 In this presentation, we will take a look at the audit process related to long-term debt. So thinking about those long-term liabilities on the balance sheet, auditor needs assurance that the amounts on the balance sheet for the various types of long-term debt are not materially misstated. So of course, that is our goal. First, a word from our sponsor. Well, actually, these are just items that we picked from the YouTube shopping affiliate program, but that's actually good for you because these aren't things that were just given to us from some large corporation, which we don't even use in exchange for us selling them to you. These are things that we actually researched, purchased, and used ourselves. Here we have a Western Digital WD elements, 20 terabyte USB 3.0 desktop external hard drive we use as part of our backup system, noting that if you lower the number of terabytes of storage, the price will lower dramatically as well. 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Once the work is done, then save the project to an external hard drive such as this. If you would like a commercial free experience, consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com where we have many different courses. You can purchase one at a time or have a subscription model given you access to all the courses, courses which are well organized, have other resources like Excel files and PDF files to download and no commercials. We're considering the accounts of long term debt. Our goal in the audit is to make sure that those amounts are not materially misstated or at least to give an opinion and some assurance that those amounts are not materially misstated. Also also needs assurance about the recognition of interest expense. So whenever we think of long term debt, we automatically think about interests because those things will be related when we start to test long term debt, the value of long term debt. We know that interest has to be involved given the fact that it's long term. If it's correctly restated in the format of the loan or the long term debt, whatever form it takes, if it's correctly stated as long term liabilities, there should be some time of interest related to it. For most of the entities, it is more efficient to use a strategy of conducting substantive testing. So this is one area note that our normal process when we go through the auditing process is we say, let's test, let's look at the inherent risk. Let's take a look at the control risk. Let's hope that we can rely on the controls and then do less substantive testing. The long term debt is one area where we still want to look at the controls. We still want to understand the controls as part of the audit process. However, we're probably just going to spend more time on the substantive test to really fill up the bucket that we need of the types of assurance we need because of just the characteristics of the long term debt. And we'll discuss a little bit about more of those as we go, but just note that long term debt, probably we're going to be jumping to and we're going to be doing more of just the substantive procedures. Although we still want to understand the internal controls, we're probably going to do a lot of the substantive testing in order to really fill up that bucket to get the evidence we need. Now we're going to take a look at inherent risk. So we're going to go through our process as we have done with other accounts and account types. So we're going to take a look at inherent risk. We're going to take a look at control risk. And then we're considered the types of testing related to controls and the types of testing related to the substantive tests. So normally assessed at a low to moderate level because the volume of transactions are typically low. So when we're thinking about long term debt, we're not really considering a whole lot of transactions. And typically then the inherent risk can be considered to be lower. It also means that we can do more testing in that we can basically test more of the transactions given the fact that there should be fewer of them. The accounting is not complex. So the accounting for normally long term debt is fairly straightforward. Most loan structures and bond type structures, although they can be a little bit confusing given the interest and the time value of money type of calculations, they're usually put together in a fairly straightforward way. However, there could be exceptions. They could be formatted in complex ways in certain circumstances if someone chose to do so. So in that case, there might be higher inherent risk. The entity often receives third party statements or amortization tables. So we can typically under a normal loan put together a fairly straightforward amortization table if it's a straightforward type of debt instrument. And we often have third party information, third party documentation, which we would consider to be more reliable and therefore more trustworthy in terms of our testing process. However, the amount, the amounts are often large with regards to the long term debt and the financial markets have developed sophisticated and complex instruments that have characteristics of both debt and equity. And if so, if we're using complex type of instruments, in other words, if we're having debt financing that's formatted in such a way that we're using complex instruments of financial instruments that have both a debt and equity component to them, well, now it gets a little bit more confusing because we're not using basically straightforward types of loans, straightforward amortization tables. Anytime, of course, we add the complexity to the loan or the bond structure, it's going to be more complex. If we just have a straight, normal type of bond, a normal type of loan that's going to be paid back at some fixed amount and we can make an amortization schedule that's standardized pretty straightforward type of thing. Anytime we start to vary that a lot more than the more complex the structure of repayments, the way the interest is going to be calculated terms to the loan, then those things are going to add to the level of complexity and the inherent risk with relation to these instruments instruments will, of course, be higher as well. When a substantive strategy is followed, the auditor will still need sufficient understanding of the business's internal control system. So note that we will be thinking about more of a substantive strategy. However, within the audit process, although we're probably going to depend on a substantive strategy, you might think, well, then why are we even thinking about inherent risk or control risk, we should just skip them, go straight to the substitutes testing, since that's what we're going to do anyways, because the only reason we might think to do the controls and inherent risk testing is to lower the amount of substantive testing, but that's not necessarily the case. We also we want to get an understanding of the inherent risks and the controls in of themselves as part of the audit evidence, it's just part of that understanding process, even if we plan on basically taking more of a substantive test procedure and still applying in essence the same procedures we would, no matter what our assessment is on the controls and inherent risk in essence. So now we're going to think about the assertions and control activities related to long term debt, assertions and control activities. So we have the assertions of occurrence and authorization. We want sufficient documentation that needs to verify that the note or bond was correctly authorized. All large debt commitments must be approved by the board of directors or by executives who have been delegated this authority. So basically we want to make sure that there has been the proper delegation of authority. These could be large dollar amounts, of course, we want to make sure that there has been authorization for them. Now note that occurrence might be something that we're not as concerned with or we wouldn't think is be as big of an issue or as much of a risk to the audit perspective. Because remember occurrence would mean that there's something on the books, and then we'd go back and there and there's not any transaction that really relates to that item on the books. But we're talking about liabilities here. So there might be an error where a liability is on the books. But if you were thinking about something like fraud or something like that, an intentional misstatement, you would think that you wouldn't intentionally look bad by putting a liability on the books, which wasn't actually incurred. So therefore, from an audit perspective, we're probably not as concerned with thinking that there's going to be a liability on the books that wasn't incurred as we are with basically completeness, which is going to go on the other side of things. So possibly having a liability that happened that wasn't on the books would be something that if there was an intentional misstatement, we would think would be more plausible to happen. Again, the only reason that wouldn't be the case is if you're trying to look bad. And the only time that's the case is usually when you're dealing with taxes. That's the only time a company tries typically to look bad. Otherwise, they're going to try to look good. And so you would think that's the way it would go. With regards to completeness, business should maintain a subsidiary ledger that has information about all long term debt owed by the company. So we're thinking that on the books, we're going to have the amount that's going to be in long term debt, we're going to need the detail of the amount that's going to be included in long term debt. Typically, we would have a subsidiary ledger similar to a ledger that we might have for like accounts receivable, accounts receivable, what's owed to the company, subsidiary ledger breaking that out by who owes them customer. Here we're thinking we have the controlling account of say, notes payable or bonds payable and or bonds payable. Then we're going to have the detailed in the subsidiary ledger that's going to show us the multiple bonds that may be included in that one amount. Notice that if you look at the trial balance, there's like many different ways a company might break this out on a trial balance. They might just have one controlling about account on the trial balance, and then have multiple of the subsidiary ledgers that breaks it out into the different loans that are involved that make up that one controlling account. They may have say two accounts on the trial balance that they maintain a short term and a long term portion breaking up the short term and long term. But each of those having multiple loans involved in it that you'd have to break out in a subsidiary ledger, or they might break out multiple different loans in the trial balance, so that if we have like five loans, we've got five trial balance accounts that give us the controlling account. But we're still going to need the subsidiary ledger, which is going to give us the detail of that, including the short term and the long term portion, because oftentimes if we pay something like monthly, we're going to have a short term amount that is due and a long term amount. That's one of the more complex things that we as the auditor have to audit for that the company needs to basically break out in some format. So just note that if you're working in a company, you want to consider those different options, how do I want to track my loans? If I have multiple loans, do I want to have a master account for each loan? Or do I want to group them in one account and have a subsidiary ledger that breaks them out? How am I going to deal with the short term and long term portion? With regards to an audit, we would expect that all to be kind of figured out at this point in time, have the, if it's a publicly traded company, we would expect this and we would have the two breaking out between short term and long term. We would want to get the controlling accounts then or the subsidiary ledgers and double check that the amounts are correct, that the loans add up to the amounts that are in those accounts, the short term and long term portion are breaking out and broken out properly. If you look at a smaller company and you're doing a review or an audit or something for a smaller company, this may be an area where they need help with is basically making sure those amortization schedules are done properly and making sure that they have the proper breakout between the short term and long term portion with relation to them. Amount recorded in the subsidiary ledger will be reconciled to the general ledger. Then we'll think about the assertion of valuation. Notes and bonds will be recorded at face value minus any unamortized discount plus any unamortized premium. So we're going to put these on the books as liabilities for the face amount and then account for amortization of unamortized amounts for discounts and premiums, those of course related to bonds. So bonds are a bit more confusing because of these discounts and premiums and you'll recall that the discount and premium just means that when we sold the bond, we sold it at some other rate than the market rate resulting in a discount or premium. If we sold it for more, if we sold something for more than the face amount of the bond, we sold it at a premium. If we sold it for less than the face amount of the bond, we sold it at a discount. We've got to record the discount on the books with relation to the bond payable itself. Then we need to amortize that discount in some way. Now the easy way to do it, which is not completely proper way to do it, you wouldn't do it this way unless it's an immaterial amount, would be to just straight line method it and take and reduce it and record it to interest along with the bond payments. So that if it was a semi-annual bond, you would basically reduce it an even amount every time period. However, we should be using the effective method, which basically will allocate the interest more in alignment with the face value of the bond. It's a more proper method to use in terms of the accrual method. So that's what we would be expecting and testing for. We would need bond amortization schedules to make sure that it was indeed amortized in accordance with the effective method. The essence of this process, of course, is that the reason the discount's on the books and the reason the premium is on the books is because of that difference in interest rates. And therefore, these amounts are going to be written off to interest over the life of the bond. The next assertion is classification. Controls need to provide assurance that notes and bonds are correctly classified. The major issue that controls are in place to ensure that the portion of long term debt that is due in the next year is properly classified as short term liability. So this is our major classification issue. And again, it's one of the major things that it's going to just be a problem with regards to the bonds and the notes. Oftentimes, we have monthly payments on a note. If it's a long-term note that's going to be over a year, we're going to have some portion that's going to be due within a year, short term, some portion that's going to be due sometime beyond the year's time period, long term, we're going to have to break those two things out. This is going to be an adjusting type process because it's going to be something that isn't really practical normally to do with regards to every payment. So most businesses will actually do this as an adjusting entry periodically at some point in time at the end of the period, monthly or basically yearly. We need to make sure that that is broken out correctly. How can we do that? We actually usually have to look at the subsidiary ledgers and possibly go to the amortization schedules to see what amount of the payments are going to be due in the short term in the long term time period. Primary issues to make sure that the portion of long term debt that is due in the next year is correctly classified as short term liability. So the short term liability portion, the amount of the debt that we're paying next year needs to be short term. And remember that doesn't mean what we're going to pay because we're going to pay possibly, we're most likely going to pay both the principal portion and the interest, but the short term portion of it is only the principal portion. Why? Because the interest hasn't been incurred. If we recorded the interest portion as short term liability, even though we know we're going to pay it, that would be like us recording the liability for something like the electric bill that we know we're going to pay some or the rent. We know what the rent is in the future on the building, but we're not going to record it now as a liability because we haven't used the building. We haven't incurred it yet, even though we know we're going to pay it. And the same would be due for interest. Even though we know that part of the payments we make our interest, we haven't yet incurred that expense because we haven't gone through that time period and rented, in essence, the money. And therefore, we're only going to record the thing that has been incurred. And that's going to be the principal payments that are going to be paid back. So the principal payments, the only portion that we're going to be thinking about when you're breaking out the short term and long term portions.