AUDITING

You are auditing the financial statements of a new audit client: Karkun Slack, a health-food chain that has a June 30 year-end. The company is privately held and has just obtained some long-term financing that includes various restrictive covenants. In order to obtain debt financing, companies often agree to certain conditions, some of which may restrict the way in which they conduct their business. If the borrower fails to comply with the stated conditions, it may be considered in default, which would give the lender the right to accelerate the due of the debt, add other restrictions, wave the default for a stated period, or revise the covenants. Usually, there is a grace period during which the borrower can default. You believe that it is possible that at August 31, Karkun Slack was in violation of the debt covenant restrictions, which became effective on that date. The debt covenants require the company to maintain a certain debt equity ratio. You are not certain, however, because of the accounting records, including period-end cutoffs for sales and purchases, have not been well maintained. Nevertheless, Karkun Slack's executives assure you that if they were in violation, the company will be able to obtain a waiver or modification of the covenants. Required: a. Discuss the audit procedures that you would conduct if Karkun Slack violated the debt covenants. How would you determine whether Karkun Slack would be able to obtain a waiver, assuming that the company was in violation of the debt covenants? b. Based on the case scenario, should Karkun Slack continue to class this liability as non current