Loan covenants
Sharon Rock, assistant accountant for Brady Industrial Products, was discussing the finalization of the financial statements of the business as at 30 June 2018 with the accountant of the business, Tim O'Shea.
Both agreed that everything appeared to be in order. Sharon, however, had noticed that everything that a large loan had been taken Out by the owner with Localtown Bank and that, as part of the loan agreement. Brady Industrial Products was to maintain a ratio of current assets (less inventories) to current liabilities of at least 1:2:1. The relevant figures prepared showed current assets (less inventories) standing at $100000, whereas current liabilities stood at $11000,000. Sharon raked her concerns with Tim O'Shea about not maintaining the desired minimum ratio for the purpose of the loan agreement. Tim replied: Yes I can see the potential problem here. We could. I suppose sell some inventory or put pressure on some trade debtors to pay up but we may not have the time to get the ratio right for the hank's information. The bank will want the 30 June figures.
Tim thought about the problem a little further and then explained: I have a better solution. There is a large loan of $120000 which the business has made to the owner. This is currently classified as a non-current receivable as the loan is not due for repayment for another 14 months. This is probably close enough to be a current receivable, so let us simply reclassify the loan to the owns- as a current receivable and this will overcome the potential problem with the bank's ratio requirement. I am sure the owner will agree with me on this.
Required
1. Identify the stakeholders involved in this situation.
2. What are the main ethical issues involved?
3. What actions are available to Sharon to resolve the dilemma she faces?
4. What would you do if you were Sharon?