Near the end of 2016, The Cheesecake Factory entered into a new loan agreement with its creditors. This new four-year agreement provided loan commitments totaling up to $200 million. The commitments enable The Cheesecake Factory to borrow funds as needed at specified rates and terms. As of January 3, 2017, The Cheesecake Factory had not borrowed any funds associated with the commitment, so its long-term debt related to the new loan agreement was zero.

As part of the loan agreement, The Cheesecake Factory agreed to maintain a maximum “Net Adjusted Leverage Ratio” of 4.0 and a minimum “EBITDAR Ratio” of 1.9. Roughly, the Net Adjusted Leverage Ratio is a measure using specific debt balances divided by specific earnings items, while the EBITDAR Ratio is a measure of specific earnings items before interest, taxes, and other items divided by interest and rental expenses. As of December 29, 2015, The Cheesecake Factory’s Net Adjusted Leverage Ratio was 2.4 and its EBITDAR Ratio was 3.1.

Suppose that The Cheesecake Factory borrows $30 million on July 1, 2018. Assume also that the interest rate in effect during 2018 is 1.5% for this loan and that The Cheesecake Factory does not make any principal payments on the loan during 2018 and had no other loans outstanding from this loan agreement during the year. Assume further that the loan terms call for monthly interest payments due on the 1st of the month for the month just ended. Monthly interest payments will begin on August 1, 2018.

Requirements

1. When the new loan agreement was made at the end of 2016, would The Cheesecake Factory have recorded the loan agreement in its general ledger? Would this new loan agreement have impacted The Cheesecake Factory’s balance sheet in 2016? Explain.

2. What entry would The Cheesecake Factory make on July 1, 2018, to record its borrowing? How would the new borrowing impact its assets, liabilities, and equity on that date?

3. How much interest expense related to the hypothetical borrowing would The Cheesecake Factory need to accrue at its fiscal 2018 year-end? (Assume that fiscal year end for 2018 is December 31, 2018.) How would the adjusting entry for interest expense impact The Cheesecake Factory’s assets, liabilities, and equity?

4. What would be the total interest expense related to the hypothetical borrowing for 2018?

5. Would the hypothetical borrowing in 2018 cause the Net Adjusted Leverage Ratio to increase, decrease, or stay the same? Explain.

6. Would the hypothetical borrowing in 2018 cause the EBITDAR Ratio to increase, decrease, or stay the same? Explain.