Ethics
Eugene Wright is CFO of Caribbean Cruise Lines. The company designs and manufactures luxury boats. It's near year-end, and Eugene is feeling kind of queasy. The economy is in a recession, and demand for luxury boats is way down. Eugene did some preliminary liquidity analysis and noted the company's current ratio is slightly below the 1.2 minimum stated in its debt covenant with First Federal Bank. Eugene realizes that if the company reports a current ratio below 1.2 at year-end, the company runs the risk that First Federal will call its $10 million loan. He just cannot let that happen.
Caribbean Cruise Lines has current assets of $12 million and current liabilities of $10.1 million. Eugene decides to delay the delivery of $1 million in inventory purchased on account from the originally scheduled date of December 26 to a new arrival date of January 3. This maneuver will decrease inventory and accounts payable by $1 million at December year-end. Eugene believes the company can somehow get by without the added inventory, as manufacturing slows down some during the holiday season.
Required:
1. How will the delay in the delivery of $1 million in inventory purchased on account affect the company's current ratio on December 31? Provide supporting calculations of the current ratio before and after this proposed delivery delay.
2. Is this practice ethical? Provide arguments both for and against.
Written Communication
Western Manufacturing is involved with several potential contingent liabilities. Your assignment is to draft the appropriate accounting treatment for each situation described below. Western's fiscal year-end is December 31, 2012, and the financial statements will be issued in early February 2013.
a. During 2012, Western experienced labor disputes at three of its plants. Management hopes an agreement will soon be reached, However, negotiations between the company and the unions have not produced an acceptable settlement, and employee strikes are currently under way. It is virtually certain that material costs will be incurred, but the amount of possible costs cannot be reasonably estimated.
b. Western warrants most products it sells against defects in materials and workmanship for a period of a year Based on its experience with previous product introductions, warranty costs are expected to approximate 2% of sales. A new product introduced in 2012 had sales of $2 million, and actual warranty expenditures incurred so far on the product are $25,000. The only entry made so far relating to warranties on this new product was to debit Warranty Expense $25,000 and credit Cash $25,000.
c. Western is involved in a suit filed in January 2013 by Crump Holdings seeking $88 million, as an adjustment to the purchase price in connection with the company's sale of its textile business in 2012. The suit alleges that Western misstated the assets and liabilities used to calculate the purchase price for the textile division. Legal counsel advises that it is reasonably possible that Western could lose up to $88 million.
Required:
In a memo, describe the appropriate means of reporting each situation and explain your reasoning.