Question

Gail Easy, the Controller of Tech-It-Up, just left a meeting with Bob Devious, the CFO of the company. Easy told Devious that because the inventory was slow-moving, it should be written down by $100,000. Devious told Easy not to record her proposed $100,000 write-down of inventory because it would reduce the current ratio below debt covenant requirements on a $1 million loan to Pay-Up-Now Bank & Trust. Moreover, the company anticipates a new public offering of stock next year and Devious wants the earnings to be as high as possible.

What would you do if you were in Gail’s position? Why?

Answer 1

The debt covenants requirements between Tech-It-Up and Pay-Up-now bank and trust means there would be restrictions imposed on the debt agreement between both the parties

The restrictions could be in nature of

1.       Maintaining financial ratios , which can include DSCR , interest coverage ratio , liquidity ratios like Current ratio / quick ratio

2.       Accounts to be maintained as per GAAP

3.       Audit should be done regularly

4.       Strong internal controls systems

In this case if I had been in Gail position keeping in mind the recommendations proposed by Bob devious would have done the following pro-active measures

1.       First having identified the slow moving items , before it becomes obsolete will flag the list of slow moving items to the sales director

2.       Devise sales promotion schemes with the sales and marketing head to sell this items and convert into cash

3.       Explore export possibilities of these items in developing markets /economies

4.       Identify new markets so that these items can be sold

These measures will help Gail to

1.       To maintain the inventory as per Generally accepted accounting principles

2.       This will not force Gail to indulge in fraud reporting , as in future there is possibility for company going public