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You are the CFO of Diversi?ed Industries. Diversi?ed has suffered through 4 or 5 tough years. This has deteriorated its ?nancial condition to the point that Diversi?ed is in danger of violating two loan covenants related to its largest loan, which is not due for 12 more years. The loan con-tract states that if Diversi?ed violates any of these covenants, the loan principal becomes immediately due and payable. Diversi?ed would be unable to make this payment, and any additional loans taken to repay this loan would likely be at higher rates, forcing Diversi?ed 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 Diversi?ed'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?

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Accounting Basics, Accounting

Category:- Accounting Basics
Reference No.:- M9969350

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