Question

Dumars Corporation reports in the current liability section of its balance sheet at December 31, 2017 (its year-end), short-term obligations of \(15,000,000, which includes the current portion of 12% long-term debt in the amount of \)10,000,000 (matures in March 2018). Management has stated its intention to refinance the 12% debt whereby no portion of it will mature during 2018. The date of issuance of the financial statements is March 25, 2018.

Instructions

(a) Is management’s intent enough to support long-term classification of the obligation in this situation?

(b) Assume that Dumars Corporation issues \(13,000,000 of 10-year debentures to the public in January 2018 and that management intends to use the proceeds to liquidate the \)10,000,000 debt maturing in March 2018. Furthermore, assume that the debt maturing in March 2018 is paid from these proceeds prior to the issuance of the financial statements. Will this have any impact on the balance sheet classification at December 31, 2017? Explain your answer.

(c) Assume that Dumars Corporation issues common stock to the public in January and that management intends to entirely liquidate the \(10,000,000 debt maturing in March 2018 with the proceeds of this equity securities issue. In light of these events, should the \)10,000,000 debt maturing in March 2018 be included in current liabilities at December 31, 2017?

(d) Assume that Dumars Corporation, on February 15, 2018, entered into a financing agreement with a commercial bank that permits Dumars Corporation to borrow at any time through 2019 up to \(15,000,000 at the bank’s prime rate of interest. Borrowings under the financing agreement mature three years after the date of the loan. The agreement is not cancelable except for violation of a provision with which compliance is objectively determinable. No violation of any provision exists at the date of issuance of the financial statements. Assume further that the current portion of long-term debt does not mature until August 2018. In addition, management intends to refinance the \)10,000,000 obligation under the terms of the financial agreement with the bank, which is expected to be financially capable of honoring the agreement.

(1) Given these facts, should the $10,000,000 be classified as current on the balance sheet at December 31, 2017?

(2) Is disclosure of the refinancing method required?

Short answer

1. No, the intent of the business entity is not sufficient.
2. Yes, the event will affect the balance sheet of the business entity.
3. No, the current portion of long-term debt maturing in March 2018 must not be included in the current liabilities section.
4. (1) No, the $10,000,000 must not be classified as current on the balance sheet.

(2) Yes, the refinancing method must be disclosed.

Step-by-step solution

Definition of Audit Report

An audit report is a letter representing the auditor’s opinion about the financial statement. The auditor provides information on whether the financial statement is free from misstatement or not. Auditor also reports whether the financial statements are prepared using GAAP or not.

Step 2:Long-term classification made by the business entity

Under GAAP,refinancing short-term debt inthe long-term means that short-term debt is replaced with long-term obligation or by issuing equity securities.

Therefore, the management intends to refinance the obligation as the long-term is insufficientto classify short-term debt. Instead, the business entity must also support its intent by reflecting the ability of the business entity to prove the refinancing.

Impact of bonds liquidation on the balance sheet

Yes, the above event will affect the balance sheet of the business entity on 31 December 2017 because the management intends to finance the short-term obligation on a long-term basis, and such items must be excluded from the current liabilities section of the balance sheet.

Classification of maturing debts

No, the business entity must not include $10,000,000 in the current liabilities section because the current portion of the long-term debt is refinancing in a way prescribed by GAAP.

Disclosure of re-financing

1.The business entity must report $10,000,000 as one of the following:

1. Long-term debt
2. Short-term debt is expected to be refinanced.
3. Interim debt

2.The business entity must report the description of the refinancing of the short-term debt on a long-term basis. It must also include the terms of new obligation.