The Tony Hawk Skate Park was built in early 2021. The construction was financed by a $3,000,000, 7% note due in 6 years, with payments of $51,147 required each month. The first year has not been as profitable as hoped. The discussion at the executive board meeting at the end of 2021 focused on the potential need to obtain additional financing. However, board members are concerned that the company’s debt level at the end of 2021 will make the company appear too risky to additional lenders. The balance of the note at the end of 2021 is $2,583,026. By the end of 2022, the 12 monthly payments will reduce the balance by an additional $447,116. Separate from the note, the company has the following amounts at the end of 2021: current assets of $3,100,00; current liabilities of $2,700,000; total equity of $4,000,000. Jim Trost, the VP of finance, tells board members that he plans to classify the full balance of the note at the end of 2021 as long-term because the full length of the note is six years. He explains that lenders will be more willing to let the company borrow and will offer a lower interest rate if the company reports fewer current liabilities. Plus, he plans to tell lenders that there is no problem with long-term solvency because the company long-term profits will be used to pay its long-term debt.Required: 1. Understand the reporting effect: How does Jim’s decision affect the reported amount of current liabilities versus long-term liabilities as of December 31, 2021? 2. Specify the options: Calculate the current ratio and the debt to equity ratio at the end of 2021 (a) with and (b) without Jim’s assumption. 3. Identify the impact: Can Jim’s decision affect lenders? 4. Make a decision: Should Jim record the full balance of the note as a long-term liability in its balance sheet as of December 31, 2021?
The Tony Hawk Skate Park was built in early 2021. The construction was financed by a $3,000,000, 7% note due in 6 years, with payments of $51,147 required each month. The first year has not been as profitable as hoped. The discussion at the executive board meeting at the end of 2021 focused on the potential need to obtain additional financing. However, board members are concerned that the company’s debt level at the end of 2021 will make the company appear too risky to additional lenders. The balance of the note at the end of 2021 is $2,583,026. By the end of 2022, the 12 monthly payments will reduce the balance by an additional $447,116. Separate from the note, the company has the following amounts at the end of 2021: current assets of $3,100,00; current liabilities of $2,700,000; total equity of $4,000,000.
Jim Trost, the VP of finance, tells board members that he plans to classify the full balance of the note at the end of 2021 as long-term because the full length of the note is six years. He explains that lenders will be more willing to let the company borrow and will offer a lower interest rate if the company reports fewer current liabilities. Plus, he plans to tell lenders that there is no problem with long-term solvency because the company long-term profits will be used to pay its long-term debt.
Required:
1. Understand the reporting effect: How does Jim’s decision affect the reported amount of current liabilities versus long-term liabilities as of December 31, 2021?
2. Specify the options: Calculate the
3. Identify the impact: Can Jim’s decision affect lenders?
4. Make a decision: Should Jim record the full balance of the note as a long-term liability in its balance sheet as of December 31, 2021?
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