PROBLEM 15-20 Ethics and the Manager LO15-2 .LO15-4 Venice InLine, Inc., was founded by Russ Perez to produce a specialized in-line skate he had designed for doing aerial tricks. Up to this point, Russ has financed the company with his own savings and with cash generated by his business. However, Russ now faces a cash crisis. In the year just ended, an acute shortage of high-impact roller bearings developed just as the company was beginning production for the Christmas season. Russ had been assured by his suppliers that the roller bearings would be delivered in time to make Christmas shipments, but the suppliers were unable to fully deliver on this promise. As a consequence, Venice InLine had large stocks of unfinished skates at the end of the year and was unable to fill all of the orders that had come in from retailers for the Christmas season. Consequently, sales were below expectations for the year. and Russ does not have enough cash to pay his creditors. Well before the accounts payable were due, Russ visited a local bank and inquired about obtaining a loan. The loan officer at the bank assured Russ that there should not be any problem getting a loan to pay off his accounts payable providing that on his most recent financial statements the current ratio was above 2.0, the acid-test ratio was above 1.0, and net operating income was at least four times the interest on the proposed loan. Russ promised to return later with a copy of his financial statements. Russ would like to apply for a $80,000 six-month loan bearing an interest rate of 10% per year. The unaudited financial reports of the company appear below: 100 290 180 Venice Inline, Inc. Comparative Balance Sheet As of December 31 (dollars in thousands) This Year Last Year Assets Current assets: Cash $ 70 $ 150 Accounts receivable, net 50 Inventory 160 Prepaid expenses _12 Total current assets 302 Property and equipment 270 Total assets $482 Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 154 $ 90 Accrued liabilities Total current liabilities Long-term liabilities Total liabilities 100 Stockholders' equity: Common stock and additional paid-in 100 100 capital Retained earnings 296 282 Total stockholders' equity 396 382 Total liabilities and stockholders' equity $560 $482 $560 To 100 130 Venice InLine, Inc. Income Statement For the Year Ended December 31 (dollars in thousands) This Year Sales (all on account) $420 Cost of goods sold 290 Gross margin Selling and administrative expenses: Selling expenses Administrative expenses Total selling and administrative expenses Net operating income Interest expense Net income before taxes Income taxes (30%) Net income $ 14 Required: 1. Based on the unaudited financial statements and the statement made by the loan officer, would the company qualify for the loan? 2. Last year Russ purchased and installed new, more efficient equipment to replace an older plastic injection molding machine. Russ had originally planned to sell the old machine but found that it is still needed whenever the plastic injection molding process is a bottleneck. When Russ discussed his cash flow problems with his brother-in-law, he suggested to Russ that the old machine be sold or at least reclassified as inventory on the balance sheet because it could be readily sold. At present, the machine is carried in the Property and Equipment account and could be sold for its net book value of $45,000. The bank does not require audited financial statements. What advice would you give to Russ concerning the machine