John Smith is CFO of Happy Cruise Lines The company designs

John Smith is CFO of Happy Cruise Lines. The company designs and manufactures luxury boats. It’s near year-end, and Smith is feeling kind of queasy. The economy is in a recession, and demand for luxury boats is way down. Smith did some preliminary liquidity analysis and noted the company’s current ratio is slightly below the 1.2 minimum stated in its debt covenant with First Federal Bank. Smith realizes that if the company reports a current ratio below 1.2 at year-end, the company runs the risk that First Federal will call its $10 million loan. He just cannot let that happen. Happy Cruise Lines has current assets of $12 million and current liabilities of $10.1 million. Smith decides to delay the delivery of $1 million in inventory purchased on account from the originally scheduled date of December 26 to a new arrival date of January 3. This maneuver will decrease inventory and accounts payable by $1 million at December year-end. Smith believes the company can somehow get by without the added inventory, as manufacturing slows down some during the holiday season. Required: 1. What is the definition of current liabilities? 2. How will the delay in the delivery of $1 million in inventory purchased on account affect the company’s current ratio on December 31? Provide supporting calculations of the current ratio before and after this proposed delivery delay. 3. Is this practice ethical? Provide arguments both for and against.

Solution

1. when the order is delayed for a month, then the inventory worth of $1 million will be added to the current assets of the $12 millions. then total current assets can becomes as $13 millions and the current liabiliites will be remines as $10.1 only.

2. if the deliver the lot then the current ratio= 12/10.1= 1.1881

if they delvered the lot in the month of January, then the current ratio= 13/10.1= 1.287

so, it can be helpful them to comeout from the problem.

3. there is nothing wrong here, while we are able to solve the problem in sooner, we can support this kind of activites. otherwise these are ethically and legally also not acceptable.