Solved by verified expert :BACKGROUND:
Notes payable to financial institutions are
confirmed as part of the confirmation of cash deposit balances. Standard
confirmation forms include a request that the financial institution confirm all
borrowings by the depositor.
McGraw CPA is the auditor for Dillon
Industries, a manufacturer of widgets. Dillon has debt (a mortgage and line of
credit) to ABC Bank, the same bank that holds its cash, lockbox, and money
market accounts. A standard AICPA confirmation was sent to ABC Bank, asking it
to confirm cash balances and debt terms and balances. The debt balances and
account numbers were listed on the confirmation sent to the bank. The client’s
controller prepared the confirmation and mailed it to the bank. The bank gave
it back to the controller when he came to make the next day’s deposit. The
controller then gave it to the auditor.
1What was wrong with filling out the debt
balance and account number on the confirmation?
2.What was wrong with the mailing of the
3.Was there a problem with the bank giving
the confirmation back to the client?
Read the case. Then answer the questions
based on it.
Given current economic conditions and
individual operating results, companies may not comply fully with lender
restrictions on debt and, thus, fail to meet one of the debt covenant
requirements (e.g., to maintain a certain working capital ratio). The debt
agreement may have a trigger to make the debt due on demand and, therefore, a
current liability. Often, the client will be able to obtain a waiver of
compliance on this violation in order to comply with the provision. Certain
auditing procedures need to be performed to ensure this failure of a covenant
and subsequent waiver are properly documented and correctly reported.
Sunshine CPA is the auditor for Shumacher
Industries, a manufacturer of widgets. Shumacher has debt (a mortgage and line
of credit) to ABC Bank, the same bank that holds its cash, lockbox, and money
market accounts. The mortgage has certain covenants that must be complied with
at year-end. When the client did an initial analysis of the covenants with its
year-end numbers, the debt to equity required ratio, i.e. the “debt to
equity ratio,” was not met. The CFO of Shumacher approached the bank and
received a covenant waiver from the audit date (12/31/XX) for a period of one
1.What audit procedures are needed for
Sunshine CPA to test the failure of the covenant?
2.How should the waiver be dated in this
3. What if the waiver were dated the same
date as it was received (12/31/XX year-end, dated 02/01/XX)?