$16-7$ Auditing Secured Notes and Equity Securities

You have been engaged to audit the financial statements of the Elliott Company for the year ended December $31,2007.$ You audited the December $31,2006,$ financial statements. Following is the December $31,2007,$ trial balance.

Dr$.($Cr$.)$

Cash $ $128,000$

Interest receivable $47,450$

Dividends receivable $1,750$

$14$ percent secured note receivable $730,000$

Investments at cost: Bowen common stock $322,000$

Investments at equity: Woods common stock $284,000$

Land $185,000$

Accounts payable $(31,000)$

Interest payable $(6,500)$

$16$ percent secured note payable to bank $(275,000)$

Common stock $(480,000)$

Paid$-$in capital in excess of par $(800,000)$

Retained earnings $(100,500)$

Dividend revenue $(3,750)$

Interest revenue $(47,450)$

Equity in earnings of investments carried at equity $(40,000)$

Interest expense $26,000$

General and administrative expense $60,000$

You have obtained the following data:

a$.$ The $14$ percent note receivable is due from Tysinger Corporation and is secured by a first mortgage on land sold to Tysinger by Elliott on December $21,2006.$ The note was to have been paid in $20$ equal quarterly payments beginning March $31,2006,$ plus interest. Tysinger, however, is in very poor financial condition and has not made any principal or interest payments to date.

b$.$ The Bowen common stock was purchased for cash on September $21,2006,$ in the market where the stock is traded actively. The stock is used as security for the note payable and is held by the bank. Elliott$$s investment in Bowen represents approximately $1$ percent of Bowen$$s total outstanding shares.

c$.$ Elliott$$s investment in Woods represents $40$ percent of the outstanding common stock that is actively traded. Woods is audited by another auditor and has a December $31$ year end.

d$.$ Elliott neither purchased nor sold any equity investments during the year other than what is noted above.

Required: For the following account balances, discuss $($a$)$ the types of evidence you should obtain and $($b$)$ the audit procedures you should perform.

$1.14$ percent secured note receivable

$2.$ Bowen common stock

$3.$ Woods common stock

$4.$ Dividend revenue