Gilbert Consulting Services, a firm started three years ago by Bruce Gilbert, offers consulting services for material handling and plant layout. The balance sheet prepared by the firm's accountant at the close of 2018 is shown here.

Earlier in the year, Gilbert obtained a bank loan of \(\$ 30,000\) for the firm. One of the provisions of the loan is that the year-end debt-to-equity ratio (ratio of total liabilities to total stockholders' equity) shall not exceed 1.0. Based on the above balance sheet, the ratio at the end of 2018 is 1.08 \((\$ 45,900 / \$ 42,600)\).

Gilbert is concerned about being in violation of the loan agreement and asks your assistance in reviewing the situation. Gilbert believes that his rather inexperienced accountant may have overlooked some items at year-end.
In discussions with Gilbert and the accountant, you learn the following:

1. On January 1,2018 , the firm paid a \(\$ 4,500\) insurance premium for two years of coverage. The amount in Prepaid Insurance has not been adjusted.

2. Depreciation on the equipment should be 10 percent of cost per year. The accountant inadvertently recorded 15 percent for 2018 .

3. Interest on the bank loan has been paid through the end of 2018 .

4. The firm concluded a major consulting engagement in December, doing a plant layout analysis for a new factory. The \(\$ 6,000\) fee has not been billed or recorded in the accounts.

5. On December 1,2018 , the firm received an \(\$ 11,300\) advance payment from Croy Corporation for consulting services to be rendered over a two-month period. This payment was credited to the Unearned Consulting Fees account. One-half of this fee was earned by December 31, 2018.

6. Supplies costing \(\$ 4,800\) were on hand on December 31. The accountant filed the record of the count but made no entry in the accounts.

Required

a. What is the correct debt-to-equity ratio at December 31, 2018? Is the firm in violation of the loan agreement? Prepare a schedule to support your computation of the correct total liabilities and total stockholders' equity as of December 31, 2018.

b. Why might the loan agreement have contained the debt-to-equity provision?

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GILBERT CONSULTING SERVICES Balance Sheet As of December 31, 2018 Assets Cash... Accounts receivable Supplies. Prepaid insurance. Liabilities $ 3,400 Notes payable... $30,000 22,875 Accounts payable... 4,200 13,200 Unearned consulting fees.. 11,300 4,500 Wages payable..... 400 Equipment $68,500 Total Liabilities. 45,900 Less: Accumulated depreciation.... (23,975) 44,525 Stockholders' Equity Common stock... 20,000 Retained earnings 22,600 Total Stockholders' Equity 42,600 Total Liabilities and Total Assets $88,500 Stockholders' Equity...... $88,500