Question

            Assets at 12/31/03                                 Liabilities at 12/31/03

            Cash                                   $   200         Short-term trade payables            $   500

            Short-term trade receivables     600         Note payable to CEO, due 8/31/04 (2) 350

            Inventories                               700         Wages payable                                 100

            Prepaid warehouse rentals (1) 300         Customer advances (3)                     150

            Property & equipment, net       900         Income taxes payable                         50

            Total assets                       $2,700         Bonds payable, due 2004-11 (4)       800

                                                                           Total liabilities                            $1,950

            Notes:

            1.   Prepaid warehouse rentals cover the period 1/1/04-12/31/05.

2.   Following a plan adopted on 12/31/03, the Company borrowed $350 from the bank on 1/15/04, giving a 10% note payable due on 8/31/05 in exchange, and used the proceeds from this loan to repay the 8/31/04 note payable.

            3.   Customer advances are for goods to be delivered during 2004.

4.   Bonds payable are due in annual increments of $100, beginning on 12/31/04 and ending on 12/31/11.

Shown above is a complete listing of Zed Corp.’s assets and liabilities at December 31, 2003. Zed’s 12/31/03 balance sheet will be issued to shareholders and the SEC on or about 1/31/04.

In its contract with bondholders, Zed promises, while the bonds are outstanding, to maintain:

       a. a current ratio no smaller than 1.75;

       b. working capital no smaller than $500;

       c. a ratio of total liabilities to total stockholders’ equity no greater than 3.00; and

       d. a ratio of noncurrent liabilities to total assets no greater than 0.40.

Bondholders may declare the bonds immediately due and payable if Zed violates one or more of these contract provisions.

Are Zed’s 12/31/03 balance sheet relationships in compliance with the terms of the company’s contract with bondholders? Support your answer with a detailed calculation of total current assets, total current liabilities, and each of the balance sheet relationships in (a)-(d) above.

  

Answer 1

Current portion of Bonds Payable is $100, as the first installment of $ 100 is due on 12/31/04.

Also, only 150 of the prepaid warehouse rental is current.

a. Total current assets = Cash + Short Term Trade Receivables + Inventories + Prepaid warehouse rentals ( current ) = $ 200 + 600 + 700 + 150) = $ 1,650.

Total current liabilities = Short Term Trade Payable + Note Payable + Wages Payable + Customer Advances + Income Taxes Payable + Bonds Payable ( Current) = $ ( 500 + 350 + 100 + 150 + 50 + 100 ) = $ 1,250.

Current Ratio = Total Current Assets / Total Current Liabilities = $ 1,650 / $ 1,250 = 1.32 : 1

b. Working Capital = Total Current Assets - Total Current Liabilities = $ 1,650 - $ 1,250 = $ 400.

c. Total Liabilities to Total Stockholders' Equity = $ 1,950 / $ ( 2,700 - 1,950) = 2.6

d. Non-current liabilities to total assets = $ 700 / $ 2,700 = 0.26

Zed's balance sheet relationships are not in compliance with the terms of the company's contract with the bondholders. The current ratio of 1.32 is lower than the minimum stipulated. Working capital of $ 400 is also lower than the minimum of $ 500.