Assignment Question:
IMPORTANT NOTE: Answer in your own words, DO NOT COPY from slides, fellow students, or internet sources without proper citation.
Q1. Gerrard Smith, senior-in-charge, is auditing Mndooz, Inc.’s long-term debt for the year ended December 31. 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. Gerrard has examined the bond agreements for each issue. The agreements provide that if Mndooz fails to comply with the covenants of the contract, the debt becomes payable immediately. Gerrard identified the following covenants when reviewing the bond agreements:
“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 $650,000. Officers include the chairperson of the board and the president.”
“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 actual value. Policies of insurance comprising this protection shall be filed with the trustee.”
“The company is required to restrict 40 percent of retained earnings from availability for paying dividends.”
“A sinking fund shall be established with the First Bank, and semiannual payments of $500,000 shall be deposited in the fund. The bank may, at its discretion, purchase bonds from either issue.”
Required:
Provide any audit steps that Gerrard should conduct to determine whether the company complies with the bond indentures or not.
Answer:
List any reporting requirements that the company’s financial statements or footnotes should include.