Rem Inc. produces electronic components for sale to manufacturers of radios, television sets, and digital sound systems. In connection with her examination of Rem's financial statements for the year ended December 31, 2007, Maggie Zeen, CPA, completed field work 2 weeks ago. Ms. Zeen now is evaluating the significance of the following items prior to preparing her auditor's report. Except as noted, none of these items have been disclosed in the financial statements or notes.
A 10-year loan agreement, which the company entered into 3 years ago, provides that dividend payments may not exceed net income earned after taxes subsequent to the date of the agreement. The balance of retained earnings at the date of the loan agreement was $420,000. From that date through December 31, 2007, net income after taxes has totaled $570,000 and cash dividends have totaled $320,000. On the basis of these data, the staff auditor assigned to this review concluded that there was no retained earnings restriction at December 31, 2007.
Please discuss additional disclosures in the financial statements and provide specific notes that the auditor should recommend to her client.
The terms of the loan agreement would already be disclosed in the notes to the financial statements in the long term debt portion of the disclosures. The additional terms of the agreement regarding dividend payments would be a separate disclosure (but cross referenced to the long term debt footnote).
What is ...
The solution first discusses the terms of the loan agreement and its effects to financial reporting and disclosure items in an audited financial statement. The solution is cited with two possible conclusions for resolution.