Sales & Marketing: Will Enron’s Fall Now Cause Your Business’ Bank Loan to Trip? Could new accounting standards impact your business’ finances?
September 1st, 2005


by Mark A. Prusinski
September-October 2005

For the most part, the collapse of Enron and other similar accounting scandals have had minimal direct impact on the day-to-day management and operations of most small and midsize non-public businesses in the United States—until perhaps now.

The highly-publicized fraudulent financial reporting by Enron has put pressure on those who set accounting standards to reconsider the question of when the financial statements of related entities need to be fully-included in a business’ financial statements. Although Enron initially focused attention on a technique in which a company designs a separate entity so that consolidation is not required, and then transfers unprofitable activities or debt to it, the breadth of the new standard has now snared many smaller businesses, too.

Over the years, many entrepreneurial business enterprises have looked at a variety of ways to structure certain financing activities so as to not impact the company’s financial results. While that may initially conjure up images of exotic financial transactions and sinister “off balance sheet” dealings, common, less-complex, plain vanilla instruments are often used, such as equipment leases, real estate leases and guarantees. Although a number of valid business reasons exist for a privately-owned business to house operating assets in a separate entity (for example, to protect real estate from lawsuits against the operating entity, to avoid unfavorable tax consequences and for family estate planning), many of these innocent and well-intentioned techniques are now within the scope of the new “consolidation” standards.

Beginning in 2005, these new accounting standards will require many related, formerly “off balance sheet” entity’s assets, debt, liabilities, income and expenses to now be consolidated in the operating business’ financial statements. Unfortunately, reporting these activities in the business’ financial statements will cause many business’ bank loan covenants (and for some, bonding company requirements) to be tripped. As a result a company can be in default of its loan agreement. These covenant violations could include bank requirements for the business to maintain or limit certain levels of debt, debt-to-equity, cash flow, interest expense and distributions to owners, and will require adjustments to or waivers of the tripped covenants by the bank to cure.

The impact of these standards will vary from company to company depending on the specific facts and structure of the relationship with the related entity. The end results will also vary from requiring consolidation of the related entity to just adding some additional disclosures to the financial statements. In any event, the key to a smooth transition is to take the time now to understand and work through the required complex evaluations with your accounting firm and, if necessary, address the impact and the options with your banker and/or bonding company on a proactive basis, well in advance of any year-end surprises.

Mark A. Prusinski, CPA, is a partner in Pease & Associates, where he leads the firm’s Accounting and Auditing practice, overseeing all financial statement audits and reviews and other special financial accounting projects. His background includes working with companies ranging in size from small privately owned businesses to large multi-national SEC companies in a variety of industries, including manufacturing, financial services, and real estate. He can be reached at

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