Ch 15 Flashcards
Long-term debt:
Substantial in amount and often extend for periods of 20 years or more.
Examples: Debentures, secured bonds and notes payable.
Formal document creating bond indebtedness is indenture or trust indenture.
May contain restrictive covenants.
Examples of restrictive covenants from text:
prohibits the company from declaring dividends unless the amount of working capital is maintained above a specified amount.
The acquisition of plant and equipment, or the increasing of managerial salaries, may be permitted only if the current ratio is maintained at a specified level and if net income reaches a designated amount. If these restrictions are violated, the indenture may provide that the entire debt is due on demand.
Activities of company designed to obtain capital funds.
Involves issuance and repayment of debt and equity.
Payment of interest and dividends.
Primary concern of fin cycle work
Proper authorization by appropriate official in the company or by board of directors.
Inherent Risk
Similar to accounts payable in that understatement of debt is a major potential audit problem.
Disclosure of debt.
Auditor must determine whether company has met all significant requirements and restrictions of debt agreement.
Internal Control Over Interest—Bearing Debt
Authorization by the board of directors.
Use of an independent trustee. (trustee maintains detailed records of names and addresses of registered owners, distributes interest payments and distributes principal payments upon maturity)
Interest Payments on Bonds and Notes Payable–Cash disbursement controls.
Questions:
Are amounts of new debt authorized by appropriate management?
Is an independent trustee used for all bond issues?
Does a company official monitor compliance with debt provisions?
Substantive Tests of Interest- Bearing Debt 1 Obtain analyses of interest-bearing debt and related accounts.
Payment or other disposition of notes listed as outstanding in the previous year’s audit can be verified.
Propriety of individual debits and credits can be established.
Amount of year-end balance of the account is proved through the step-by-step examination of all changes in the account during the year.
Misstatements may be due to improper reporting of debt, incomplete recording of debt or improper amortization.
Substantive tests: Examine copies of notes payable and supporting documents.
ST: Confirm interest-bearing debt:
Confirmed by financial institution.
Included with standard confirmation form for cash.
For others, use letter drafted on client’s letterhead.
Confirm dates of origin, due dates, unpaid balances of notes, interest rates, dates to which interest has been paid and collateral for notes.
Confirm bonds with trustee.
ST: Vouch borrowing and repayment transactions:
Trace cash received from issuance of notes or bonds to validated copy of bank deposit slip and to bank statement.
Examine payments and agree to repayment schedule.
Examine canceled notes for retired notes.
Trace disposition of any collateral used to secure canceled notes.
ST: Perform analytical procedures:
Determine overall reasonableness of interest expense by examining relationship of recorded interest to average principal amount of debt outstanding during year.
ST: Test computations of interest expense, interest payable, and amortization of discount and premium.
Evaluate compliance with debt provisions:
Vouch payments to sinking fund.
Maintenance of stipulated minimum levels of working capital.
Examine evidence of insurance of pledged property.
Compare amounts of management compensation and dividends paid to amounts allowed by agreements.
ST: Verify authority for issuance of debt to
corporate minutes.
Waivers are often issued by banks if
covenants are violated
ST: Review notes payable paid or renewed after the balance sheet date.
Perform procedures to identify notes payable to related parties.
Send confirmation letters about financing arrangements.
Separate confirmation letter to verify details of financing arrangements.
Examples: Lines of credit or contingent liabilities.
