(Lease accounting and financial ratios, LO 5, 9) Uphill Corp. (Uphill) operates four amusement arcades in Calgary. Uphill’s summarized balance sheet on March 31, 2004 is shown on page 645.

The non-current liabilities of $115,000 include an $80,000 eight-year term note that matures in 2009. The terms of the note stipulate that Uphill must maintain a current ratio greater than 1.6 and a debt-to-equity ratio of less than 1.0. If either of these covenants is violated, the term note becomes payable immediately.
On April 1, 2004 management decided to upgrade the quality of the games in the arcades, many of which were no longer popular with the young people who are Uphill’s primary customers. Uphill arranged a five-year lease for new games. The terms of the lease require annual payments of $22,000. The lease allows Uphill to replace up to 25% of the leased arcade games each year with newer games that are carried by the lessor.

Required:

a. Calculate the current ratio and debt-to-equity ratio on March 31, 2004.

b. Calculate the current ratio and debt-to-equity ratio on April 1, 2004 if the new lease is accounted for as an operating lease.

c. Calculate the current ratio and debt-to-equity ratio on April 1, 2004 if the new lease is accounted for as a capital lease. Assume that the appropriate interest rate that should be applied to the lease is 10%.

d. You are Uphill’s controller. The president of the company has just informed you of his plan to lease the new arcade equipment. Write a memo to the president raising any concerns you have with the plan and providing advice and recommendations on how he should proceed.

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Assets Uphill Corp. Balance Sheet As of March 31, 2004 Liabilities and shareholders' equity Current liabilities Current assets $ 45,000 $ 30,000 Capital assets and Non-current liabilities 115,000 other non-current 145,000 assets 295,000 Shareholders' equity 195,000 Total liabilities and Total assets $340,000 shareholders' equity $340,000