Angela Gore is CFO of Bahamas Boat Company. The company designs and manufactures luxury boats. It's near year-end, and Angela is feeling kind of queasy. The economy is in a recession, and demand for luxury boats is way down. Angela 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 Key Bank. Angela realizes that if the company reports a current ratio below 1.2 at year-end, the company runs the risk that Key Bank will call its $10 million loan. She just cannot let that happen.

Bahamas Boat Company has current assets of $12 million and current liabilities of $10.1 million. Angela 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. Angela believes the company can somehow get by without the added inventory, as manufacturing slows down some during the holiday season.

Required:

1. 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.

2. Is this practice ethical? Provide arguments both for and against.

1. 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.

Answer:

The delay in the delivery of inventory will decrease both current liabilities. Prior to the proposed delay of the delivery of inventory, current ratio is set at 1.19, below than the minimum ratio required per debt covenant at 1.2. With the delay of the delivery, Current assets will decrease from 12,000,000 to 11,000,000 and Current Liabilities will decrease from 10,100,000 to 9,100,000. This will result to a current ratio of 1.21, higher than the required ratio. Hence the proposal will cause the entity to meet its covenant and thus continue its propriety over the loan.

Please see computation below for more details:

2. Is this practice ethical? Provide arguments both for and against.

Answer:

This practice is not unethical per se, this can be comparable to tax avoidance when it comes to tax payments.

It will become unethical when:

1. The delayed inventory will cause disruptions in the processes of the firm and its production will be underutilized due to such delay
2. Customers and partners in the supply chain will be adversely affected by the delayed delivery of their ordered goods due to the delay in production
3. The delay is made for personal goals of the management, which is not the case in this problem since the purpose of the adjustment is for the attainment of the loan.

Since none of the cases above are expressed in the case, it can be ethical as the delay as it will help the company avoid such adverse repercussion without giving disadvantage to any of the parties.

Please see the attached file for the complete solution