Loan Covenants: Ethical and Governance Issues Case Study Report

This report, titled "Ethics and Governance – Loan Covenants," examines a case study involving a company's adherence to loan covenants and the ethical considerations that arise. The report's primary objectives are to highlight ethical issues, analyze the impact of decisions on stakeholders, and assess the ethical integrity of actions taken. The case study focuses on Braddy Industrial Products and its financial challenges concerning a current ratio stipulation from its financial institutions. Key stakeholders include financial institutions, employees, shareholders, and government agencies. The report delves into ethical issues within finance, compliance, and personnel, specifically addressing manipulation of financial statements to meet the current ratio requirement. The actions available to the assistant accountant, Sharon Rock, are discussed, along with a personal perspective on the appropriate course of action. The report emphasizes the importance of ethical conduct in financial reporting and governance and offers recommendations for maintaining integrity and transparency.

LOAN COVENANTS - ETHICS AND GOVERNANCE
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9/7/2017

EXECUTIVE SUMMARY
The title of the report is Ethics and Governance – Loan Covenants. As the title suggest, the
report is based on the case study where the terms and conditions of the loan has been discussed.
The main aim of this report is to highlight the ethical issues involved in the study and to discuss
how the interest of the stakeholders have been affected by the decisions involved in the case
study. The second aim that has been flowed throughout the report is that whether the decision
made by the personnel involved in the case study is as per the ethics. The third major aim is to
make aware the users of the financial statements and the preparers of the financial statements
regarding the importance of ethics and governance and usefulness of doing rightful act at right
time. With these aims, the study has been bifurcated in different sections.

Contents
EXECUTIVE SUMMARY.................................................................................................................................2
INTRODUCTION...........................................................................................................................................4
STAKEHOKDERS INVOLVED..........................................................................................................................5
ETHICAL ISSUES INVOLVED IN THE CASE.....................................................................................................7
ACTIONS AVAILABLE TO SHARON..............................................................................................................10
IF I WERE SHARON.....................................................................................................................................11
CONCLUSION AND RECOMMENDATION...................................................................................................12
REFERENCES..............................................................................................................................................13

INTRODUCTION
Ethics acts as the key for the success of the organization. It is because only the ethics which help
the company to make their personnel understand about the nature of the business and how
employees are required to perform their functions. It provides the way through which work shall
be performed and helps in achieving the goals of the organization. Governance along with the
ethical climate in the organization helps in monitoring the work with regard to the standards
defined by the management of the company. In case any deviation is found then the corrective
action is taken place early.
In this report, Braddy Industrial products challenges have been discussed with reference to the
stipulation made by their financial institutions regarding the current ratio. Sharon Rock, assistant
accountant and Tim, accountant of the company has identified the idea to reach at the objective
but certain issues have evolved. The first focus that has been made is on the stakeholders who are
related to the case under question. Second question that has been answered includes the ethical
and the governance issues that are involved in the case under study. Third question that has been
solved is to state whether the act done is correct and is as per the law governing the issue. The
last question that has placed the reliability on the writer of this report is to have an emphatic
point of view as to what action would have been taken in case writer were involved in that act.
After that the study has been concluded with the appropriate recommendation.

STAKEHOKDERS INVOLVED
Stakeholders are the personnel who have the stake in the particular matter. The matter may be
the agreement, contract or any other arrangement in which the stakeholders have the very
important position irrespective of the contribution made by them in the development of the
company (Donaldson and Preston,2005; Freeman, 2011). In respect of the Corporate World, the
stakeholders of the company are the persons who have the vital form of interest in the various
matters and decisions of the company that the company takes on the regular basis. Stakeholder is
the broader term and it cannot be restricted to one or two parties and they can affect the decision
of the company (Freeman, 2010). Commonly, following are regarded as the stakeholders of the
company in each and every situation:
- Customers to whom the good are sold and the services are provided
- Shareholders of the company to whom the shares have been allotted by the company
- Employees who are working in the company
- Creditors who supplies the products or services to the company
- Financial institutions from whom the loan has been obtained by the company
- Government department like Income Tax, Goods and Service Tax, etc (Freeman, Jeffrey,
Andrew and Parmar,2012).

As per the given situation, Assistant Accountant Sharon Rock has approached the Accountant
Tim for discussing the financial statements of the company. They both were in order except one
thing that has been progressively noticed by Sharon that the current ratio of the company has fell
down to 1:1. The company has taken loan on behalf of the owner of the company due to which
the current ratio has been decreased and there is stipulation from the bank granting loan that the
company’s current ratio shall not be less than 1.20 in any case otherwise loan facility will be
withdrawn. As per the case study following stakeholders are involved in this issue:
- Financial institutions –The financial institution are the organizations which have provided
the loan to the company on behalf of the owner of the company. These are regarded as
the stakeholder because of the fact that the company is forced to act as per the
requirements of the financial institutions to maintain the current ratio otherwise the loan
facility will be withdrawn. These force states how much stake the bank have in the
company which can even change the business decision of the company. Tim has after
sometime founded the way to increase the current ratio from the decreased current ratio
Fontaine, Haarman and Schmid, 2006).
- Employees of the Company – As the company is forced by the banks to maintain the
current and in case it is not met then the company will soon face the problem of
liquidation and soon the company will go for the liquidation like other companies like
Lehman Brothers, etc. Employee’s pressure to maintain the current ratio and to carry the
ethics in the business and reporting will show the effect of the employee’s interest in the
business.
- Shareholders of the company – Shareholders are the person who has invested their
amount in the business of the company in lieu of the shares. As the changes are being

done in the financial statements of the company, the shareholder will feel uncomfortable
as the company is doing wrong act and the shareholders will not be provided the true and
correct picture of the financial position and the financial performance of the company
(Phillips, 2012).
- Government Agencies – As the Sharon and Tim, both have decided to transfer the
amount from the head of Noncurrent receivable to the current receivable, the same will
be regarded as the sort of manipulative practices which otherwise is clearly not
permissible as per law governing the country and hence the decision might gets affected
with the intervention of the government agencies. It will be an alarm for the financial
institutions as to how the current ratio of the company will become high irrespective of
the decrease in sales of the company.
- Tim and Sharon – Tim and Sharon both have decided to transfer the amount of $120000
from the head Non Current Receivable to Current receivable as the same will dues for
payment after fourteen months. Through this the company will enter into manipulating
practices which will come across after sometime.
ETHICAL ISSUES INVOLVED IN THE CASE
Every company shall have an ethical climate in the organization. It brings the motivational
culture in an organization. The term ethics has been derived from the word used in Greek
mythology as ethos. It means the character of the person involved his moral nature and beliefs of
having the ethical climate (Andrews, 2011; Arjoon, 2013; Gomez, 2010) . In the broader sense,
the term ethics has been defined as the predefined principles, policies and procedures of the
company for the humans involved in the organization so as to govern or control the behavior of
the organization and let the humans to have the controlled working so as to divert their work

towards the achievement of organizational goals (Dandino, 2004). Following is the series of
events that have led the introduction of various ethical issues.
- Sharon, assistant accountant of the company – Brady Industrial Products, has informed to
Tim, accountant of the company regarding the financial stipulation made by the financial
institutions from whom the company has taken loan.
- The immediate answer made by the Tim to sell the inventories as it is piling up in the
books of accounts and making the follow up from the debtors of the company to have the
payment.
- Simultaneously informed that the bank requires the figures for 30th June and it will not be
possible for company to make such manipulation so fast.
- After that he informed that the current ratio can be improved by changing the grouping of
the loan given to the owner from Non Current receivable to Current receivable as the
repayment will fall after fourteen months.
Three heads of the ethics has been faced by the company which includes ethics in finance, ethics
in compliance and ethics in employees. These have been detailed as follows:
Finance –
The financial statements have been manipulated with the consent of the employees
involved in act to transfer the non current item to current item so as to maintain the
current ratio. It will against the paragraph number 60 and 61 of the Australian
Accounting Standard 101 on Presentation of financial statements. It states that Current
items are those which are held for less than 12 months, otherwise it will be noncurrent
(Australian Accounting Standard Board, 2015). Therefore, transferring 14 months

noncurrent assets into current assets will violate the accounting rule (Badaracco, 2005;
Harsen, 2014).
Discussing the change in the valuation of inventory by selling it on adhoc basis and
further by intimating that start receiving the payment from the debtors of the company. It
indicates that the company has the bogus inventory or the debtors (Longstaff, 2011).
On what basis and why the company has taken loan from the financial institutions on
behalf of the owner of the company. It depicts that the company has provided interest free
loan to the owner irrespective of the fact that the company has paying interest on the
amount of loan taken.
Compliance – The word compliance denotes with the adherence by the company to the defined
rules, procedures, policies and regulations of the company as well as adherence to the provisions
of the law of the governing country (Metzger, Dalton and Hill, 2012). Following issues were
involved:
Entering into the manipulating practices by finding out the way to maintain the current
ratio.
Levels of Surety that the owner will definitely be agree on the same gives an impression
that the owner of the company is also not complying with the rules and regulations.
Manipulating the books of accounts of the company only for the sake of the financial
institutions.
Violation of the requirements laid down by the Australian Accounting Standard 101 on
Presentation of financial statements for classification of noncurrent assets to current
assets.

Personnel –
Transparency and the trueness in work has been deteriorated as the both the accountants
were finding ways to maintain the current ratio instead of giving the actual picture to the
bank.
For securing the job, the both employees Sharon and Tim have founded the way for
making the manipulation.
ACTIONS AVAILABLE TO SHARON
Sharon Rock is working as the assistant accountant of the company. While finalizing the
financial statements for the year ending 30th of June 2018, accountant, Tim and assistant
accountant, Sharon Rock has been discussing the various issues relating to the financials of the
company. All discussions have been made in order except one thing. They both have struck at
one place. This place is the requirement of the stipulation made by the bank to maintain the
current ratio of 1.2. Both the employees have analysed the various advantages and disadvantages
and the ways to maintain the current ratio. Sharon has come to place where she is facing the
dilemma of available two options. One dilemma is that the company shall submit the financial
statements of the company as at the year ending 30-06-2018 without the manipulation
mentioning the actual figures and second dilemma is that the manipulated financial statements
shall be provided to the banker of the company with the higher current ratio with or without
informing the fact to the owner of the company. As per the given situation in the case study, she
has the following actions to resolve the dilemma she is facing:

- She shall inform all the manipulations to the owner of the company and shall take the
approval as through which option the company shall go with.
- She shall make the adjustment to the financial statement of the company in relation to
shifting of an item from Noncurrent assets to current asset in accordance with approval
and the accounting standards. .
IF I WERE SHARON
In case, I was Sharon, then I would have adopted the following procedures to clear the dilemma
and to complete the work in the desired manner as per the stipulation made by the bank:
 Requirements of AASB 101 – At first, the requirements of the Australian Accounting
Standard Board 101 on the presentation of the financial statements will be checked. As
per the paragraph number 60, 61 and 61 of the Australian Accounting Standard Board
101, the company shall classify the assets into the current assets and the noncurrent assets
on the basis of the holding period or due period. The period that has been specified is of
12 months. If any asset becomes due for more than 12 months then it will be classified as
the noncurrent assets. The company shall classify any asset as current asset only if the
following conditions are satisfied:
- It is expected that the company will be able to realize the money or liquid from
the asset in the period of the normal operating cycle of the company
- The asset has been held majorly for the purpose of trading
- The period of holding is twelve months after the date when the financial
statements of the last year are reported and
- Such asset is restricted to be transferred or exchange or to be use as for settling
the short term liability.
In the given case it falls due for less than 12 months, than it will be classified as the
current assets. As in the given case the loan will fall due for repayment for more than 14
months therefore it shall be classified Noncurrent assets instead of current assets.
 Disclosure – In case it is finalized at the top management level that the loan shall be
treated as the current assets instead of noncurrent assets, then it is required to disclose the

fact of change in the treatment of the loan amount in the notes to the financial statements
of the company.
 Resign- If the management would not have agreed to make the clear cut disclosure of all
the facts then she should have resigned from the immediate effect.
CONCLUSION AND RECOMMENDATION
Ethics and governance plays the very important role in the smooth functioning of the company.
The company may be small or big. Ethics provides the measure to monitor the performance and
the behavior of each individual engaged in an organization. Governance deals with the
controlling and execution power of the person who is charged with the corporate governance of
the company. Through the report, the requirements of the Brady Products Private Limited have
been discussed as to how the company can change its current ratio from 1.1 to 1.2 and the ways
founded and discussed by Tim and Sharon have been detailed along with the requirements of
Australian Accounting Standard 101. Ethical issues in relation to manipulating has been
discussed and detailed. To conclude with the study, the manipulation shall be done within the
ambit of law and in case the law is being challenged then the company shall not enter into such
practice.
It is recommended that every company shall follow the ethics and governance in business and
shall perform all the accounting work in accordance with accounting standards and shall present
the financial statements of the company at the reporting date.