Leave My Current Ratio Alone!
Soto Inc., a closely held corporation, has never been audited and is seeking a large bank loan for plant expansion. The bank has requested audited financial statements. In conference with the president and majority stockholder of Soto, the auditor is informed that the bank looks very closely at the current ratio. The auditor’s proposed reclassifications and adjustments include the following:
(a) A note payable issued 41⁄2 years ago matures in six months from the balance sheet date.
The auditor wants to reclassify it as a current liability. The controller says no because “we are probably going to refinance this note with other long term debt.”
(b) An accrual for compensated absences. Again the controller objects because the amount of the pay for these absences cannot be estimated. “Some employees quit in the first year and don’t get vacation, and it is impossible to predict which employees will be absent for illness or other causes. Without being able to identify the employees, we can’t determine the rate of compensation.”
If you were the auditor, how would you respond to the controller?