Discount Hardware Wishes to expand its business and has borrowed $200,000 from the Toronto Dominion Bank. As a condition for making this loan, the bank required discount hardware to maintain a current ratio of atleast 1.50 and a debt ratio of no more than 0.50, and to submit annual financial statements to the bank.

Business during the third year has been good but not great. Expansion costs have brought the current ratio down to 1.40 and the debt ratio up to 0.51 at december 15. The managers od discount hardware are considering the implication of reporting this current ratio to TD canada trust. One course of action that managers are considering is to record in december of the third year some revenue on account that discount Hardware will earn January of next year. The contract for this job has been signed, and discount Hardware will deliver the materials during January.

Question
1) Journalize the revenu transaction using your own numbers, and indicate how recording this revenue in December would affect the current ratio and the debt ratio?

2) State whether it is ethical to record the revenue transactionin December. Identify the accounting principle relevant to this situation?

3) Propose an ethical course of action for Discount Hardware?

1) To journalize the revenue transaction, let's assume that the revenue to be recorded in December is $10,000.

The journal entry would be as follows:
Date: December 15
Accounts Receivable $10,000
Sales revenue $10,000

Recording this revenue in December would affect the current ratio and the debt ratio. The current ratio is calculated by dividing current assets by current liabilities. By recording the revenue in December, it would increase the current assets (accounts receivable) and could potentially improve the current ratio. However, since the current ratio is currently below the required minimum of 1.50, recording this revenue alone may not be sufficient to meet the bank's requirement.

The debt ratio is calculated by dividing total debt (both short-term and long-term) by total assets. If the revenue is recorded, it would not directly impact the debt ratio as it only considers liabilities. However, if the revenue were to increase the company's net income, it could potentially improve the debt ratio indirectly as net income affects retained earnings, which is part of the total assets.

2) Recording the revenue transaction in December to artificially improve the current ratio and debt ratio would be considered unethical. The accounting principle relevant to this situation is the Matching Principle. According to this principle, revenue should be recognized when it is earned, not when cash is received. In this case, although the contract has been signed, the revenue should only be recorded in January when Discount Hardware has delivered the materials and fulfilled its obligation.

3) An ethical course of action for Discount Hardware would be to accurately report its financial position and ratios to TD Canada Trust, even if it means not meeting the required ratios. They could communicate their current situation to the bank, explain the reasons for the temporary decrease in ratios, and discuss potential solutions or plans to improve the ratios in the future. Discount Hardware could also explore alternative financing options if the bank becomes hesitant to extend further credit due to the current ratios not meeting the requirements. It would be important for Discount Hardware to maintain transparency and integrity in their financial reporting and relationships with their stakeholders.