In early fiscal 2020, the company increased its debt load significantly by borrowing $300,000 from Colo Investors Limited. The covenants state that the debt-to-equity ratio will not exceed 2:1. Debt is defined as all liabilities of the company.
1. In 2015, Kings Limited introduced a new model of a gas furnace with a ten-year warranty that was popular with consumers because its reduced gas consumption resulted in lower heating bills. Historically, claims have been minimal but in 2020, several warranty claims were made against Kings Limited for cracked heat exchangers. Thirty claims were made and Kings Limited paid for repairs, which cost $150. Kings Limited has expensed
an amount for the claims paid but has not made any further entries. Jacob Kovacs believes that the furnaces were damaged because of poor installation by contractors and he is thinking about counter suing. He cannot see more than an additional 40 or 50 units being damaged in total. The 30 repaired furnaces were manufactured in 2018 and 2019. Over 10,000 units of this model have been sold over the past five years.
2. In January 2020, Kings Limited bid on and won a $1.05 million contract to supply heating and air conditioning equipment for a large commercial and residential project. Construction on the project began in March 2020. The fixed-price contract called for Kings Limited to start delivering and installing the equipment in early September 2020. In addition, Kings Limited has agreed to pay a penalty of 20% of revenues if Kings Limited is unable
to meet the agreed-to timetable with installation by the end of February 2021. A brief strike by its factory employees has caused production and delivery to lag about two weeks behind schedule, so Kings Limited is shipping units as soon as they are produced. Jacob Kovacs is confident that Kings Limited will be able to catch up to the promised timetable. In 2020, Kings Limited recognized $350,000 of revenue based on the number of units shipped to year end. Kings Limited has received $50,000 for the units that have been installed by year-end.
3. Kings Limited has been working on a new technology for heating office buildings. The project began in early 2020. Market studies completed in late 2020 confirmed strong consumer interest in the technology. According to management, the project is nearing the end of development and it is now only a matter of time before it is successfully brought to market. Jacob Kovacs does not think that it will be possible to bring the project to market in the coming fiscal year without additional financing. He is optimistic that negotiations with a private investor will be successful, allowing the project to go forward. Kovacs estimates that an additional $150,000 to $200,000 is needed to bring the product to market. Costs of
$580,000 has been capitalized.

Required: analyze the issues above, noting one relevant audit procedure for each of the major issues. (think what/why/how for procedures)

Answer rating: 100% (QA)

1 Do you think that parties such as investors and analysts can properly determine the risk of investing in an organisation if they do not have information about the various debt covenants a company ha... View the full answer