Chapter 5

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What risk does poor credit quality pose to the bank?

Decrease in interest rates

Enhanced credit practices

Increase in receivables rebilled

Poor collateral quality (correct)

What is a potential consequence of selling consistently to questionable accounts?

Increased collateral value

Deterioration of the bank's collateral (correct)

Enhanced client relationships

Improvement in overall credit quality

How can fictitious receivables impact advances by the bank?

Encourage healthy credit practices

Provide genuine collateral support

Result in increased credit limits

Introduce risk due to lack of collateral (correct)

What is the risk associated with unbilled receivables from a bank's perspective?

Lack of collateral until invoicing Signup and view all the answers

How do bonded receivables differ from traditional receivables for a bank?

Inherent bonding security Signup and view all the answers

What is the primary focus of the review of the client's management information systems (MIS) related to receivables?

To determine if the systems permit comprehensive and timely reporting of the status of credit sales Signup and view all the answers

When evaluating the client's bad debt expense practices, what is the examiner primarily interested in determining?

Whether the client complies with generally accepted accounting principles by using the allowance method Signup and view all the answers

If the client uses the allowance method, what is the examiner primarily interested in reviewing?

The adequacy of the allowance for bad debts and the method for determining bad debt expense Signup and view all the answers

When evaluating the client's credit and collection practices, what does the examiner consider?

Industry practices, especially if extended invoice terms are the norm Signup and view all the answers

What is the examiner primarily interested in reviewing when it comes to the timeliness of payment and credit memo posting?

Whether the client's systems permit comprehensive and timely reporting of the status of credit sales Signup and view all the answers

What is the primary purpose of reconciling the client's aging to the general ledger and financial statements?

To ensure the accuracy of the client's borrowing requests to the bank Signup and view all the answers

What might a credit adjustment to the receivables by the client's outside accountants indicate?

The potential for uncollectible accounts that have been deemed uncollectible Signup and view all the answers

What could discrepancies between the company's internal records and reports filed with the bank potentially indicate?

Tampering with records to support fraudulent borrowing requests Signup and view all the answers

What is the primary purpose of verifying the aging?

To verify that the accounts receivable are as current as represented by the borrower Signup and view all the answers

What steps are involved in verifying the aging?

Taking a sample of invoice records and verifying the invoice date, due date, and invoice amounts against the aging report Signup and view all the answers

What type of documentation is inspected to verify that the shipment took place the same day or one day before the invoice date?

Bills of lading Signup and view all the answers

In an examination, why is it important to identify customer concentrations?

To detect potential financial risks Signup and view all the answers

What is a key concern when reviewing a client's credit approval procedures?

Setting appropriate credit limits Signup and view all the answers

What may be indicated if an invoice lacks proof of order such as a purchase order or a note in the file?

Potential fraud Signup and view all the answers

Why is verifying that quantities shipped match those marked on the invoice and bill of lading important?

To identify potential shipping errors Signup and view all the answers

What is the primary reason why verification of tax payments is important, according to the text?

To determine if the client has any outstanding tax liens that could take precedence over secured creditor liens. Signup and view all the answers

What is the purpose of reviewing the client's A/P aging as part of the payables/taxes examination procedures?

To determine if the client is meeting their payables obligations on a timely basis. Signup and view all the answers

What is the purpose of identifying payables concentrations as part of the payables/taxes examination procedures?

To ensure the client is not over-relying on a single vendor for critical supplies or goods. Signup and view all the answers

What is the purpose of identifying contra accounts as part of the payables/taxes examination procedures?

To compare the receivable balance of vendors who are also customers with their payable balance. Signup and view all the answers

What is the purpose of identifying ineligible inventory categories as part of the payables/taxes examination procedures?

To ensure that ineligible inventory categories have not been included in the borrowing base calculation. Signup and view all the answers

What is the primary purpose of conducting periodic inspections of collateral as part of the payables/taxes examination procedures?

To evaluate the current value of the collateral pledged to the bank to ensure it remains sufficient to support the outstanding loan. Signup and view all the answers

What is the priority lien that the bonding agent will have if they complete the project?

A lien on project receivables Signup and view all the answers

What is the purpose of guaranteed sales contracts between clients and retailers?

To guarantee the retailer will take back unsold goods from the client Signup and view all the answers

Why are intercompany receivables considered questionable collateral?

All of the above Signup and view all the answers

What is the purpose of reconciling and verifying the accounts receivable aging?

All of the above Signup and view all the answers

Why are guaranteed sales considered weak collateral support for advances?

Because the sales are contingent on the retailer being able to sell the goods Signup and view all the answers

What is the primary purpose of conducting periodic inspections of collateral?

All of the above Signup and view all the answers

What is the primary reason for the bank to be concerned about the value of intercompany receivables?

All of the above Signup and view all the answers

What is the primary purpose of the receivables examination procedures?

To identify and quantify the loss exposure areas in the receivables Signup and view all the answers

What is the primary reason for the bank to be concerned about guaranteed sales contracts?

The sales are contingent on the retailer being able to sell the goods Signup and view all the answers

What is the primary purpose of the receivables examination procedures outlined in the text?

To identify and quantify the loss exposure areas in the receivables Signup and view all the answers

In examining accounts receivable, which of the following practices would be a significant red flag for potential overstatement of collateral value?

All of the above Signup and view all the answers

When examining a borrower's cash collateral account, what should the examiner verify regarding deposit activity?

All of the above Signup and view all the answers

Based on the information provided, which type of receivable would be considered the LEAST risky from a collateral valuation perspective?

Receivables for goods shipped and billed in the normal course Signup and view all the answers

What is a critical consideration when evaluating the value of equipment as a secondary repayment source?

The equipment's age Signup and view all the answers

When assessing the value of plant and equipment, what factor plays a significant role in determining collateral value?

Useful life expiration of the equipment Signup and view all the answers

Why is it important to know whether facilities housing equipment are owned or leased when evaluating collateral?

To identify ownership interest and control over the property Signup and view all the answers

In equipment appraisal, why is it crucial to consider how much of the equipment's useful life has already expired?

To determine potential future depreciation Signup and view all the answers

When evaluating plant and equipment for operational adequacy, what is a key question to address?

Is the current facility sufficient for future needs? Signup and view all the answers

Which factor is likely to increase the liquidation value of equipment used as collateral?

The equipment being essential to customer's operations Signup and view all the answers

Why might a two-year-old machine with a service life of three years be less valuable as collateral compared to a five-year-old machine with a service life of 20 years?

The five-year-old machine has transferable warranty protection Signup and view all the answers

If equipment is permanently or semipermanently affixed to real property, what issue might arise concerning its liquidation?

Legal issues regarding landlord rights in a lease situation Signup and view all the answers

What characteristic of equipment makes it easily identifiable and helps in determining specific collateral?

Having a serial number Signup and view all the answers

Which type of equipment is less susceptible to default when financed as per the text?

Essential equipment Signup and view all the answers

How does the presence of an active secondary market impact the estimation of liquidation value for equipment?

It makes it easier to estimate the liquidation value. Signup and view all the answers

How does a surplus of equipment in a customer's industry affect the equipment's value?

Decreases its value as it becomes less desirable. Signup and view all the answers

Why is it important to consider current industry trends when evaluating the value of equipment?

To assess potential impacts on the equipment's value. Signup and view all the answers

How do consolidations and bankruptcies in an industry affect the value of equipment used in production?

Decrease the equipment value as surplus equipment floods the market. Signup and view all the answers

What role do appraiser credentials play when reviewing an equipment appraisal?

They indicate the appraiser's expertise and reliability. Signup and view all the answers

Which of the following factors is most important to consider when evaluating the collateral value of equipment?

The condition of the equipment and its maintenance history Signup and view all the answers

When assessing the collateral value of equipment, what is the primary concern regarding its portability?

The ease of relocating the equipment to a different facility Signup and view all the answers

How does the age of equipment typically impact its collateral value?

Newer equipment typically has a higher collateral value due to lower obsolescence risk Signup and view all the answers

In evaluating the collateral value of equipment, which of the following factors is least important?

The brand name and reputation of the equipment manufacturer Signup and view all the answers

Which of the following types of equipment would likely have the highest collateral value, according to the information provided?

General-purpose equipment used in a clean, climate-controlled environment Signup and view all the answers

Which of the following is NOT a factor that can make rollover expenses difficult to quantify accurately?

Fixed rental rates Signup and view all the answers

What is the main purpose of using a discounted cash flow analysis in the income capitalization approach?

To estimate the property's potential pretax, unlevered cash flow Signup and view all the answers

Which of the following is NOT a component of the Net Operating Income (NOI) calculation?

Rental income Signup and view all the answers

What is the primary purpose of applying a capitalization rate (cap rate) to the Net Operating Income (NOI) in the income capitalization approach?

To calculate the value of the property under the income capitalization approach Signup and view all the answers

Which of the following is a key factor that the capitalization rate (cap rate) is correlated to?

The property's risk profile Signup and view all the answers

In a triple net (NNN) lease, which of the following expenses are typically passed on to the tenant?

Taxes, insurance, and maintenance Signup and view all the answers

What is the purpose of including a reserve for replacement expenses in an appraisal?

To cover the eventual replacement of items like parking lots, roofs, and appliances due to normal wear and tear Signup and view all the answers

In the context of rent analysis, what is the likely purpose of including a 'cushion' in a gross lease rate?

To provide a buffer for uncertainties in operating expenses Signup and view all the answers

Which of the following expenses is NOT typically included in rollover expenses?

Costs of replacing appliances or fixtures for re-leasing space Signup and view all the answers

In the context of rent analysis, what is the primary purpose of carefully reviewing the expense sharing arrangement in subject and comparable leases?

To accurately measure the net expense burden to the property owner Signup and view all the answers

According to the passage, which of the following is a key factor to consider when establishing a relevant vacancy rate for a property?

The overall economic trends and market conditions affecting the property's location. Signup and view all the answers

The passage discusses how operating expenses are typically expressed. Which of the following is the LEAST common way that operating expenses are presented?

As a fixed monthly amount. Signup and view all the answers

According to the passage, which of the following is a key characteristic of operating expenses for a property?

They are relatively fixed and do not change significantly over time. Signup and view all the answers

The passage discusses the concept of 'vacancy' for a property. Which of the following is the LEAST likely reason for a property to have vacant space?

The property owner is intentionally holding vacant units off the market to drive up rents. Signup and view all the answers

How does the passage suggest the vacancy factor should be applied in calculating a property's effective gross income (EGI)?

The vacancy factor is subtracted from the property's GPI to determine the EGI. Signup and view all the answers

In the income capitalization approach, what is the primary purpose of applying a capitalization rate (cap rate) to the Net Operating Income (NOI)?

To estimate the property's market value by converting the expected future income stream into a present value. Signup and view all the answers

In the context of real estate valuation, what is the primary purpose of the band of investment technique?

To determine the appropriate capitalization rate for a property based on its financing structure. Signup and view all the answers

What is the theoretical basis for the weighted average cost of capital (WACC) approach in real estate valuation?

The net present value (NPV) rule, which states that a project should be accepted if its NPV is positive. Signup and view all the answers

In the context of real estate valuation, what is the primary purpose of the loan constant?

To calculate the periodic mortgage payment for a loan with a given interest rate and term. Signup and view all the answers

In the practical application of the income capitalization approach, how is the vacancy factor typically incorporated into the Net Operating Income (NOI) calculation?

The vacancy factor is applied as a percentage deduction from the gross potential rental income to arrive at the effective gross income (EGI). Signup and view all the answers

In the weighted average cost of capital (WACC) approach, what is the primary purpose of incorporating the cost of debt and cost of equity components?

To account for the different risk profiles and required rates of return for debt and equity financing. Signup and view all the answers

In the band of investment technique, what is the primary purpose of the mortgage constant?

To determine the appropriate capitalization rate for the debt component of the property's financing structure. Signup and view all the answers

In the income capitalization approach, what is the primary theoretical justification for using the loan constant to calculate periodic mortgage payments?

The net present value (NPV) rule, which states that the present value of the mortgage payments should equal the loan amount. Signup and view all the answers

In the weighted average cost of capital (WACC) approach, how is the required rate of return for the equity component typically determined?

By adding a risk premium to the risk-free rate, based on the property's risk profile. Signup and view all the answers

In the practical application of the income capitalization approach, what is the primary consideration when selecting an appropriate capitalization rate (cap rate) for a property?

The property's financing structure and the required rates of return for debt and equity components. Signup and view all the answers

Chapter 5

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Questions and Answers

What risk does poor credit quality pose to the bank?

What is a potential consequence of selling consistently to questionable accounts?

How can fictitious receivables impact advances by the bank?

What is the risk associated with unbilled receivables from a bank's perspective?

How do bonded receivables differ from traditional receivables for a bank?

What is the primary focus of the review of the client's management information systems (MIS) related to receivables?

When evaluating the client's bad debt expense practices, what is the examiner primarily interested in determining?

If the client uses the allowance method, what is the examiner primarily interested in reviewing?

When evaluating the client's credit and collection practices, what does the examiner consider?

What is the examiner primarily interested in reviewing when it comes to the timeliness of payment and credit memo posting?

What is the primary purpose of reconciling the client's aging to the general ledger and financial statements?

What might a credit adjustment to the receivables by the client's outside accountants indicate?

What could discrepancies between the company's internal records and reports filed with the bank potentially indicate?

What is the primary purpose of verifying the aging?

What steps are involved in verifying the aging?

What type of documentation is inspected to verify that the shipment took place the same day or one day before the invoice date?

In an examination, why is it important to identify customer concentrations?

What is a key concern when reviewing a client's credit approval procedures?

What may be indicated if an invoice lacks proof of order such as a purchase order or a note in the file?

Why is verifying that quantities shipped match those marked on the invoice and bill of lading important?

What is the primary reason why verification of tax payments is important, according to the text?

What is the purpose of reviewing the client's A/P aging as part of the payables/taxes examination procedures?

What is the purpose of identifying payables concentrations as part of the payables/taxes examination procedures?

What is the purpose of identifying contra accounts as part of the payables/taxes examination procedures?

What is the purpose of identifying ineligible inventory categories as part of the payables/taxes examination procedures?

What is the primary purpose of conducting periodic inspections of collateral as part of the payables/taxes examination procedures?

What is the priority lien that the bonding agent will have if they complete the project?

What is the purpose of guaranteed sales contracts between clients and retailers?

Why are intercompany receivables considered questionable collateral?

What is the purpose of reconciling and verifying the accounts receivable aging?

Why are guaranteed sales considered weak collateral support for advances?

What is the primary purpose of conducting periodic inspections of collateral?

What is the primary reason for the bank to be concerned about the value of intercompany receivables?

What is the primary purpose of the receivables examination procedures?

What is the primary reason for the bank to be concerned about guaranteed sales contracts?

What is the primary purpose of the receivables examination procedures outlined in the text?

In examining accounts receivable, which of the following practices would be a significant red flag for potential overstatement of collateral value?

When examining a borrower's cash collateral account, what should the examiner verify regarding deposit activity?

Based on the information provided, which type of receivable would be considered the LEAST risky from a collateral valuation perspective?

What is a critical consideration when evaluating the value of equipment as a secondary repayment source?

When assessing the value of plant and equipment, what factor plays a significant role in determining collateral value?

Why is it important to know whether facilities housing equipment are owned or leased when evaluating collateral?

In equipment appraisal, why is it crucial to consider how much of the equipment's useful life has already expired?

When evaluating plant and equipment for operational adequacy, what is a key question to address?

Which factor is likely to increase the liquidation value of equipment used as collateral?

Why might a two-year-old machine with a service life of three years be less valuable as collateral compared to a five-year-old machine with a service life of 20 years?

If equipment is permanently or semipermanently affixed to real property, what issue might arise concerning its liquidation?

What characteristic of equipment makes it easily identifiable and helps in determining specific collateral?

Which type of equipment is less susceptible to default when financed as per the text?

How does the presence of an active secondary market impact the estimation of liquidation value for equipment?

How does a surplus of equipment in a customer's industry affect the equipment's value?

Why is it important to consider current industry trends when evaluating the value of equipment?

How do consolidations and bankruptcies in an industry affect the value of equipment used in production?

What role do appraiser credentials play when reviewing an equipment appraisal?

Which of the following factors is most important to consider when evaluating the collateral value of equipment?

When assessing the collateral value of equipment, what is the primary concern regarding its portability?

How does the age of equipment typically impact its collateral value?

In evaluating the collateral value of equipment, which of the following factors is least important?

Which of the following types of equipment would likely have the highest collateral value, according to the information provided?

Which of the following is NOT a factor that can make rollover expenses difficult to quantify accurately?

What is the main purpose of using a discounted cash flow analysis in the income capitalization approach?

Which of the following is NOT a component of the Net Operating Income (NOI) calculation?

What is the primary purpose of applying a capitalization rate (cap rate) to the Net Operating Income (NOI) in the income capitalization approach?

Which of the following is a key factor that the capitalization rate (cap rate) is correlated to?

In a triple net (NNN) lease, which of the following expenses are typically passed on to the tenant?

What is the purpose of including a reserve for replacement expenses in an appraisal?

In the context of rent analysis, what is the likely purpose of including a 'cushion' in a gross lease rate?

Which of the following expenses is NOT typically included in rollover expenses?

In the context of rent analysis, what is the primary purpose of carefully reviewing the expense sharing arrangement in subject and comparable leases?

According to the passage, which of the following is a key factor to consider when establishing a relevant vacancy rate for a property?

The passage discusses how operating expenses are typically expressed. Which of the following is the LEAST common way that operating expenses are presented?

According to the passage, which of the following is a key characteristic of operating expenses for a property?

The passage discusses the concept of 'vacancy' for a property. Which of the following is the LEAST likely reason for a property to have vacant space?

How does the passage suggest the vacancy factor should be applied in calculating a property's effective gross income (EGI)?

In the income capitalization approach, what is the primary purpose of applying a capitalization rate (cap rate) to the Net Operating Income (NOI)?

In the context of real estate valuation, what is the primary purpose of the band of investment technique?