Given current economic conditions and individual operating results, companies may not comply fully with lender restrictions on debt and, thus, fail to meet one of the debt covenant requirements (e.g., to maintain a certain working capital ratio). The debt agreement may have a trigger to make the debt due on demand and, therefore, a current liability. Often, the client will be able to obtain a waiver of compliance on this violation in order to comply with the provision. Certain auditing procedures need to be performed to ensure this failure of a covenant and subsequent waiver are properly documented and correctly reported.

Sunshine, CPA, is the auditor for Shumacher Industries, a manufacturer of widgets. Shumacher has debt (a mortgage and line of credit) to ABC Bank, the same bank that holds its cash, lockbox, and money market accounts. The mortgage has certain covenants that must be complied with at year-end. When the client did an initial analysis of the covenants with its year-end numbers, the debt to equity required ratio, i.e. the "debt to equity ratio," was not met. The CFO of Shumacher approached the bank and received a covenant waiver from the audit date (12/31/XX) for a period of one year.

1. What audit procedures are needed for Sunshine, CPA, to test the failure of the covenant?

2. How should the waiver be dated in this case?

3. What if the waiver were dated the same date as it was received (12/31/XX year-end, dated 02/01/XX)?

Answer rating: 100% (QA)

1 Audit procedures required to be followed a Bank loan agreement has to be obtained and properly stu... View the full answer