Pete Ltd's statement of financial position is shown below.

The above balances include a receivable from Patricia Ltd for an amount of $100,000 and a payable to Patricia Ltd for $50,000. A debt contract with ABC Bank signed by Pete Ltd requires a debt equity ratio of no more than 50%.
Based on the above information, which course of action will be consistent with positive accounting theory?
A) Pete Ltd will re-negotiate the debt contract with ABC Bank to increase the required debt equity ratio.
B) Pete Ltd will offset the receivable from Patricia Ltd with the payable to Patricia Ltd.
C) Pete Ltd will offset the payable to Patricia Ltd with the receivable from Patricia Ltd.
D) Pete Ltd need not do anything as the entity is not in violation of a debt covenant.
E) All of the given answers.

Question

Pete Ltd's statement of financial position is shown below.

The above balances include a receivable from Patricia Ltd for an amount of $100,000 and a payable to Patricia Ltd for $50,000. A debt contract with ABC Bank signed by Pete Ltd requires a debt equity ratio of no more than 50%.
Based on the above information, which course of action will be consistent with positive accounting theory?
A) Pete Ltd will re-negotiate the debt contract with ABC Bank to increase the required debt equity ratio. 
B) Pete Ltd will offset the receivable from Patricia Ltd with the payable to Patricia Ltd. 
C) Pete Ltd will offset the payable to Patricia Ltd with the receivable from Patricia Ltd. 
D) Pete Ltd need not do anything as the entity is not in violation of a debt covenant. 
E) All of the given answers.

Quizplus · Accepted Answer

Offsetting the payable to Patricia Ltd with the receivable from Patricia Ltd will reduce the liabilities of Pete Ltd and increase its equity. This will help the company maintain a debt equity ratio of no more than 50% as required by the debt contract with ABC Bank, which is consistent with positive accounting theory. Renegotiating the debt contract to increase the required debt equity ratio would be counter to the objective of maintaining the required ratio. Offsetting the receivable with the payable will have no impact on the debt equity ratio, and there is no reason for Pete Ltd to take any action in case of not violating the debt covenant.

Pete Ltd's Statement of Financial Position Is Shown Below