As assistant controller of Midwest Construction Company, you are reviewing with your

boss, Controller 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.

Midwest Construction Company

Balance Sheet

December 31

(in millions of dollars)

Current asset $16 Current liabilities $10

Longterm assets 64 Longterm liability 15

____ Stockholder's equity 55

Total $80 Total $80

Jackson has drawn up the following preliminary condensed balance sheet for the year just ended:

Jackson wants to discuss two items with you and make sure you are in agreement with

him. 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 doesnt 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 shouldnt be any question

about being able to collect.

Questions

1. Based on the balance sheet that Jackson prepared, is Midwest committing fraud? Why or

why not? Your answer should include computations of the current and debt-to-equity ratios.

2. Who may benefit if the two items are handled as suggested by the controller? Who may be

harmed? How?

3. What would YOU do in this situation? Jobs are hard to come by in the town where Midwest

is located and you have a family to support.