07-Contracting-1 - True-False 1. Financial accounting...

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True-False 1. Financial accounting numbers can be used to define contract terms and monitor compliance with contract terms. 2. An essential feature of the modern corporation and most business rela- tionships is the delegation of financial reporting responsibility. 3. When one party to a business relationship can make decisions that benefit him or her but harm the other party a conflict of interest arises. 4. One low-cost, effective way of eliminating or reducing conflicts of in- terest in business relationships is to use lawyers to negotiate all terms. 5. Debt covenants benefit creditors because the covenants reduce default risk. 6. Affirmative covenants stipulate actions the borrower must take. 7. A Certificate of Compliance affirms the creditor’s managers have re- viewed the financial statements and found no violation of any covenant provi- sion. 8. A payment default occurs when the borrower violates one or more loan covenants but has made all principal and interest payments. 9. Management tends to make accounting changes and to manipulate discretionary accruals that increase income in order to avoid violating debt cove- nants. 10. A covenant that specifies a required minimum level of net worth and working capital is a compliance covenant. 11. Potential conflicts of interest between managers and owners can be overcome if compensation packages are tied to improvement in firm value. 12. Long-term incentives motivate and reward executives for the com- pany’s growth and prosperity in three to seven years. 13. Stock options are the most common short-term incentive device. 14. Phantom stock has all the characteristics of restricted stock, except that the executive receives the cash value of all the shares, not the shares themselves. 15. The methods and procedures that must be followed for financial state- ments that are utilized by regulatory agencies are known as RAP. 16. In the banking industry, the ratio of invested capital/gross assets, as defined by RAP, is the capital asset ratio. 17. A bank’s estimated bad debt expense associated with its loan receiv- ables is the loan loss provision. 18. IRS regulations govern the computation of net income for the SEC. 19. Potential earnings surprises are also known as accounting torpedoes. 20. Asset substitution transfers wealth from shareholders to creditors. 21. Creditors have a more serious problem when an investment has a high risk and the expected value of the project is lower than the alternative project. 22. Loan provisions that are specifically designed to restrict asset substitu- tion are called debt covenants. Multiple-Choice Questions Select the best answer from those provided. 23. A lender may be protected from deterioration of the borrower’s credit risk if the commercial lending agreement requires the borrower to maintain a a. current ratio above a certain level. b.
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This note was uploaded on 02/27/2012 for the course FIN 132 taught by Professor Afda during the Spring '12 term at Centenary College New Jersey.

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07-Contracting-1 - True-False 1. Financial accounting...

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