Part C: Tests and Procedures for Long-Term Liabilities In your continuing effort

Question

Part C: Tests and Procedures for Long-Term Liabilities In your continuing effort to perform a financial audit for B, P, & J Truck Repair Service for the year ended December 31, 2016, you discover that the company obtained a long-term loan from a local bank. The nance terms are as follows: 1. The loan is secured by inventory and accounts receivable of the company. 2. The company’s debt-to-equity ratio should not exceed 2:1. 3. Monthly installment payments began July 1, 2016. 4. The company must get permission from the bank before paying dividends. In addition to this loan, you learn that the company borrowed short-term funds from the company president. The loan is material and the transaction occurred just prior to year end. (a) What procedures (other than internal control tests) should you use when auditing the described loans? (b) What issues do you believe should be addressed by the nancial statement disclosures with respect to the president’s loan?

Explanation / Answer

Audit of long term debt loans:

Auditor should make an audit plan and review the following:

1. Minute of the board meetings should be reviewed and the approval for getting loan should be confirmed by the board. The terms of the loan, interest rates, pledging of inventory and receivables should be cross checked with that of the loan documents.

2. Verification of the outstanding loan balance in the balance sheet with that of the loan documents should be ensured.

3. Check the cash transactions of the company to know about the mode of payment of interest and the principal.

4. Hypothecated inventory and receivables should be audited for accounting accuracy. The method of revenue recognition and the process of accounting for closing stock of raw materials such as stock of spare parts etc. Should be checked. The methods should confirm with the one mandated by US GAAP.

2. The financial statements should disclose the loan take from the company's President as loans from related party. Disclose the loan arrangements, rate of interest, tenure of loan.

The auditor should check wether the loan terms are in accordance with the market terms and if not found in conformity should be reported in audit report. The loan from company's President should be authorised by the board and should be recorded in the board meeting minutes.

The financial statements should disclose the purpose of the loan and should ensure that the loan won't adversely effect shareholders wealth.

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