Williamson
Keyword(s):  
Balance Sheet ◽  
Rapid Expansion ◽  
Farm Income ◽  
Cash Income ◽  
Content Type ◽  
Balance Sheets ◽  
Age Cohorts ◽  
Income Statement ◽  
Beginning Farmers ◽  
Over Time

Purpose The paper examines the evolution of beginning farms’ income statement and balance sheet items over a 15-year period. The purpose of this paper is to gain insight into the diversity of beginning farms from a financial point of view. Design/methodology/approach Using the USDA’s Agricultural Resource Management Survey (ARMS), the author constructs a synthetic panel of data consisting of age cohorts of beginning farmers and follow them over time. Baseline financial information for the farm income statement and balance sheet is examined in 1999 and again in 2014 for each cohort. Findings Overall, there is a marked contrast in the evolution in the income statement between beginning farmers who are under 45 years old and those over 45. The gross cash income of the youngest cohorts grows tremendously, as do their expenses, indicating rapid expansion in production on the part of the youngest cohorts. The change in the balance sheets of the cohorts also provides a glimpse into the changing roles of beginning famers over time. The youngest cohort of beginning farmers increase the current and non-current assets on their balance sheets by a substantial amount, more than doubling both. Furthermore, the youngest cohort is the only group to take on more current liabilities, indicating increased financing of the production expenses. Practical implications Differences in the evolution of financial profiles of beginning farms may predict differences in future output, and it could be a predictor of the farm’s operational goals or intentions, as well as predictor of future financial needs and challenges. Originality/value Knowing and understanding likely trajectories of beginning farmers may provide an opportunity to better tailor farm programs, outreach, and support to beginning farmers.

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