Ethical Issue Case Summary: The long-term creditors of Company R made conditional agreement that the company cannot purchase treasury stock more than the amount in the balance of the retained earnings , the long-term debt may not exceed the stockholders equity , and the current ratio should not fall below 1.50 at any point of time. If such conditions are violated the lenders of the company will take over the management of the company. Recently Company R is facing a low demand for the products and its current liabilities grows faster than the current liabilities, resulting in the current ratio become 1.47. The management is worried to work out something before releasing the financial statements. The controller suggested to convert the long-term investments into short-term by choosing to payoff within one year. The board of directors votes for the recommendation of the controller to reclassify the long-term investments to short-term investments. To Ascertain: The effect of reclassification of investments on the current ratio, and if the financial condition of Company R will be stronger by such re-classification.

Question

Want to see the full answer?

Answer 1

Question

Chapter 15, Problem 15.1CTEI

1.

To determine

Ethical Issue

Case Summary: The long-term creditors of Company R made conditional agreement that the company cannot purchase treasury stock more than the amount in the balance of the retained earnings, the long-term debt may not exceed the stockholders equity, and the current ratio should not fall below 1.50 at any point of time. If such conditions are violated the lenders of the company will take over the management of the company.

Recently Company R is facing a low demand for the products and its current liabilities grows faster than the current liabilities, resulting in the current ratio become 1.47. The management is worried to work out something before releasing the financial statements. The controller suggested to convert the long-term investments into short-term by choosing to payoff within one year. The board of directors votes for the recommendation of the controller to reclassify the long-term investments to short-term investments.

To Ascertain: The effect of reclassification of investments on the current ratio, and if the financial condition of Company R will be stronger by such re-classification.

2.

To determine

To Ascertain: If the managers of Company R have behaved unethically.

Expert Solution & Answer

Want to see the full answer?

Check out a sample textbook solution

See solution

Students have asked these similar questions

Ross’s Lipstick Company’s long-term debt agreements make certain demands on the business. For example, Ross may not purchase treasury stock in excess of the balance of retained earnings. Also, long-term debt may not exceed stockholders’ equity, and the current ratio may not fall below 1.50. If Ross fails to meet any of these requirements, the company’s lenders have the authority to take over management of the company. Changes in consumer demand have made it hard for Ross to attract customers Current liabilities have mounted faster than current assets, causing the current ratio to fall to 1.47. Before releasing financial statements, Ross’s management is scrambling to improve the current ratio. The controller points out that an investment can be classified as either long-term or short-term, depending on management’s intention. By deciding to convert an investment to cash within one year, Ross can classify the investment as short-term-a current asset. On the controller’s recommendation,…

Management and shareholders favor debt financing over equity financing for all of the following reasons, except A. The present owners remain in control of the corporation B. The interest incurred in debt financing is a deductible expense in arriving at taxable income while dividends are not C. The charge for interest on the debt may be less than the amount of dividends that might be expected by shareholders D. The interest on debt is not required to be paid periodically when the enterprise results in unfavorable operations and financial position

Agency costs of debt arise any time there is a conflict between lender interests and borrower interests. Assuming that agency costs of debt are high at a company relative to the rest of the market, other things being equal, which of the following would you expect to observe with the company's borrowing? It will be able to borrow less than other companies. AND It will have to pay lower interest rates on its loans than otherwise companies. It will have to pay lower interest rates on its loans than otherwise similar companies. It will have to pay lower interest rates on its loans than otherwise similar companies. AND It will face more "covenants" than otherwise similar companies. NONE. it will face more "covenants" than otherwise similar companies. It will be able to borrow less than other companies. It will be able to borrow less than other companies. It will face more "covenants" than otherwise similar companies.