Reference no: EM133004511

As Chief Financial Officer of Mahala Construction Company, you are reviewing with your accountant, Dumi Jackson, the financial statements for the year just ended. During the review, Jackson reminds you of an existing loan agreement with Southern National Bank.

Mahala has agreed to the following:

• The current ratio will be maintained at a minimum level of 1.5 to 1.0 at all times
• The debt-to-equity ratio will not exceed 0.5 to 1.0 at any time.

Jasckson has drawn up the following preliminary condensed Statement of Financial Position (balance sheet) for the year just ended:

Mahala Construction Company Balance sheet As at 31 December 2019 (in millions of Rands)
Current assets R16
Longterm assets 64
Total R80
Longterm debt 15
Shareholders equity 55
Current liabilities R10
Total R80

Jackson wants to discuss two items with you. First, longterm debt currently includes a R5 million loan payable to Eastern Bank that is due in six months. The plan is to go to Eastern Bank before the loan is due and ask it to extend the maturity date of the loan for five years. Jackson does not believe that Mahala needs to include the R5 million in current liabilities because the plan is to roll over the loan.
Secondly, in December this year, Mahala received a R2 million deposit from the government for a major road project. The contract calls for the work to be performed over the next 18 months. Jackson recorded the R2 million as revenue this year because the contract with government, and there should not be any question about being able to collect.

Required:

Problem 1. Based on the balance sheet that Jackson prepared, is Mahala in compliance with its loan agreement with Southern National Bank? Support your answer with any necessary calculations.

Problem 2. What would you do with the two items in question? Do you see anything wrong with the way Jackson has handled each of them? Explain your answer.

Problem 3. Prepare a revised balance sheet based on your answer in part (2) of this question

Problem 4. Calculate a revised current ratio and debt-to-equity ratio. Based on the revised ratios, is Mahala in compliance with its loan agreement?