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Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881

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BuyFindarrow_forward

Cornerstones of Financial Accounti...

4th Edition
Jay Rich + 1 other
ISBN: 9781337690881
Textbook Problem
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Long-Term Debt and Ethics

You arc the CFO of Diversified Industries. Diversified has suffered through 4 or 5 tough years. This has deteriorated its financial condition to the point that Diversified is in danger of violating two loan covenants related to its largest loan, which is not due for 12 more years. The loan contract states that if Diversified violates any of these covenants, the loan principal becomes immediately due and payable. Diversified would be unable to make this payment, and any additional loans taken to repay this loan would likely be at higher rates, forcing Diversified into bankruptcy. An investment banker suggests forming another entity (called “special purpose entities” or SPE) and transferring some debt to this SPE. Structuring the SPE very carefully will have the effect of moving enough debt off Diversifier's balance sheet to keep the company in compliance with all its loan covenants. The investment banker assures you that accounting rules permit such accounting treatment.

Required:

How do you react to the investment banker?

To determine

Concept introduction:

Liabilities:

Liabilities are the obligation of the business or amount payable by the business. Liabilities can current or long term. Current liabilities are liabilities payable within the short term or business cycle of the company, for example Accounts payable for purchases and utilities payable. Long term liabilities are liabilities payable in a long period/ years, for example long term loan.

To discuss:

The validity of proposal to transfer the existing company’s loan to a special purpose entity.

Explanation

Liabilities are the obligation of the business or amount payable by the business. Liabilities can current or long term. Current liabilities are liabilities payable within the short term or business cycle of the company, for example Accounts payable for purchases and utilities payable...

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