You are one of the accountants at Grace Manufacturing Company. Grace has a $ 50

Question

You are one of the accountants at Grace Manufacturing Company. Grace has a $ 50 million loan with Lone Star Bank. One of the stipulations on the loan is that Grace must have a current ratio of 1.5; in other words, Grace’s current assets must be at least one and one-half of the current liabilities. Based on the preliminary financial statements for the year just ended, Grace will violate the stipulation. Violation will negatively affect current and future loans. The accounting staff has identified two options to fix the problem that include:

1.) Reclassifying “long-term investments” as “short- term investments.” Doing this would require a statement from management that the intention is to sell the property within one year. Actually, Grace intends to hold the investment for several years, and the classification would be changed back to long-term next year when the threat of loan violation has disappeared.

2.) Reclassifying certain short-term loans as long- term on the basis that Grace will refinance the loans. Technically, this is true. However, Grace has no formal refinancing commitment and will not have one until at least six months from now.

Present the findings of the accounting staff to the Board of Directors. What points will you emphasize in your presentation? What is your recommendation?

Explanation / Answer

The points to be included in the recommendation are:

1)Doing any of the two above suggestions is not ethical in the investors perspective as it is like forging the balance sheet which is not good for long term prospect of the company

2)If management decided to go head it is better to do this with option 1 as by doing this the current asset will increase and current ratio will go high and next year we can re clasiify them as long term investment and this is good idea

The recommendation is to go ahead with option 1 as this does not require any other outsider decision and it is purely management decison while playing with loan part is not with management and it is with bank and it is time taking as well as risky

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