Ross’s Lipstick Company’s long-term debt agreements make certain demands on the business.
Ross’s Lipstick Company’s long-term debt agreements make certain demands on the business. For example, Ross may
not purchase treasury stock in excess of the balance of retained earnings. Also, long-term debt may not exceed stockholders’ equity, and the current ratio may not fall below 1.50. If Ross fails to meet any of these requirements, the company’s lenders have the authority to take over management of the company.
Changes in consumer demand have made it hard for Ross to attract customers. Current liabilities have mounted faster than current assets, causing the current ratio to fall to 1.47. Before releasing financial statements, Ross’s management is scrambling to improve the current ratio. The controller points out that an investment can be classified as either long-term or short-term, depending on management’s intention. By deciding to convert an investment to cash within one year, Ross can classify the investment as short-term—a current asset. On the controller’s recommendation, Ross’s board of directors votes to reclassify long-term investments as short-term.