Brony’s Bikes’ long-term liabilities consist of the following:
10% mortgage note payable to Dallas Dollar Bank - $60 million; and 12% note payable to Bank Two - $45 million.

Ignore the long-term deferred income tax liability arising from the difference between book depreciation and depreciation for income tax purposes.  In this case, the deferred income tax liability account will not be adjusted.

In 20X4, Brony’s Bikes upgraded its manufacturing facilities at a cost of $150 million. The project was financed by issuing 2 million shares of common stock at $25 per share, and by issuing a $100 million 10% mortgage note payable to Dallas Dollar Bank. The mortgage agreement requires repayment in ten annual installments of $10 million each. Interest on the unpaid principal is payable on the first day of each month. The principal installments are due on January 1. The next payment is due on 1/1/Y0.

The 12% note payable to Bank Two was issued to alleviate the effects of the liquidity problems encountered in 20X9. This note is unsecured and requires repayment in ten equal annual installments. Unlike the Dollar Bank mortgage loan, interest on the Bank Two loan is payable annually. The first principal installment, together with interest, is due on 3/1/10. This note contains restrictive covenants, as described earlier, relating to a $10 million compensating balance requirement and restrictions regarding further borrowing and dividend payments. Derick has asked that you analyze the long-term notes payable, being particularly alert to any violations of the restrictive covenants contained in the Bank Two loan agreement.

Requirements

1. Using Excel download the file labeled “20X9 Notes.xlxs.”  Locate the following documentation in this file:

WP 14 - Notes payable and accrued interest - lead schedule; and

WP 14.3 - Notes payable—long-term.

Scroll to WP 14.3, “Notes Payable - Long-Term.” What are the audit objectives in the examination of long-term notes payable? What would the auditor consider to be the most relevant assertions? Has the evidence provided in the document addressed the audit objectives and the most relevant assertions?

2. Record Reclassification Journal Entry C for the current portion of both notes as of 12/31/07, and enter the amounts in WP 14.3. Now scroll up to WP 14, the lead schedule for notes payable and interest. Post your reclassifications to the lead schedule.

3. What is the probable nature of the adjustment to “notes payable - trade” and to “interest payable” appearing in the adjustments column of the lead schedule?