All-inclusive interest rate;
  Interest plus annual fee;
  Interest plus annual and monthly fees;
  Interest plus annual and monthly fees plus the cost of the field exam(s) and/or a minimum line usage fee.

Debtor access to the lender's internal files is rarely, if ever, requested or questioned. However, in those cases in which the lender invoices the borrower for a specific administrative service, the borrower may request a copy of the file, exam report, etc. Often, the request is precipitated by the way the loan officer introduces the exam concept to the client. For instance: To justify the exam fee, some loan officers persuade the borrower that it will benefit from the examiner's constructive recommendations, insights, etc. 

In any event, the request saddles the loan officer with a perplexing dilemma: To distribute the report to facilitate the invoice's payment and/or goodwill, or not distribute, and incur the wrath of an irate customer. Most lenders/loan officers, who would not give consideration to a borrower's request for a copy of the Credit Approval File (CAF), have caved into the borrower's pressure for a copy of the field exam report.

Traditional reasons for restricting distribution Lenders have been customarily reluctant to distribute the examiner's report for the following reasons:

1) Restricting distribution affords the examiner the luxury of reporting his or her intuitions and other subjective observations. This information could be a red flag of existing and/or future problems with the credit. However, the examiner may not have adequate time to appropriately investigate these intuitions and subjective observations to a conclusion supported by fact. After reviewing the exam report, the lender may deem it appropriate to investigate further. Consequently, such unsupported comments, would be excluded if the borrower had access to the exam report, as it could expose the examiner to libel suits. Debtor access to the CAF would have a similar effect, which would severely impair the credit underwriting process.

Example: After receiving noncommittal responses from the controller, along with the controller constantly looking over the examiner's shoulder, the examiner believed the controller was either incompetent or trying to hide something. However, the examiner did not have substantive evidence to corroborate his gut feeling. This subjective evaluation would not be reported to the lender if the examiner knew that the borrower was to receive a copy of the report. Given the freedom to express these feelings, the lender has the option to either discard the comments or engage the examiner to expand the examination and further investigate the controller's competence and/or integrity.

2) The contract/engagement, whether the examiner is an independent firm or a department within the financial institution, is between the lender/loan officer and the examiner. Consequently, the examiner is responsible for responding to the lender's inquiries, but not to the borrower and its CPA. If distributed, the examiner runs the potential risk of receiving calls from such third parties requesting explanations and/or substantiation. This obviously would increase the exam costs well beyond anticipated fees. Further, the examiner's responses to the borrower could interfere with lender's credit underwriting. Additionally, the examiner's knowledge of the banking relationship is usually limited to the exam. Thus, the examiner's responses could be totally off the mark.

Example: Examiners are frequently asked to opine on the advance rate. Should the examiner, independent of the loan officer, conclude that an 80 percent rate is appropriate while the lender is using a 60 percent rate? No. The borrower could use this information to negotiate a higher advance rate.

3) Giving the exam report to the ABL customer educates the borrower to the examiner's "audit" techniques. Armed with this knowledge, the borrower is poised to negate the procedures' future effectiveness in uncovering improprieties.

Example: Assume the examiner's procedures prescribe the selection and examination of appropriate supporting documentation for all accounts receivable with balances of $5,000 and greater to the exclusion of all other accounts receivable. The borrower could circumvent these procedures by overstating the eligible receivables. The borrower could properly report the accounts, subject to inspection, on the receivable ageing, and also report fictitious accounts with balances of less than $5,000, which would not be subject to examination. Also, if the borrower knew that the examiner would be reviewing bills of lading as support for accounts receivable, the client could perpetrate a defalcation by creating "dummy" bills of lading to support the fictitious receivables.

4) Customers have used information contained in exam reports as ammunition for lender liability suits. Even when suits are without merit, the lender incurs significant defense costs. Nonaccess to the field exam report reduces litigation.

Example: During the field exam, cash is reviewed, on a limited scope basis, to discern incidents of diversion. Specifically, deposits are reviewed to insure that the client's source of funds is the lender's advances -- receivable remittances are directed to the lock box and are used to pay down the line. An examiner's review in which no diversion was noted may read, "Our review of cash revealed no unusual transactions." Suppose the client read this comment in wake of discovering an employee embezzlement. This could be an inducement for the client to sue the lender for not uncovering the embezzlement scheme, particularly if the loan officer touted the exam's benefits. 

Another reason to restrict distribution

In September 1995, The American Institute of Certified Public Accountants' (AICPA) Auditing Standards Board issued Statement on Auditing Standards No. 75- Engagements to Apply Agreed-Upon Procedures to Specified Elements, Accounts or Items of a Financial Statement (SAS No. 75). This statement restricts the use of the report to "specified users," and it is effective for reports dated after April 30, 1996.

"Specified users" are those responsible for the sufficiency, nature, timing, and extent of these agreed-upon procedures. In the case of ABL field exams, the lender(s) is the specified user(s). Additionally the pronouncement sets forth standards and provides guidance to the "accountant" (CPA) concerning the performance and reporting in all such agreed-upon procedures engagements. SAS No. 75 defines "accountant" as a person possessing the professional qualifications required to practice as an independent auditor (CPA).

An engagement to apply agreed-upon procedures is one in which a CPA is engaged by a client/lender to issue a report of findings based on specific procedures performed on the specific subject matter of specified elements, accounts or items of a financial statement. Specified elements, accounts or items of a financial statement refer to accounting information that is a part of, but significantly less than, a financial statement. Specified elements, accounts, or items of a financial statement may be directly identified in a financial statement or appended notes; or they may be derived therefrom by analysis, aggregation, summarization or mathematical computation.

Examples of specified elements, accounts and items of a financial statement include:

The cash accounts, as of a certain date, included in the borrower's general ledger maintained for the purpose of preparing financial statements represented as being in accordance with generally accepted accounting principles.

A schedule of the borrower's accounts receivable, as of a certain date, that reflects the accounts receivable presented in conformity with generally accepted accounting principles.

The amounts included in the caption "property and equipment" identified in a statement of assets, liabilities, and capital, as of a certain date, presented on an income-tax basis. 

The reader will probably agree, the subject of the asset-based field exam (cash, accounts receivable, inventory, etc.) satisfies the specified elements, accounts and items of a financial statement criterion.

Since the lender requires that the findings be independently derived, the services of a CPA are obtained to perform procedures and report findings. The lender and the CPA agree upon the procedures which the lender believes are appropriate. Since the lender's needs may vary widely, the nature, timing, and extent of the agreed-upon procedures may vary as well. Consequently, the lender assumes responsibility for the sufficiency of the procedures. In an engagement performed under SAS No. 75, the CPA does not perform an audit and does not provide an opinion or negative assurance relating to the fair presentation of the specified elements, accounts, or items of a financial statement. An example of a negative assurance is: "Nothing came to my attention that caused me to believe that the assertion was not fairly stated in accordance with the established or stated criteria..." Instead, the CPA's report on agreed-upon procedures is required to be in the form which delineates the procedures applied and the attendant findings. Exhibit I provides a specimen report.

As a consequence of the lender's role in agreeing upon the procedures performed or to be performed, the pronouncement requires that the CPA's report on such engagements clearly indicate that its use is restricted to the specific user(s)/lender(s). Although CPA reports such as compilations, reviews, and audits, which are based on a defined level of service, are appropriate for general distribution, these agreed-upon procedure reports are not. All informed users understand the nature of compilation, review, and audit services and the extent of the assurances provided therein. Agreed-upon procedures engagements, on the other hand, are designed specifically to meet the specified lender's needs, who have determined the procedures to be performed and who take responsibility for their sufficiency.

Nevertheless, the pronouncement does permit adding a "nonparticipant" party (borrower) as a specified user under certain conditions. To do so, the CPA is required to obtain an affirmative acknowledgment, normally in writing, from the nonparticipant agreeing to the procedures performed and of that third party taking responsibility for the sufficiency of the procedures. This means the borrower would have to participate in the planning stages of the exam, and agree to the exam's scope and the examiner's work papers. Logistics, however, would normally prohibit such amendment. The reason: actual explanation process of the exam procedures to the borrower will heighten the lender's awareness of its increased vulnerability to deceit and/or fraud that this education process would create. 

Conclusion
In the end, it is the lender's prerogative to distribute the field exam report, absent SAS No. 75. However, the following are points to consider:

However, it behooves the lender to treat the exam report with the same reverence given to the CAF -- restrict its distribution to the lender's internal use. This does not preclude discussing the exam findings with the borrower. Nevertheless, the lender may be hard pressed to fend off a persistent debtor's request. SAS No. 75 requires a CPA to restrict the distribution. By performing the examination, the engaged CPA provides the lender the needed leverage when he or she faces an adamant request for the exam report.

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