c.

Performing Substantive Fraud-Related Procedures
- If the auditor identifies a risk of material misstatement due to fraud
related to debt obligations accounts, the auditor needs to determine the
appropriate responses, potentially including changing the nature,
timing, and extent of audit procedures.
 Fraud-Related Substantive Procedures for Debt Obligations
 In those audits where there is a heightened risk of fraud
related to debt obligations, the auditor should consider
performing the following procedures or, if the procedures
are already being performed, altering the timing and extent
of the procedures:
 Search public records to identify debt obligations.
 Vouch and trace loan proceeds and debt payments.
 Send confirmations to lenders and creditors,
including confirmation of compliance with any debt
covenants.
 Require original supporting documents rather than
copies.
 Agree detail of debt terms to authorization in
minutes of board meetings.
- Restrictions in debt agreements aimed at protecting the lender (creditor,
debt holder, or investor) by restricting the activities of the borrower
(debtor). (Terms and conditions of the debt.)
SUMMARY
1. Auditing debt obligations is usually straightforward—perform substantive
tests of the few, but typically material, transactions recorded during the audit
period. (Why test of controls is optional)
2. The auditor should be skeptical, and therefore alert to the possibility that
management is managing earnings by not appropriately recording expenses,
such as charging expenses directly to retained earnings or under recording
interest expense. (The assertion of completeness, accuracy, and valuation.)
3. Management may attempt to avoid appropriate disclosures related to these
accounts, especially disclosures related to debt covenants and possible
covenant violations. (Presentation and disclosure assertion.)

d. Documenting Substantive Procedures

- A number of important items should be documented when performing
substantive procedures for debt obligations activities. For debt
obligations, the auditor’s documentation should include:
 Copies of the debt agreements.
 Identification of the specific items tested.
 Schedule of debt obligations and interest.
 A summary of the calculations supporting compliance with
debt covenants.
 Confirmations or documentation of alternative procedures
performed.

SIGNIFICANT TERMS

 Bond indenture
- A contract between an issuer of bonds and the bondholder stating the time
period before repayment, amount of interest paid, if the bond is
convertible (and if so, at what price or what ratio), if the bond is callable,
and the amount of money that is to be repaid.
 Debt covenants