Eugene Wright is CFO of Caribbean Cruise Lines. The company offers luxury cruises. It's near year-end, and Eugene is feeling kin
d of queasy. The economy is in a recession, and demand for luxury cruises is way down. Eugene doesn't want the company's current ratio to fall below the 1.0 minimum stated in its debt covenant with First Federal Bank. If the company reports a current ratio below 1.0 at year-end, First Federal may require immediate repayment of its $8 million loan, which is not due for another two years.
At the end of the year, Caribbean Cruise Lines reports current assets of $10.1 million and current liabilities of $10 million. These amounts include advanced payments of $1 million from customers in December for cruises to be provided the following summer. Instead of treating the $1 million as deferred revenue, Eugene decided to count the cash received as revenue. He reasoned that cash has already been collected and the company has a long history of providing cruises, so customers will be provided their cruise as scheduled and the company will have cash to pay the bank in the future.
Required:
1. Understand the reporting effect: How does Eugene's decision affect the reported amount of current assets and current liabilities at the end of December?
2. Specify the options: Calculate the current ratio assuming the $1 million is treated as (a) service revenue or (b) deferred revenue.
3. Identify the impact: Does Eugene's decision have an effect on First Federal Bank?
At the end of the year, Caribbean Cruise Lines reports current assets of $10.1 million and current liabilities of $10 million. These amounts include advanced payments of $1 million from customers in December for cruises to be provided the following summer. Instead of treating the $1 million as deferred revenue, Eugene decided to count the cash received as revenue. He reasoned that cash has already been collected and the company has a long history of providing cruises, so customers will be provided their cruise as scheduled and the company will have cash to pay the bank in the future.
Required:
1. Understand the reporting effect: How does Eugene's decision affect the reported amount of current assets and current liabilities at the end of December?
2. Specify the options: Calculate the current ratio assuming the $1 million is treated as (a) service revenue or (b) deferred revenue.
3. Identify the impact: Does Eugene's decision have an effect on First Federal Bank?
1 answer:
Answer:
1) Current Assets and Current Liability before Transection:
$9,100,000 and $10,000,000
Current Assets and Current Liability After Transection:
$10,100,000 and $10,000,000
2a. Treated as a service Revenue Ratio = 1.01: 1
2b. Treated as a deferred Revenue Ratio = 0.92:1
3. Eugene's decision means that First Federal Bank will not require Caribbean Cruise lines to immediately repay the $8 loan
Explanation:
See attachment
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Answer: $6,891
Explanation: This question requires that the principle amount be calculated. This is the current value of the lump sum saving on the first day, before interest has been compounded. In essence this is the original savings value. To calculate this value, the compound interest formula can be used. However this formula needs to be manipulated so that the principal value, P, is determined:
P =
Where:
P = Principal value: the original value of the saving on the first day, before interest has been taken into account.
A = Amount: The amount at the end of a specific period.
i = Rate of return: the profit, expressed as a an interest rate, that the savings earns periodically.
n = The amount of time that the savings is invested for.
When this formula is applied then the following answer is computed:
P =
= $6 890,887434
Rounded off to $6,891