Problem 21-3 (LO 1, 2) Effect of a quasi-reorganization. Marshall Tool and Die Com- pany has been experiencing significant foreign competition and a declining market. Annual net losses from operations have averaged $250,000 over the last three years. The company’s balance sheet as of December 31, 20X7, is as follows:

 

 

Assets		Liabilities and Equity
Cash . . . . . . . . . . . . . . . . . . . . . . . . .	$       (15,000)	Accounts receivable (net) . . . . .	$   320,000
Accounts payable . . . . . . . . . . . . . . .	500,000	7% Note payable . . . . . . . . . . .	1,500,000
Inventory . . . . . . . . . . . . . . . . . . . . . .	150,000	Common stock at par. . . . . . . . .	550,000
Plant and equipment (net) . . . . . . . . .	1,560,000	Contributed capital in
		excess of par . . . . . . . . . . . . .	550,000
Goodwill . . . . . . . . . . . . . . . . . . . . . .	150,000	Retained earnings . . . . . . . . . . .	(300,000)
Other assets. . . . . . . . . . . . . . . . . . . .	35,000	20X7 Net income . . . . . . . . . . .	(240,000)
Total assets . . . . . . . . . . . . . . . . . . . .	$2,380,000	Total liabilities and equity . . . . .	$2,380,000

 

                                                                                                                                                                                    

 

After analyzing accounts receivable and inventory, it has been determined that the allowance for uncollectibles should be increased by $75,000 and the inventory should be written down by

$20,000. Based on recent appraisals, it is estimated that the plant and equipment have a market value of $900,000. The goodwill is traceable to the purchase of a small tooling company in 20X3. Based on an analysis of cash flows associated with that acquisition, it is estimated that the goodwill has an impaired value of $0. Other assets represent a note receivable from officers of the corpora- tion. The note calls for five annual payments of $8,309 including interest at the rate of 6%.

 

 

 

 

In response to the current situation, the company has decided to take the following actions:

a.    Record the suggested impairment in all assets.

b.    Restructure the note receivable from the officers to reflect four annual payments and an interest rate of 7.5%.

c.    Restructure the note payable, which was due in 20X9, to provide for 12 semiannual pay- ments of $120,000 including interest at the annual rate of 6%.

d.    Engage in a quasi-reorganization to eliminate the deficit in retained earnings.

1.    Prepare a revised classified balance sheet to reflect the effect of management’s actions.

2.    Compute the following ratios before and after management’s actions: current ratio and debt-to-equity ratio.

3.    Given the above ratio analysis, if the ratios do not suggest an improvement, discuss the bene- fits of management’s actions.