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
Based on generally accepted accounting principles (GAAP), long-term liabilities are defined as obligations that are not expected to be settled within one year. In order to reflect the current portion of long-term liabilities that will be due within one year, adjusting entries are typically made to move the appropriate amount from long-term liabilities to current liabilities.
In this specific case, it is required by GAAP to make an adjusting entry to remove the current year's principal from long-term liabilities. By making this entry, the long-term liabilities will be reduced, while the current liabilities will increase.
However, the owner of Biker's Business has requested that you do not make this adjusting entry, as it would trigger the immediate repayment of the loan. The owner is likely trying to avoid the risk of having to repay the loan earlier than anticipated.
It's important to consider the implications of not making the adjusting entry. By keeping the current portion of the long-term liabilities in the long-term category, the loan will not be reflected as a current liability. As a result, Biker's Business may not meet the bank's requirement for a current ratio of 1.5 times. This could potentially violate the terms of the loan agreement and may have negative consequences, such as penalties or even default.
As the bookkeeper, it is crucial to inform the owner about the potential risks of not making the adjusting entry. It's important to explain that adhering to GAAP principles is necessary for accurate financial reporting and maintaining compliance with loan agreements. Discussing these consequences can help the owner make an informed decision about whether to proceed with the adjusting entry or explore alternative solutions to meet the bank's requirement and mitigate potential risks.
Based on the information provided, the generally accepted accounting principles (GAAP) require making an adjusting entry to remove the current year's principal from the long-term liabilities. This entry would reduce the long-term liabilities and increase the current liabilities.
However, the owner of Biker's Business has requested not to make this adjusting entry because the loan agreement requires a current ratio of 1.5 times. If the adjusting entry is made, it would affect the current liabilities and potentially jeopardize the current ratio requirement. Consequently, the loan may need to be repaid immediately.
It is important to consider the implications of not following GAAP guidelines and not making the adjusting entry. While it may prevent the loan from becoming due immediately, it could impact the accuracy and transparency of the financial statements. Not following GAAP principles may have consequences for the business, such as difficulties securing credit in the future or potential legal issues.
It is advisable to discuss the situation with the owner and explain the importance of adhering to GAAP principles. Alternatively, seeking professional guidance from an accountant or financial advisor would be recommended to ensure compliance with GAAP and make informed decisions regarding the loan and financial reporting.