Provisions in a Loan Agreement
As assistant controller of Midwest Construction Company, you are reviewing with your boss, the controller, Dave Jackson, the financial statements for the year just ended. During the review, Jackson reminds you of an existing loan agreement with Southern National Bank. Midwest has agreed to the following conditions:
- The current ratio will be maintained at a minimum level of 1.5 to 1.0 at all times.
- The debt-to-equity ratio will not exceed 0.5 to 1.0 at any time.
Jackson has drawn up the following preliminary condensed balance sheet for the year just ended:
Midwest Construction Company Balance Sheet December 31 (in millions of dollars)
|
Current assets
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$16
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Current liabilities
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$10
|
|
Long-term assets
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64
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Long-term debt
|
15
|
|
|
|
Stockholders' equity
|
55
|
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Total
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$80
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Total
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$80
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Jackson wants to discuss two items with you and make sure you are in agreement with him. First, long-term debt currently includes a $5 million note payable to Eastern State Bank that is due in six months. The plan is to go to Eastern before the note is due and ask it to extend the maturity date of the note for five years. Jackson doesn't believe that Midwest needs to include the $5 million in current liabilities because the plan is to roll over the note.
Second, in December of this year, Midwest received a $2 million deposit from the state for a major road project. The contract calls for the work to be performed over the next 18 months. Jackson recorded the $2 million as revenue this year because the contract is with the state; there shouldn't be any question about being able to collect.
Required
Use the Ethical Decision Framework in Exhibit 1-9 to complete the following requirements:
1. Recognize an ethical dilemma: Based on the balance sheet that Jackson prepared, is Mid- west in violation of its loan agreement? Support your answer by computing the current and debt-to-equity ratios. Do you see anything wrong with the way Jackson handled these two items? If so, compute revised current and debt-to-equity ratios. What ethical dilemma(s) do you face?
2. Analyze the key elements in the situation:
a. Who may benefit if the two items are handled as suggested by the controller? Who may be harmed?
b. How are they likely to benefit or be harmed?
c. What rights or claims may be violated?
d. What specific interests are in conflict?
e. What are your responsibilities and obligations?
3. List alternatives and evaluate the impact of each on those affected: As assistant control- ler, what are your options in dealing with the ethical dilemma(s) you identified in (1) above? If the two items are handled as suggested by the controller, will users have reliable informa- tion needed to make decisions? Why or why not?
4. Select the best alternative: Among the alternatives, which one would you select?