Why Might the Debt Covenants Have Originally Been Agreed to by Southern Cross - Accounting & Finance Assignment Help

Assignment Task

Question 1
In an article that appeared in The Australian on 28 July 2014 entitled ‘Southern Cross CFO quit over writedown’ (by Darren Davidson) it was reported that:
Mr Lewis joined Southern Cross after it issued a profit downgrade in May. The owner of the 2DayFM radio network said that it expected full-year net profit to fall 10 per cent below the previous year’s underlying NPAT of $89 million. Although the company’s gearing remains within its banking covenant of less than 3.5 times earnings before interest, taxes, depreciation and amortisation, there is concern in the market the company is slipping into a danger zone with its debt covenants. Some market analysts believe that if revenues continue to deteriorate, gearing of above three times EBITDA could trigger a breach of banking covenants.

Required:
Why might the debt covenants have originally been agreed to by Southern Cross?
Why would a reduction in earnings potentially affect the debt covenants?
In general, and according to the ‘debt hypothesis’ often utilised within Positive Accounting Theory, if an entity is close to breaching accounting-based debt covenants then what action might the entity take?

Question 2
In an article by Carrie La Frenz entitled ‘Hastie auditor rejects PPB concerns’ that appeared in The Australian Financial Review on 22 January 2013 (p. 16) and which is adapted here, it was reported that:
In 2012 Hastie Group collapsed and there were wide-ranging job losses (2,100). PPB Advisory was appointed as Hastie’s administrator.
PPB’s second report to Hastie’s creditors criticised the company’s auditors, Deloitte Australia, and said there were issues with Deloitte’s diligence in checking Hastie’s accounts. Deloitte’s adherence to accounting standards was in question and it appeared that undervaluing of impairment charges by Hastie had occurred or that they were not expensed when they should have been. This had given a false impression of Hastie’s earning forecasts.
Craig Crosbie from PPB said that Deloitte knew that Hastie was carrying excessive goodwill in the June 2011 statements despite Hastie’s ongoing poor financial performance but didn’t insist on further impairment. At the time the company collapsed the impairment charges were $254M and goodwill was $291M. The PPB report said the goodwill should have been written down at the time of the June 2011 statements especially as it was followed by a capital raising of $160M in July 2011 and a further write down in December 2011.
In its defence, Deloitte said that it had implemented proper auditing standards in its audits of Hastie Group and refused to comment further.
 

Required:
On the basis of the facts provided, what do you believe was the correct accounting treatment in relation to goodwill? If you need additional information to make your judgement, then what information would that be?
What are some possible reasons for why the management of the Hastie Group might not have wanted to reduce the value of the assets being reported in its financial statements?

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