Problem:
The chief financial officer (CFO) of SuperClean Corporation requested that the accounting department prepare a preliminary balance sheet on December 30, 2007, so that the CFO could get an idea of how the company stood. He knows that certain debt agreements with its creditors require the company to maintain a current ratio of at least 2:1. The preliminary balance sheet is as follows:
SUPERCLEAN CORP.
Balance Sheet
December 30, 2007
Current assets Current liabilities
Cash $30,000 Accounts payable $ 25,000
Accounts receivable 20,000 Salaries payable 15,000 $ 40,000
Prepaid insurance 10,000 $ 60,000 Long-term liabilities
Notes payable 80,000
Total liabilities 120,000
Property, plant, and equipment (net) 200,000 Stockholders' equity
Total assets $260,000 Common stock 100,000
Retained earnings 40,000 140,000
Total liabilities and stockholders equity $260,000
Instructions (show work):
Question 1: Calculate the current ratio and working capital based on the preliminary balance sheet.
Question 2: Based on the results in (a), the CFO requested that $25,000 of cash be used to pay off the balance of the accounts payable account on December 31, 2007. Calculate the new current ratio and working capital after the company takes these actions.
Question 3: Discuss the pros and cons of the current ratio and working capital as measures of liquidity.
Question 4: Was it unethical for the CFO to take these steps?