C2-3 (Debt covenant restrictions and the financial statements) Condensed statements of income and balance sheets for Deere & Co. are provided below (in millions) Statement of Consolidated Income 1 994 1993 1992 Total sales and revenues $ 9,029.8 $ 7,753.5 $ 6,960.7 Costs and expenses 7,805.9 7,112.1 6,503.8 Earnings before interest, taxes, and other charges $ 1,223.9 $ 641.4 $ 456.9 Interest expense 303.0 369.1 413.4 Earnings before taxes and other charges $ 920.9 $ 272.3 S 43.5 Income tax expense (332.2) (97.2) (14.7) Other additions (deductions) 14.9 (1,096.0) 8.6 Net income (loss) $ 603.6 $ (920.9) S 37.4 Consolidated Balance Sheet 1 994 1 993 Total assets $12,781.2 $11,467.2 Current liabilities $ 5,798.1 $ 4,463.6 Long-term debt 4,425.2 4,918.2 Stockholders’ equity 2,557.9 2,085.4 Total liabilities and stockholders’ equity $12,781.2 $11,467.2 74 Part 1 An Overview of Financial Accounting (Investing andfinancing transactions) The following restrictions, pertaining to the company’s outstanding debt, were described in the footnotes. “Certain credit agreements have various requirements ofJohn Deere, including the mainte¬ nance of earnings before interest charges/interest charges of not less than 1.05 to 1. In addition, the ratio of long-term debt to stockholders’ equity may not be more than 8 to 1. The credit agreements also contain provisions requiring Deere & Co. to maintain consolidated net worth (book value) of $1.6 billion, as measured by U.S. generally accepted accounting principles as of October 31, 1992.” REQUIRED:

a. How close is Deere & Co. to violating its debt covenants? What kind of activities would cause the company to move closer to violation?

b. Analyze the company’s reported earnings numbers over the past three years. Comment on the distinction between “core” earnings and “one-shot” items. What appears to have hap¬ pened in 1993?

c. Assume that in 1993 the FASB issued an accounting standard that Deere & Co. was required to adopt. The adoption led to a large special charge that reduced the company’s net income and net worth (book value) to $1.5 billion. Would the company have violated its debt covenant? Why or why not?