Keep Shipping, We Need the Revenue
Datarite, a maker of computer hardware systems, sells its products to dealers who in turn sell to the final customer. Datarite offers very liberal credit terms and allows its dealers to take up to 90 days to pay. These terms allow dealers to hold larger inventories. As the end of the fiscal year nears, Datarite needs to increase its current ratio and decrease its debt to equity ratio to avoid violating its debt covenants. The president of the company has asked that all dealers be shipped extra inventory. This will increase both sales and accounts receivable, thereby allowing Datarite to remain in compliance with its debt covenants. The chief financial officer remarks that shipping inventory that has not been ordered should be accounted for as consigned inventory rather than revenue. Should the inventory shipments be accounted for as sales or as consigned inventory? Debt covenants exist to protect the interests of creditors. In this instance, are debt covenants effective in monitoring the company’s activities?