Question

Part B (45 marks total) You are the senior audit partner auditing Abdul Wahab Enterprises long-term debt for the year 30 June 2019. Long-term debt is composed of two bond issues, which are due in 10 and 15 years, respectively. The debt is held by two insurance companies. You have examined the bond indentures for each issue. The agreement provides that if Abdul Wahab fails to comply with the covenant of the indentures, the debt becomes payable immediately. You identified the following covenants when reviewing the bond indentures:

1. The debtor company shall endeavor to maintain a working capital ratio of 2 to 1 at all times, and in any fiscal year following a failure to maintain the said ratio, the company shall restrict compensation of officers to a total of AUD 650,000 Officers include the chairperson of the board and the president

2. The debtor company shall keep all property that is security for these debt agreements insured against loss by fire to the extent of 100 percent of its fair value. Policies of insurance comprising this protection shall be filed with the trustee.

3. The company is required to restrict 40 percent of retained profits from the availability of paying dividends. 4. A sinking fund shall be established with the NAB Bank, and sem-annual payments of AUD 500,000 shall be deposited in the fund. The bank may, at its discretion, purchase bonds from either issue.

Required:

a. Identify the audit procedures you should conduct to determine if the company is in compliance with the bond agreements.

b. What are the disclosure requirements for the debt in the notes to the financial statements? 1

Answer 1

(A) following procedures must be performed by the auditor
• The auditor must obtain  an understanding of operational procedures through reading relevant bond fund
documentation and interviewing various personnel;
• he must obtain an understanding of monitoring performed by the Company to ensure bond fund
requirements are complied with;
• Obtain an understanding of whether bond proceeds were used in a manner not outlined in
original bond transcripts, and if so how these changes were communicated and assessed to
determine the possible effect on the bond’s tax-exempt status;
• Tested a sample of outstanding bonds to determine if invested bond proceeds were
segregated, and reserve funds were maintained at the level required, if applicable;( in the given case company must retain 40%)
• he must test on basis of Sampling technique  to determine if bond proceeds were spent as required for
both eligible activity and timeliness; and,
• He must Test a sample of outstanding bonds that required arbitrage calculations to determine if
rebate calculations were completed and submitted timely.

(B) Disclosure requirements regarding debt in notes to financial statements:

1) The nature of debt whether long-term or short term.

2) purpose of debt.

3) Related parties involved in debt agreement.

4) period of debt.

5 ) Rate of interest on debt.

6 ) Reasons for mis utilisation of debt for the said purpose ( if any )

Thus the above were some of the debt requirements for disclosure in notes to financial statements.