Provisions in a Loan Agreement As controller of Midwest Construction Company, you are reviewing with your assistant,

Question:

Provisions in a Loan Agreement As controller of Midwest Construction Company, you are reviewing with your assistant, Dave Jackson, the financial statements for the year just ended. During the review, Jackson reminds you of an existing loan agreement with Southern National Bank. Midwest has agreed to the following conditions:

• The current ratio will be maintained at a minimum level of 1.5 to 1.0 at all times.

• The debt-to-equity ratio will not exceed 0.5 to 1.0 at any time.

Jackson has drawn up the following preliminary condensed balance sheet for the year just ended: image text in transcribed

Jackson wants to discuss two items with you. First, long-term debt currently includes a $5 million note payable to Eastern State Bank that is due in six months. The plan is to go to Eastern before the note is due and ask it to extend the maturity date of the note for five years. Jackson doesn’t believe that Midwest needs to include the $5 million in current liabilities because the plan is to roll over the note.
Second, in December of this year, Midwest received a $2 million deposit from the state for a major road project. The contract calls for the work to be performed over the next 18 months.
Jackson recorded the $2 million as revenue this year because the contract is with the state; there shouldn’t be any question about being able to collect.
Required 1. Based on the balance sheet that Jackson prepared, is Midwest in compliance with its loan agreement with Southern? Support your answer with any necessary computations.
2. What would you do with the two items in question? Do you see anything wrong with the way Jackson has handled each of them? Explain your answer.
3. Prepare a revised balance sheet based on your answer to (2). Also compute a revised current ratio and debt-to-equity ratio. Based on the revised ratios, is Midwest in compliance with its loan agreement?