Tests of balances auditing procedures for Notes Payable and Long-Term Debt are included below with practical comments and tips. Parenthetical references are to financial statement assertions summarized in the acronym COVEROD.
A. Review the results of the risk assessment procedures
and the Small Audits Analytical Procedures Program
and assess the impact on tests of balances.
(E, C, R, Ob, and V)
Risk of material misstatement for most small to medium-size reporting entities is often high due to limited internal controls. The audit strategy is usually comprised primarily of analytical and tests of balances procedures.
B. Obtain or prepare a schedule of notes and related
interest expense showing beginning balances, additions,
payments, ending balances, and all terms of borrow-
ing and payment. Recompute the mathematical accu-
racy of the schedule and reconcile to the general ledger.
(E and C) The headings of an illustrative schedule are:
C. Obtain or prepare copies of all notes and related agree-
ments for the permanent file. (E, R, Ob and V)
Documentation is required by SAS No. 103, Audit Documentation.
D. Examine notes canceled during the period or related
evidence of payment. (C and R)
E. Confirm significant balances outstanding at any time
during the period. (E, Ob, and V)
Confirmation of debt obligations may be obtained in hardcopy format or electronically. Electronic confirmation capability is available through Capital Confirmations, Inc. at www.confirmation.com .
F. Examine loan agreements and review compliance with
restrictive covenants. (D)
A loan covenant can be defined as a condition or term included in a loan agreement that requires compliance by the borrower. Non-compliance may be considered a default on the loan and give the lender the right to demand payment in full. When a lender temporarily waives compliance with a loan covenant in writing, financial statement classifications and the auditor’s report will generally be unaffected. The causes of recurring violations of covenants, on the other hand, should be carefully considered by the auditor when evaluating going concern issues.
G. Determine if any assets are subject to lien and obtain
carrying amounts for disclosure. (D)
H. Examine notes and agreements for any guarantees.
Be alert for related-party guarantees. The accounting
and disclosure requirements of FIN 45 should be
consider for all guarantee relationships. (Ob)(D)
In most circumstances, FIN 45 requires recording the obligations for guarantees in financial statements of guarantors. Both the obligation the guarantor may be called upon to satisfy and the amount expected to be recovered upon default from the guaranteed party is required to be recognized in the financial statements of the guarantor. In addition to discounting the obligations and expected recovery amounts to present values, significant judgments are necessary to determine appropriate credit adjusted, risk-free rates for discounting purposes. In addition, the collectability of a receivable from the guaranteed party, assuming their default, will require and allowance for uncollectible amounts that may be very difficult to determine. Audit planning activities should include inquiries of management regarding guarantees.
I. Separate short-term notes and the current portion of
long-term debt for classification purposes. Categorize by
type of lender (related-party, banks, loan company,
etc.). Prepare or obtain schedule of five-year maturities
for all long-term obligations. (D)
J. Consider the need to impute interest on noninterest-
bearing or below market interest rate notes. (V)
K. Obtain copies of lease agreements. Review the computation
of, or recompute, balances in capitalized lease obligations
accounts. Gather in-formation for financial statement disclosure.
(V and D)
Efficient substantive procedures for notes, payable, long-term debt and other account classifications resulting from cost-beneficial audit strategies are discussed in my live and on-demand webcasts which can be accessed by clicking the applicable box on the left side of my home page, www.cpafirmsupport.com.