Question

Case 2 Balance Sheet Setoffs You are a partner with Wee Checkem CPAs and you have just signed a new client, Keaton Enterprises Inc. Debby Keaton, the president of the company, has been very successful in growing the company and she took it public about five years ago. The company is diversified and has sustained a minimum of a 25% growth per year since it went public. Much of the growth was through acquisitions and the company has a significant debt load on its balance sheet. While Debby Keaton is an astute businesswoman, she does not have a background in accounting and sometimes expresses displeasure at the "dumb accounting rules". This morning you saw her at the post office and she indicated that she was concerned about their year-end financial statements. With all of the debt the company has outstanding, there are loan covenants that require the company to maintain a 2:1 current ratio. She has expressed concern because the company may have difficulty meeting the ratio. She indicated that the company has a sizable account payable with Hay Co. and that her company also has a slightly larger long- term receivable from Hay. Debby Keaton indicated that she has talked to the president of Hay and discussed the possibility of offsetting the receivable and payable. This would lower Keaton's current liabilities and allow it to more than meet the creditor's current ratio requirement. She indicated that the president of Hay said he is willing to do the offset but not until after year-end because he wants to show Keaton's receivable as a current asset in his year-end financial statements. While there is an informal agreement to do the offset, no legal agreement has been signed. Debby Keaton indicated that she wants Keaton Enterprises to be permitted to offset its account payable against the long-term receivable with Hay in its year-end financial statements. She was in a hurry so she asked that you write a letter and include specific references to GAAP so that she can discuss the issue with her controller. REQUIRED: Prepare a memo to Ms. Keaton giving the information requested.

Answer 1