Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281



Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem


You are beginning the 2019 audit of Alta Tierra Company’s long-term debt, and you determine that the company’s long-term note payable requires that it comply with certain financial covenants. The note payable is dated January 1, 2016, has a face value of $1,000,000, is due December 31, 2025, and is held by First Bank of Apex. The note payable requires that Alta Tierra maintain a minimum current ratio of 1.25, and any violation of the covenant allows the lender to call the debt. You find that Alta Tierra’s year-end current ratio is 1.1. Alta Tierra’s Chief Financial Officer, Tony Plush, informs you that the company is in violation of the debt covenant but has been granted a waiver by First Bank of Apex, so there are no consequences to the violation. The waiver allows Alta Tierra 90 days from year-end to increase its current ratio to above 1.25. Your audit partner believes that the violation is an issue and is concerned that the long-term debt must be reclassified as current.


Research the related generally accepted accounting principles and prepare a short memo to your audit partner that answers whether the long-term debt should be reclassified. How would your answer change if First Bank of Apex granted a 15-month waiver as opposed to the 90-day waiver? How would your answer change if Alta Tierra met the 2019 year-end covenant, but it was probable that the first quarter 2020 current ratio covenant would be violated? Cite your references and applicable paragraph numbers.

To determine

Research the related generally accepted accounting principles and Write a short memo to audit partner regarding whether the long-term debt must be reclassified.


Generally Accepted Accounting Principles (GAAP): These are the guidelines necessary to create accounting principles for the implementation of financial information reporting.





Audit partner

Re:  Related generally accepted accounting principles and the reclassification of long-term debt.

I have done a research regarding several issued comprised with the violation of the debt covenants. FASB ASC 470-10-55-4 states that “the issue is whether the waiver of the lender’s rights resulting from the violation of the covenant with the retention of the periodic covenant tests represents, in substance, a grace period. If viewed as a grace period, the borrower would classify the debt as current unless it is probable that the borrower can cure the violation (comply with the covenant) within the grace period”. Additionally, FASB ASC 470-10-45-4 specifies that,

Current liabilities can comprise “long-term obligations” that are callable by the creditor either for the reason that the debtor’s violation of a provision of the debt agreement at the balance sheet date marks the obligation callable or because the violation, if not cured within a specified grace period, will make the obligation callable. Consequently, such callable obligations will be categorized as current liabilities until either of the following situations is met:

a. The creditor is ignored or consequently lost the right to demand repayment for more than 1 year (or operating cycle, whichever is longer) from the date of balance sheet...

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