Discussion Case 1264

A Reclassification of the note payable is permitted only if one of the following conditions is met: (1) the refinancing must actually take place during the period between year-end and the date the balance sheet is issued or (2) a definite agreement for refinancing is reached prior to issuance of the balance sheet. It is not enough to indicate that such refinancing will probably take place. Compensated absences must be accrued wherever possible, even though estimates are required. Class discussion could include exploration of how estimates might be made when the variables men-tioned by the controller are present. It is not necessary that specific employees be identified for the liability. Overall averages may be used to help compute an amount to be recorded.

Case 1272
Debt covenants exist to protect the interests of debtholders. In some cases, these debt covenants might cause managers to make decisions that are not in the best long-term interest of the company. In this case, the Larsen brothers are asking you to manipulate the current ratio, not for a business purpose, but instead to ensure that debt covenants are not violated. Now, one could argue that it is in the best interest of the company to comply with the debt covenants and if it takes a little accounting magic to do so, then so be it. Students should realize that accounting information is used for a variety of purposes and that tracking profits and losses is only one purpose. Financial statements are also used to protect the interests of many parties, debtholders in this case. Preparers of financial statements must keep the interests of these other users in mind as they prepare financial statements.