REQUIRED: Explain why the interest rate for the loan that requires a review report is lower than that for the loan that did not require a review. Explain why the interest rate for the loan that requires an audit report is lower than the interest rate for the other two loans. Calculate XYZ’s annual costs under each loan agreement, including interest and costs for the audit firm's services. Indicate whether XYZ should keep its existing loan, accept the offer from Sadaf Remo Bank, or accept the offer from Amaranth Bank. Explain why XYZ may desire to have an audit performed anyway, ignoring the potential reduction in interest costs.
In 2020, XYZ Co. has an existing loan in the amount of $1.5 million with an annual interest rate of 9.5%. The company provides an internal company prepared financial statement to the bank under the loan agreement.
Two competing banks have offered to replace XYZ’s existing loan agreement with a new one, starting 2021.
Sadaf Remo Bank has offered to loan XYZ $1.5 million at a rate of 8.5% but would require XYZ to provide financial statements that have been reviewed by an audit firm. Amaranth Bank has offered to loan XYZ $1.5 million at a rate of 7.5% but would require XYZ to provide financial statements that have been audited by an audit firm.
The controller of XYZ approached an audit firm, BRONX Partners, and was given an estimated cost of $12,000 to perform a review and $20,000 to perform an audit. The controller of XYZ approached another audit firm, Essen & Co. for an estimate. Essen & Co, has quoted $15,000 to perform a review, and $30,000 to perform an audit.
XYZ Co. has been audited by Essen & Co. for two years (2017-2019) under a senior auditor Linda. After numerous discussions and reminders from Linda, XYZ controller promised that the audit fee would be paid before the audit report for 2019 was issued. Linda called the partner at Essen & Co., Dr. Essen, to ensure that the audit report was not issued because XYZ had only paid 10% of the outstanding amount. She discovers that Dr. Essen is about to sign the audit report.
REQUIRED:
- Explain why the interest rate for the loan that requires a review report is lower than that for the loan that did not require a review. Explain why the interest rate for the loan that requires an audit report is lower than the interest rate for the other two loans.
- Calculate XYZ’s annual costs under each loan agreement, including interest and costs for the audit firm's services. Indicate whether XYZ should keep its existing loan, accept the offer from Sadaf Remo Bank, or accept the offer from Amaranth Bank.
- Explain why XYZ may desire to have an audit performed anyway, ignoring the potential reduction in interest costs.
- Explain the ethical problem faced by Linda (and/or her audit firm) with XYZ. Why is it a problem? What can be done about it?
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