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E13-4 Debt covenants expressed in terms of income (LO 4) Morton Manufacturing maintains a credit line with First Bank that allows the company to borrow
E13-4 Debt covenants expressed in terms of income (LO 4) Morton Manufacturing maintains a credit line with First Bank that allows the company to borrow up to $1 million. A covenant associated with the loan contract limits the company's dividends in any one year to 20 percent of net income. The 2018 income statement data of Morton Manufacturing is as follows: Sales $840,000 Less: Cost of goods sold 570,000 Gross profit $270,000 Selling and administrative expenses 120,000 Net operating income Gain on sale of investments Interest expense $150,000 14,000 (4,000) Net income from continuing operations before tax $160,000 Less: Income tax expense Net income from continuing operations Extraordinary gain (net of tax) 51,200 $108,800 22,000 Net income before change in accounting principle $130,800 Income on accounting change Net income 52,000 $182,800 a. Compute the maximum amount of dividends Morton can pay if the debt covenant is expressed as 20 percent of each of the following: a. Net income b. Income before change in accounting principle c. Income before extraordinary items (from continuing operations) d. Net operating income b. Explain why the bank may wish to state the contractual limitation on dividends in terms of income from operations instead of net income
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