Long-Term Debt and Ethics}

You are the CFO of Diversified Industries. Diversified has suffered through several tough years. This has deteriorated its financial condition to the point that Diversified is in danger of violating two loan covenants related to its largest loan, which is not due for 12 more years. The loan contract says that if Diversified violates any of these covenants, the loan principal will become immediately due and payable. Diversified will be unable to make this payment, and any additional loans taken to repay this loan will likely be at sufficiently higher rates that Diversified will be forced into bankruptcy. An investment banker suggests forming another entity (called a "special purpose entity" or SPE) and transferring some debt to this SPE. Structuring the SPE very carefully will have the effect of moving enough debt off Diversified's statement of financial position to keep the company in compliance with all its loan covenants. The investment banker assures you that accounting rules permit such accounting treatment.

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How do you react to the investment banker?

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