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Citizens Bank has just received draft financial statements from ABC Wholesalers, one of its clients. In the operating line of credit agreement between the bank
Citizens Bank has just received draft financial statements from ABC Wholesalers, one of its clients. In the operating line of credit agreement between the bank and ABC, there is a covenant that requires the company to have a debt to total assets ratio that does not exceed 50% and a times interest earned ratio that exceeds 5.0 times. Robert Williams, the controller of ABC, prepared the draft statement of financial position at year end that indicated that total assets were $160,000 and total liabilities were $72,000. The draft statement of income for the year showed income from operations of $90,000 and interest expense of $15,000. The corporate income tax rate is 30%. After receiving the draft financial statements, the bank was informed by Robert's boss, Jennifer Woo, that three errors were made when the draft financial statements were prepared. They were (1) interest of $2,800 was not accrued on a loan payable, (2) a loan payment was debited completely to the bank loan liability account when $1,800 of the payment related to interest, and (3) proceeds of $2,800 from the sale of gift cards were recorded as revenue even though the gift cards have not yet been redeemed. (Hint: Use the Deferred Revenue account.) (a) Calculate the ratio values used for the bank's covenant tests based on the information in the original draft statements. Debt to total assets % Times interest earned times
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