Discuss any ethical issues raised by the following actions. General Hospital is subject to a constraint in its short-term borrowing agreement with its bank. General Hospital must have a year-end current ratio that is greater than 1.5 . On December 30 of

Question

the current year, it projects that its current ratio will be only 1.4 as of the close of business on December 31 . General Hospital has a long-term loan outstanding to its chief executive officer (CEO) that is not due for ten more years. The CEO writes a check on December 30 payable to the General Hospital in an amount such that the current ratio on December 31 will be 1.65 . General Hospital renews the loan to the CEO on January 5 of the next year.

Answer 1

Ethical issues confront General Hospital's management when they make financial reporting decisions. Among the questions that one might raise are: (1) does the action violate a known law or regulation and (2) has the firm provided sufficient disclosure about the action for the users of financial statements to make their own judgments about the ethics of such actions? Some people would argue that an ethical issue does not arise. The reporting conforms with GAAP assuming that the firm provided sufficient disclosures for a user. Other people would argue that an ethical issue arises because management took an action for the primary purpose of satisfying a constraint in its short-term lending agreement. Management purposefully managed, some would say distorted the current ratio to meet the contractual constraint.