Domestic Transfer and Storage is a large trucking company headquartered in the Midwest. Rapid expansion in recent years has been financed in large part by debt in a variety of forms. In preparing the financial statements for 2017, questions have arisen regarding the way certain of the liabilities are to be classified in the company's clas-sified balance sheet.
A meeting of several members of the accounting area is scheduled for tomorrow, April 8, 2017. You are confident that that meeting will include the topic of debt classification. You want to appear knowledgeable at the meeting, but realizing it's been a few years since you have dealt with classification issues, you have sought out information you think relevant. Questionable liabilities at the company's fiscal year-end (January 31, 2017) include the following:
a. $15 million of 9% commercial paper is due on July 31, 2017. Management intends to refinance the paper on a long-term basis. In early April 2017, Domestic negotiated a credit agreement with a commercial bank for up to $12 million any time during the next three years, any borrowings from which will mature two years from the date of borrowing.
b. $17 million of 11% notes were issued on June 30, 2014. The notes are due on November 30, 2017. The com-pany has investments of $20 million classified as "available for sale."
c. $25 million of 10% notes were due on February 28, 2017. On February 21, 2017, the company issued 30-year, 9.4% bonds in a private placement to institutional investors.
d. Recently, company management has considered reducing debt in favor of a greater proportion of equity financing. $20 million of 12% bonds mature on July 31, 2017. Discussions with underwriters, which began on January 4, 2017, resulted in a contractual arrangement on March 15 under which new common shares will be sold in July for approximately $20 million.
In order to make notes to yourself in preparation for the meeting concerning the classification of these items, you decide to discuss them with a colleague. Specifically, you want to know what portion of the debt can be excluded from classification as a current liability (that is, reported as a noncurrent liability) and why.
Required:
1. What is the appropriate classification of each liability? Develop a list of arguments in support of your view prior to the class session for which the case is assigned.
2. In class, your instructor will pair you (and everyone else) with a classmate (who also has independently developed a position). You will be given three minutes to argue your view to your partner. Your partner like-wise will be given three minutes to argue his or her view to you. During these three-minute presentations, the listening partner is not permitted to speak.
3. Then after each person has had a turn attempting to convince his or her partner, the two partners will have a three-minute discussion to decide which classifications are more convincing. Arguments will be merged into a single view for each pair.
4. After the allotted time, a spokesperson for each of the four liabilities will be selected by the instructor. Each spokesperson will field arguments from the class as to the appropriate classification. The class then will discuss the merits of the classification and attempt to reach a consensus view, though a consensus is not necessary.