It is stand accounting procedures, or GAAP, to make an adjusting entry to remove the current year’s principle from the long-term liabilities. This entry reduces the long-term liabilities and increases the current liabilities. You are the bookkeeper for Biker’s Business. Biker’s Business has a bank loan that requires a current ratio of 1.5 times. The owner has asked that you do not make the adjusting entry to take the current portion from the long-term liabilities. You know if you make the adjusting entry Biker’s Business’ loan will need to be repaid immediately (or the loan called). What should you do?
As the bookkeeper for Biker's Business, you are faced with a dilemma regarding the accounting treatment of the long-term loan. According to GAAP (Generally Accepted Accounting Principles), it is standard procedure to make an adjusting entry to remove the current year's portion of the loan from long-term liabilities and classify it as a current liability. This entry is made to accurately reflect the financial position of the company, as it indicates that a portion of the loan will become due within the next year.
However, the owner of Biker's Business has requested that you do not make this adjusting entry, as doing so would trigger an immediate repayment of the loan or a "loan call". This loan call could strain the company's financial resources and potentially disrupt its operations.
In this situation, you have a few options to consider:
1. Educate the owner: Start by explaining the concept of the current ratio and the importance of accurately representing the company's financial position. Emphasize that failing to make the adjusting entry may result in a violation of the loan covenant, potentially leading to adverse consequences.
2. Seek advice or clarification: Consult with the company's accountant or financial advisor to get their input on the matter. They may be able to provide additional insight into the implications of not making the adjusting entry and offer alternative solutions.
3. Discuss alternatives: Suggest alternative strategies to improve the current ratio without triggering a loan call. For example, the company could explore options to increase its current assets or reduce its current liabilities without reclassifying the loan. This could potentially satisfy the owner's concerns while still maintaining compliance with GAAP.
Ultimately, the decision should be based on a careful evaluation of the potential risks and consequences associated with each option. It is important to consider both the financial impact and the owner's preferences, but also to prioritize adherence to accounting principles and the long-term financial stability of Biker's Business. It might be prudent to consult with professionals in the field to find the best course of action for your specific situation.