Question

Wild Adventure conducts tours of wildlife reserves around the world. The company recently purchased a lodge in Adelaide, Australia, securing a 4% mortgage from First Bank. In addition to monthly payments, Wild Adventure must provide annual reports to the bank showing that the company has a current ratio of 1.2 or better. After reviewing the annual reports, the CEO, N. O. Scrooge, approached Carl Hauptfleisch, the CFO, and stated, “We’ve decided we are going to move all our long-term debt investments into our brokerage account so we can sell them soon. Carl, go ahead and make the adjusting entries as of the current year-end.” Carl made the adjustments even though he doesn’t think the company will actually go ahead with the planned sale of the long-term debt investments. The subsequent year, the economy turned, and the company’s travel revenues dropped more than 60%. Wild Adventure eventually defaulted on the First Bank loan.

Requirements

What type of information in the financial reports would have helped the bank detect this reclassification?

Short answer

The bank will detect the reclassification of the assets through the footnotes of the balance sheet.

Step-by-step solution

Definition of Footnotes

The notes disclosed at the bottom of the financial statement reflecting the additional information not reflected in the financial statement are known as footnotes.

Information in the Financial Statements that will help the Bank to Detect the Reclassification of Assets

The full disclosure principle requires the business entity to report all the financial information on its financial statement. Some information cannot be reported in the financial statement, and the business entity report such information in a footnote or note to the financial statement.

Therefore, the transfer of assets from long-term to current assets will be reported in the note to the financial statement.