Your client, Summerford, Inc., has a debt agreement with Valley City Bank that i

Question

Your client, Summerford, Inc., has a debt agreement with Valley City Bank that includes a number of restrictions and covenants. Violation of any restriction or covenant results in the entire amount of the debt becoming due immediately. For each of the following, provide audit procedures that will address whether Summerford has met the restriction or covenant.

a. A current ratio of at least 1.5 to 1 must be maintained at year-end

b. No dividends may be paid in years in which there is a net loss. When there is net income, no more than one-half of the net income may be paid out in dividends.

c. The accounts receivable and inventory serve as security on the loan.

d. The total of the president's and vice president's salaries may not exceed $800,000 during the duration of the loan.

e. Monthly payments as per the agreement are due by the 10th of the following month.

Explanation / Answer

Audit procedures that will address whether Summerford has met the restriction or covenant are :

a.     Compute current ratio bydividing the current assets of the company by its current liabilities and see if it is between 1 to 1.5.

b.     Compute net profit or loss for the company. Than see that company do not distribute any dividend in case of loss and in case of profit dividend paid does not exceed 50% of the net income.

c.     Check that provisions of bad debts in accounts receivable are properly made, take third party confirmation for bigger clients. Take our manual inventory inspection and check that inventoy valuation method is appropriate.

d.     Check whether salaries are approved by board or remuneration committee and amount does not exceed $ 800000

e.     Bank records should be checked to confirm on 10th of every month payments are

made as per the agreement .

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