Question

Rocky Mountain Products has a line-of-credit agreement with Norwest Bank that allows it to borrow up to $100,000 at any given time provided that Rocky Mountain’s current assets always exceed its current liabilities by the principal amount of the outstanding loan. If this requirement is violated, the entire loan is payable immediately; thus Rocky Mountain is very careful to fulfill the requirement at all times. All loans under this line of credit are due in one month and bear interest at a rate of 1 percent per month. On January 1, 2011, Rocky Mountain has current assets of $150,000 and current liabilities of $92,000; hence, the excess of current assets over current liabilities is $58,000. Rocky Mountain’s current liabilities at January 1, 2011, include a short- term loan under the line of credit of $35,000 due on February 1, 2011.

Required:
1. Prepare the journal entry to record the borrowing of $35,000 on January 1, 2011. By how much did this transaction increase or decrease the excess of current assets over current liabilities?
2. Assume that Rocky Mountain used the entire amount of the loan to purchase inventory. Prepare the journal entry to record the purchase. (Note: The company uses a perpetual inventory system.) By how much did this purchase increase or decrease the excess of current assets over current liabilities?
3. Without violating the loan restriction, how much more could Rocky Mountain borrow under its line of credit on January 1, 2011, to invest in inventory? To invest in new equipment? Explain.


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  • CreatedSeptember 22, 2015
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