Harrison Outfitters Inc.'s (HOI) long-term debt agreements make certain demands on the business. For example, HOI may not repurchase company shares in excess of the balance of Retained Earnings. Long-term debt may not exceed shareholders' equity, and the current ratio may not fall below 1.60. If HOI fails to meet these requirements, the company's lenders have the authority to take over management of the corporation.
Changes in consumer demand have made it hard for HOI to sell its products. Current liabilities have increased faster than current assets, causing the current ratio to fall to 1.45. Prior to releasing financial statements, HOI management is scrambling to improve the current ratio. The controller points out that an equity investment can be classified as either long term or short term, depending on management's intention. By deciding to convert an investment to cash within one year, HOI can classify the investment as short term (a current asset). On the controller's recommendation, HOI's board of directors votes to reclassify the longterm equity investments as short-term equity investments.
Required
1. What effect will reclassifying the investment have on the current ratio? Is Harrison Outfitters Inc.'s financial position stronger as a result of reclassifying the investment?
2. Shortly after releasing the financial statements, sales improve and so, then, does the current ratio. As a result, HOI management decides not to sell the investments it had reclassified as short term. Accordingly, the company reclassifies the investments as long term. Has management behaved unethically? Give your reason.