Saturday, April 20, 2013

Review of management's assessment for compliance with debt covenant

It is common that debt covenants are imposed on loans extended by bankers to their own customers, including: financial covenants based on year-to-date financial performance/ financial position of our audit client.

It is important to remind our audit client to read the clauses carefully and understand that term completely. For instance, a banker required an audit client to maintain consolidated net worth of US$60 million at all times. The definition of interpretation will be clearly defined in the clause the bank facility letter. This need to be reviewed carefully to ensure that breach of debt covenant is identified on a timely basis.

To illustrate, our audit client XYZ may have a consolidated net worth of US$62million, including foreign currency translation reserve of S$5million. Certain banks may exclude foreign currency translation reserve in computing the net worth- this will lead to the breach of debt covenant if the requiement is US$60million.

In short, it is important for auditor to understand the bank facility letter and review management's assessment cautiously.

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