Davidisthenewaccountantforacompanythatbuildssmallaeroplanesforhobby…

Question Answered step-by-step Davidisthenewaccountantforacompanythatbuildssmallaeroplanesforhobby… David is the new accountant for a companythat builds small aeroplanes for hobby enthusiasts. The company,HobbyAero Ltd, employs 200 people. About3 years ago, the companyunderwent a majorexpansion of its aeroplane-building facilities because of increased demand for its aeroplanes from overseas buyers.To do this it borrowed $10 million through a loan with a bank. The loan agreement containsthe following clauses: HobbyAero is to maintain a current ratioof at least 2:1The after-tax profitmargin must be at least10 per cent If the company fails to meet either ratio in any year, the $10 million is immediately payable. Last year the government removed a 20% tariff on small aeroplanes and the company has had difficulty competing against international competitors. Consequently, the company has had to reduce its profit marginsto compete with overseas suppliers. The following are extractsof the preliminary final resultsfor HobbyAero Limited: BALANCE SHEET Assets$ Amount (in millions)CURRENT ASSETS Cash5mAccounts receivable45mInventory150mNON CURRENT ASSETS BuildingCost $400m LessAccumulated depreciation $100m300mGoodwill100mTotal Assets600mLiabilities CURRENT LIABILITIES Accounts payable70mIncome tax payable30mNON CURRENT LIABILITIES Bank loan400mTotal liabilities500m  INCOME STATEMENT Total salesrevenue100mNet profit after tax10.5m After reviewing the accounts, David found the following issues: One small hobby plane that was still unsold at year-end is recorded as inventory in the balance sheet at $50m. However,David is certainthat the most this plane could be sold for is $20m.An overseas customer owing the company $10 million has recently informed HobbyAero Ltd that they are in severe financial troubleand will only be able to pay half the amount owing.The balance in the provisionfor doubtful debts is only $1m. These two items have not been reflected in the preliminary final results. As you are an accounting student, you have been asked to adviseon the following: Explain to David how the accounts receivable and inventory should be valued on the financial statement. After applying the correct measurement basis, determine the effect of the adjustment of the accounts receivable and inventory on: (1) profit and (2) assets. Explain to David the effect of the adjustment to accounts receivable and inventory on the Current ratio and the after-tax profit margin. Will the change in these ratios have an effect on the loan agreement with the bank? Business Accounting HC 1010 Share QuestionEmailCopy link Comments (0)