13-59

The auditor should review the bond indenture at the time a bond is issued and anytime subsequent changes are made to it.

a.Briefly identify the information the auditor would expect to obtain from a bond indenture. List at least five specific pieces of information that would be relevant to the conduct of the audit

b.Because auditors are especially concerned with the potential understatement of liabilities, should they confirm the existenece of the lilability with individual bondholders? State your rationale.

c.A company issued bonds at a discount. Explain how the amount of the discount is computed and how the auditor could determine whether the amount is properly amortized each year.

d.Explain how the auditor could verify that semiannual interest payments are made on the bond each year

e.The company has a fifteen year, $20 million loan that is due on September 30 of next year. It is the company's intent to refinance the bond before it its due, but it its waiting for the best time to issue new debt. Because its intent is to issue the bond next year, the company believes that the existing $20 million bond need not be classified as a current liability. What evidence should the auditor gather to determine the appropriate classification of the bond?

13-60

The following covenants are extracted from a bond indenture. The indenture provides that failure to comply with its terms in any respect automatically advances the due date of the loan to the date of noncompliance (the maturity date is twenty years hence). Identify the audit steps that should be taken or reporting requirements necessary in connection with each one of the following independent scenarios:

a.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 the CEO and executive officers to a total of no more than $500,000. Executive officers for this shall include the chairman of the board of directors, the president, all vice presidents, the secretary, and the treasurer.

b.The debtor company shall insure all property that is security for this debt against loss by fire to the extent of 100% of the actual value. Insurance policies securing this protection shall be filled with the trustee.

c.The debtor company shall pay all taxes legally assessed against the property that serves as security for the this debt within the time provided by law for payment without penalty and shall deposit receipted tax bills or equally acceptable evidence of payment of the same with the trustee.

d.A sinking fund shall be deposited with the trustee by semiannual payments of $300,000, from which the trustee shall, at his or her discretion, purchase bonds of this issue.