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RSM 323 Tutorial #2
ZR Software Inc. (“ZRS”) is a manufacturer of application and programming software for
specialty niche markets.
ZRS was first formed in 1991 by two friends.
At the beginning, ZRS
only had four products that it sold (two application software products and two programming
software products), which had been created by ZRS’s owners.
However, after the first couple
years, ZRS started to have great success with these two products.
Due to that success, ZRS
decided it was time to expand.
However, an expansion also meant hiring more people since
managing the current software and ensuring updates were done regularly was already a full
time job for the two owners.
There are many major players in the software industry, so ZRS
knew that in order to attract employees with a lot of skill and talent to keep their reputation of
providing high quality software, they would have to pay very competitive salaries.
2001 ZRS applied for and was granted a loan of $5M for 10 years with the condition that ZRS
maintain their covenant for ZRS’s debt to equity ratio and submit monthly financial statement to
Using the loan, ZRS was able to hire 15 employees, 12 of which were programmers.
Within a year, ZRS had over 15 products on the market.
With this success, ZRS decided to go
public in January of 2005.
The first audited year end statements were December 31, 2005.
Since going public, ZRS has expanded to almost triple its size at the time it went public as a
result of its success and the acquisition of a smaller competitor.
As a result the loan with the
bank was also increased and the amount owning at the end of 2007 was approximately $20M.
Competition was increase and thus ZRS continued to offer competitive salaries.
In most cases
ZRS’s salaries were much higher than any of its competitors.
Unfortunately, 2007 was a bad year for ZRS because two of the major companies in the market
recognized the potential of some of ZRS’s niche markets.
As a result, they developed software
that was in direct competition with ZRS’s major products and began selling them in late 2006.
These products were a main source of revenues and cash flows for ZRS and they began feeling
the effects early.
ZRS was forced to use its line of credit that it had never used in the past in
order to cover the cost of operations while it tried to develop software to replace these major
Without realizing it, the use of the line of credit in early 2008 resulted in a breach of
the debt to equity covenant.
On March 2, 2008 the bank recalled the loan.
ZRS frantically tried
to obtain other financing, but was unable to and were forced to file for bankruptcy on March 28,
Over the last few months, you have read about how the shareholders of ZRS are suing
its auditors due to their losses suffered as a result of ZRS filing for bankruptcy.
Today is September 22, 2008. Upon arriving to work on Monday morning, you, CA/CGA/CMA, a