#77 Auditing Creditors- Creditor Turnover Analysis

In audit, it's essential to form an expectation of the Company's results before we really drill into the details. We compare the actual Company's results to our expectation, and investigate the variances accordingly. This is the analytical procedures adopted by most of the audit Company. Besides, we also compare the result / financial position with prior period.

Creditors' turnover anlaysis is one of the auditing procedure we performed. What are we expecting from the audit client, in general. We expect the creditors turnover (days) to increase, as compared to prior period.

To illustrate, majority of our audit clients are affected by the economy turmoil. They are squeezing suppliers' credit ( by delyaing the repayment), in order to maintain the Company's working capital, as our audit client's working capital are most likely affected by the delay of repayment from customers.

We have formed an expectation, and we will compare the actual result with our expectation. Any unusual movements need to be identified.

Accounting principle- Accrual Basis

Figures generated / kept in accordance to accounting principle is prepared on accrual basis. For instance, accountant record the provision for warranty ( based on estimate) even though there's no actual cash/ economic outflow yet.

In finance, cash basis figures are more relatively more valuable , as compared to accrual basis ( advocated by accounting principle), in order to value a business.

What do you think ? You prefer a an accrual method or cash method in valuing a business?

#76 Classification of Tax Refund

Should tax refund be classified as Income in financial statement?

Let's look at the double entries of tax refund upon receipt of advice / monies from the Income Tax Authority of the country:

Dr. Cash
Cr. Taxation Expense

Let's illustrate with example. Company XYZ made provision for tax in relation to Year of Assessment 2008 amouned to US$200 based on its tax computation, full payment of US$200 has been made. US$200 has been charged to its income statement as taxation expense.

In the same year/ subsequent year, Comptroller of Income Tax inform the Company that there's a computation error, and the actual tax for YA 2008 should be US$180 (ie overpaid by S$20). The Company should have recorded a credit to its taxation expense account (i.e. a gain to income statement) as tax refund.

In short, tax refund should not be classified as income in financial statement. It should be considered a credit to taxation expense account.

Small Business Accounting- Interest Expense

What are the entries to record interest expense incurred on borrowings from bank ? Upon occurrence of interest expense:

Dr. Interest Expense (P/L)
Cr. Interest Payable (B/S)

Upon repayment of interest payable to bank:

Dr. Interest Payable (B/S)
Cr. Cash (B/S)

Breach of Debt Covenant

While a Company withdrawn loans from bankers, a debt covenant condition will be stated on the term loan facility letter require the Company to maintain /meet certain financial position. For instance, the debt covenant might require the Company to maintain current ratio of at least 1, or maintain net worth ( i.e. net asset) of certain amounts.

If the Company does not meet the debt covenant requirement, the bank is contractually entitled to call back the loans immediately. To illustrate, if Company XYZ fail to meet debt covenant requirement of maintaining current ratio of 1, bank is entitled to call back the loans amount immediately.

However, in practise, the Company will negotiate with its bankers to extend the period of review ( ie. extend the timeline for the Company, in order for the Company to improve its financial positoin).

For auditing purpose, the Company must require a waiver letter from the bank as an evidence that the bank will not call back the loan immediately. If not the non-current portion of term loan has to be classified as term loan if waiver letter was not obtained after the Company has breached its debt covenant.

#75 Auditing Interest Expense

What's the most effective way of auditing interest expense recorded?

In order to verfiy the reasonableness of interest expense recorded, we used the following formula:

Principal x Average Interest Rate x Period = Interest Expense

Some of the auditor would perform vouching to bank advice by tracing the amount reflected on bank advice to amount stated on General Ledger. However, vouching only ensure the existence, it does not address completeness.

As a result, reasonableness is always useful to check for the completeness of expenses recorded.