Question #8
Reading: Reading 8 Intercorporate Investments
PDF File: Reading 8 Intercorporate Investments.pdf
Page: 4
Status: Incorrect
Correct Answer: C
Your Answer: A
Question
Barrett Inc. is advised by its banker to create a special purpose entity (SPE) to convert its existing $15 million loan off-balance sheet. Under the terms of the deal, SPE would obtain a loan for $15 million from the bank with Barrett providing loan guarantee. Barrett would then sell $15 million of accounts receivable to the SPE and use the proceeds to pay off the current loan. Barrett prepares its financial statements under U.S. GAAP. Which of the following statements is most accurate regarding the impact of such an arrangement on Barrett's ratios?
Answer Choices:
A. Barrett’s leverage would decrease and receivable turnover would increase
B. Barrett’s leverage would remain the same while receivable turnover would increase
C. Barrett’s leverage as well as receivables turnover would remain the same
Explanation
Under U.S. GAAP, the sponsor needs to consolidate SPEs using acquisition method. The
underlying loan and accounts receivable would then be included in the consolidated
balance sheet and none of the financial ratios would be affected.