The Raintree Cosmetic Company has several loans outstanding with a local bank. The debt agreements all contain a covenant stipulating that Raintree must maintain a current ratio of at least .9. Jackson Phillips, company controller, estimates that the 2016 year-end current assets and current liabilities will be $2,100,000 and $2,400,000, respectively. These estimates provide a current ratio of only .875. Violation of the debt agreement will increase Raintree's borrowing costs as the loans are renegotiated at higher rates.
Jackson proposes to the company president that Raintree purchase inventory of $600,000 on credit before year-end. This will cause both current assets and current liabilities to increase by the same amount, but the current ratio will increase to .9. The extra $600,000 in inventory will be used over the later part of 2017.. However, the purchase will cause warehousing costs and financing costs to increase.
Jackson is concerned about the ethics of his proposal. What do you think?"