MA3-54. Analyzing Transactions, Impacts on Financial Ratios, and Loan Covenants (LO2)

Kadous Consulting, a firm started three years ago by K. Kadous, offers consulting services for material handling and plant layout. Its balance sheet at the close of the current year follows.

Earlier in the year Kadous obtained a bank loan of $30,000 cash for the firm. A provision of the loan is that the year-to-equity ratio (total liabilities to total equity) cannot exceed 1.0. Based on the above balance sheet, the ratio at the December 31 of this year in 1.08. Kadous is concerned about being in violation of the loan agreement and requests assistance in reviewing the situation. Kadous believes that she might have overlooked some items at year-end. Discussions with Kadous reveal the following:

1. On January 1 of this year, the firm paid a $6,500 insurance premium for two years of coverage; the amount in Prepaid Insurance had not yet been adjusted.

2. Depreciation on equipment should be 10% of cost per year; the company inadvertently recorded 15% for this year.

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

4. The firm concluded a major consulting engagement in December, doing a plant layout analysis for a new factory. The $8,000 fee has not been billed or recorded in the accounts.

5. On December 1 of this year, the firm received an $11,300 cash advance payment from Dichev Corp. 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 but unrecorded by December 31 of this year.

6. Supplies costing $4,800 were available on December 31; the company has made no adjustment of its Supplies account.

Required

a. Record the effects of each transaction using the financial statement effects template.

b. What is the correct debt-to-equity ratio at December 31?

c. Is the firm in violation of its loan agreement? Prepare computations to support the correct total liabilities and total equity figures at December 31.

Please answer all parts of the question. Thanks!

KADOUS CONSULTING Balance Sheet 12/31/2015 Liabilities Notes payable Accounts payable Unearned consulting fees Wages payable Total liabilities Assets $30,000 $4,200 11,300 400 $ 45,900 $ 3,400 Cash Accounts receivable $20,875 Supplies Prepaid insurance $6,500 Equipment, gross 68,500 Less: Accumulated depreciation Equipment, net Total assests $ 13,200 $ Equity 23,975 $ 44,525 88,500 $8,000 34,600 Total liabilities and equity 88,500 Common stock Retained Earnings