A new accounting standard requires a firm to accrue major new liabilities for employee pensions and benefits. As a result, its debt– equity ratio rises to the point where technical violation of covenants in its borrowing agreements is threatened. Management knows that renegotiation of these covenants would be difficult and costly.
Suggest some accounting policy choices that could reduce the likelihood of technical violation. Ideally, any changes in policies should not violate GAAP, not affect the firm’s real operations, and not reduce cash flows. Justify your suggestions.