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Question - Companies sometimes face binding debt covenants. Mangers have historically used various means to improve their reported numbers to avoid binding covenants, including adjusting accounting accruals, making "real" operating changes such as decreasing certain discretionary expenses or cutting back on capital expenditures.
A. How do accounting accrual adjustments affect covenants that require minimums for retained earnings or certain ratios (such as the current ratio)? Are those effects permanent? Explain.
B. How do real operating changes affect these covenants? Are those effects permanent? Explain.
C. What consequences might arise if the company focuses on managing reported numbers to avoid violating debt covenants? List 5 stakeholders/parties that are effected by these schemes?
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