Question

Retraction Company currently has a line of credit with HSC Bank. The interest rate on the line of credit increases from 7.25% to 10.25% if the following terms of the credit agreement are not met: a) Retraction's current ratio must remain above 1.2 at all times. b) Retraction's times interest earned must be 3.0 or greater at all times.
The following preliminary financial information has been prepared by the accountants of Retraction Company:
Your senior accounting manager calls to your attention that current assets include $10,000 worth of an investment in callable bonds, which do not mature for 5 years but will be callable if the company so desires in 10 months. He also notes $12,000 worth of revenue, which is attributed to a service contract for which Retraction has received payment but has not yet performed the services. There should be no reasonable reason why the contract will not be fulfilled.
Required
a. Based on the financial information presented above, is Retraction within the guidelines set forth in its credit agreement?
b. Would you change the treatment of the two items your senior manager brought to your attention? Do you see any problem with the way these items are classified? Explain your answer.
c. Based on your response to part (b), prepare revised financial information if it is necessary. If you revised the information, is Retraction still compliant with its loan agreement?


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  • CreatedJuly 16, 2015
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