Taylor Manufacturing entered into a borrowing arrangement that requires the company to maintain a retained earnings balance of $500,000. The company also wishes to finance internally a major plant addition in the not-too-distant future. Accordingly, the board of directors has decided to appropriate $350,000 of the retained earnings balance. Prior to the board's action, the balance in the retained earnings account was $800,000.
a. Why would the board of directors appropriate retained earnings in the situation described above, and why might an auditor insist that it be done?
b. Show how retained earnings would be disclosed on the balance sheet after the appropriation.
c. Discuss the constraints with respect to dividend payments that have been imposed on the board by the debt covenant and the appropriation.