Avery Frozen Foods owes the bank $50,000 on a line of credit. Terms of the agreement specifythat Avery must maintain a minimum current ratio of 1.2 to 1, or the entire outstanding balance becomes immediately due in full. To date, the company has complied with the minimum require-ment. However, management has just learned that a failed warehouse freezer has ruined thousands of dollars of frozen foods inventory. If the company records this loss, its current ratio will drop toapproximately 0.8 to 1.Whether any or all of this loss may be covered by insurance currently is in dispute and will notbe known for at least 90 days—perhaps much longer. There are several reasons why the insurancecompany may have no liability.In trying to decide how to deal with the bank, management is considering the followingoptions: (1) postpone recording the inventory loss until the dispute with the insurance companyis resolved, (2) increase the current ratio to 1.2 to 1 by making a large purchase of inventory onaccount, (3) explain to the bank what has happened, and request that it be flexible until things getback to normal.Instructionsa. Given that the company hopes for at least partial reimbursement from the insurance company,is it really unethical for management to postpone recording the inventory loss in the financialstatements it submits to the bank?b. Is it possible to increase the company’s current ratio from 0.8 to 1 to 1.2 to 1 by purchasingmore inventory on account? Explain.c. What approach do you think the company should follow in dealing with the bank?
Avery Frozen Foods owes the bank $50,000 on a line of credit. Terms of the agreement specify
that Avery must maintain a minimum
becomes immediately due in full. To date, the company has complied with the minimum require-
ment. However, management has just learned that a failed warehouse freezer has ruined thousands
of dollars of frozen foods inventory. If the company records this loss, its current ratio will drop to
approximately 0.8 to 1.
Whether any or all of this loss may be covered by insurance currently is in dispute and will not
be known for at least 90 days—perhaps much longer. There are several reasons why the insurance
company may have no liability.
In trying to decide how to deal with the bank, management is considering the following
options: (1) postpone recording the inventory loss until the dispute with the insurance company
is resolved, (2) increase the current ratio to 1.2 to 1 by making a large purchase of inventory on
account, (3) explain to the bank what has happened, and request that it be flexible until things get
back to normal.
Instructions
a. Given that the company hopes for at least partial reimbursement from the insurance company,
is it really unethical for management to postpone recording the inventory loss in the financial
statements it submits to the bank?
b. Is it possible to increase the company’s current ratio from 0.8 to 1 to 1.2 to 1 by purchasing
more inventory on account? Explain.
c. What approach do you think the company should follow in dealing with the bank?
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