Effects of Lucy's Classification on the Financial Statements
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Lucy Shafer wants to borrow $100,000to expand her dog -brreding business. She is preparing a set of financial Statements to take to the local bank with her loan application. She currently has an outstanding loan from her uncle for $50,000. Lucy's uncle is allowing her to borrow the money at a very low interest rate, and she does not have to make any principal payments for 5 years .Due to the favorable terms of her loan from her uncle, Lucy has decided that it is not significant enough to disclose on her financial Statements .Instead,Lucy has classifiedthe $50,000as contributed Capital (equity),and the interest payments are included in miscellaneous expenses on the Company's income statement.
What are the effects of Lucy's classification on the financial Statements?
Are there any ratios that might be of concern to the local bank that will be misstated by Lucy's actions?
Do you think Lucy's actions are unethical.Suppose Lucy's uncle agrees to be a partner in the company and Lucy can afford to buy his share by repaying the $50,000 with interest. Does that change your opinion?
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This solution explains the effects of Lucy's classification on the financial statements in 420 words.
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I The effects of Lucy's classification on the financial statement
Lucy has decided that it is not significant to disclose this loan on his financial statements. Instead, Lucy has classified the $50,000 as contributed capital (equity), and the interest payments are included in miscellaneous expenses on the company's income statement.
It will increase the equity capital to $100000, and there will be no debt. It will show a apparently strong balance sheet. Similarly there will be no financial expenses in the earning statement as there is no interest because Lucy is not showing any debt, but it will also increase the other expenses.
II ...
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