Question

Recently, your uncle, Carlos Beltran, who knows that you always have your eye out for a profitable investment, has discussed the possibility of your purchasing some corporate bonds. He suggests that you may wish to get in on the “ground floor” of this deal. The bonds being issued by Neville Corp. are 10-year debentures which promise a 40% rate of return. Neville manufactures novelty/party items. You have told Uncle Carlos that, unless you can take a look at Neville’s financial statements, you would not feel comfortable about such an investment. Believing that this is the chance of a lifetime, Uncle Carlos has procured a copy of Neville’s most recent, unaudited financial statements which are a year old. These statements were prepared by Mrs. Andy Neville. You peruse these statements, and they are quite impressive. The balance sheet showed a debt-to-equity ratio of 0.10 and, for the year shown, the company reported net income of $2,424,240. The financial statements are not shown in comparison with amounts from other years. In addition, no significant note disclosures about inventory valuation, depreciation methods, loan agreements, etc. are available. Write a letter to Uncle Carlos explaining why it would be unwise to base an investment decision on the financial statements that he has provided to you. Be sure to explain why these financial statements are neither relevant nor representationally faithful.

Answer 1

To : Carlos Beltron

From : Micheal Hasting

Re : Investment advisory on corporate bond.

Dear Uncle

This letter is the extension of our discussion with regard to investment in corporate bonds being issued by Neville Corp. I have analyzed the unaudited financial statements of Neville Corp. I have the following findings out of those financial statements .

First of all these financial statements are unaudited , thus may not be very reliable and may include material omissions and errors. Also these financial statements are year ago whereas bonds are to be issued by the company in the current year. Thus, these financial statements are not that relevant . Further it also does not contain financials of precious years and no explanation or specific disclosures has been given with regard to inventory valuation, depriciation method, loan agreements. Also these financial statements are prepared by Mrs. Andy Neville and thus may contain any biases. All these facts raises concern over faithful representation of financial statements .

Considering all these factors, I think basing our decision solely on these financial statement will not be a correct approach towards the investment and it would be better and advisable that you should look for further evidence about the fiancial position and performance of the company and then only we can make decision whether we should put our hard earned money in this deal.

Thanks and regards

Michael Hasting