Non-current liabilities, equity and directors' emoluments

A manufacturing company has a ₦2 billion bank loan, 1 billion shares in issue and five directors. Each of these raises a question for the auditor. Was the loan authorised and are its covenants met? Is the ₦2 billion shown correctly as part current and part non-current? Do the shares in the ledger agree with the register of members? Were dividends paid only from distributable profit?

And what were the directors really paid? Users care about each of these, and the last one more than its size would suggest.

This topic covers non-current liabilities, including borrowing agreements and covenants, equity (share capital, reserves and dividends), the statutory books and directors' emoluments. The previous topic covered current liabilities and provisions, and the next covers the key income statement figures.

Key terms in plain English

Syllabus check

This topic is in syllabus area C, audit evidence and substantive procedures (25% of marks). It covers:

• substantive procedures for non-current liabilities, equity and directors' emoluments
• the audit of statutory books
• IAS 24 disclosures

CAMA 2020 and equity, loans and directors' pay

The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria. The sections below apply to this topic.

The rules in more depth

Non-current liabilities: reporting

Non-current liabilities are repayable more than a year after the end of the reporting period. They include debentures, loan stock, loan notes, bank loans and finance lease obligations. If a loan is repaid in instalments, part of the balance may be a current liability, repayable within the next 12 months, and the rest non-current. The auditor must check this split, since it affects classification and disclosure.

The agreements may also impose conditions, called covenants. If the company breaks them, the lender may impose penalties or withdraw the finance. This is a significant consideration, because a breach at the year end can make the whole loan repayable on demand, change its classification to current and raise a going concern question.

Substantive procedures for non-current liabilities

• Obtain or prepare a list of long-term borrowings with, for each, the lender and the movement in the period: opening balance plus interest charged less payments equals the closing balance.
• If the list is from the client, check it for accuracy.
• Agree the opening balances to last year's statement of financial position.
• Check that any new borrowing in the year was authorised under the right company procedures, for example by a board resolution and, where the company's constitution requires it, by shareholders.
• Agree the details of each loan to the loan agreement.
• Check whether the restrictions in the agreements have been complied with, for example that no covenant has been breached.
• Agree repayments in the list to the cash book, bank statements and lenders' correspondence, receipts or statements.
• Check the interest calculations and the accounting entries, including opening and closing accruals for interest.
• Obtain direct confirmation from lenders of the amounts outstanding.
• Confirm that statutory requirements are met, such as registration of charges over assets where the law requires it.
• Confirm the split of the amounts between current liabilities and non-current liabilities.

For finance leases, the auditor also checks the lease agreement, the present value at the start, the finance charge and the split of the obligation between current and non-current. For loans in foreign currency, the auditor checks that the balance is translated at the closing rate and the exchange difference is recognised. Where the entity has given security over assets, the auditor checks disclosure of the assets pledged.

The audit of equity

The specific audit work on equity depends on company law, but some general principles apply. The amount of work is usually small: if the auditor is confident that assets and liabilities are correctly stated, equity, which is assets minus liabilities, must be correct.

Share capital.

• Where the law requires an authorised share capital, check that the authorised amount in the draft statements is consistent with the company's constitution.
• Check the nominal value of shares issued in the year by reading supporting documents, and see that the terms of issue were complied with.
• For new shares, check that the cash received was properly recorded in the ledger.
• Check that issued share capital agrees to the register of members, where one is kept.

Reserves.

• Obtain an analysis of movements on all reserves.
• Check the movements to supporting documents.
• Ensure that legal requirements are met, for example that the share premium account has not been used in a way the law forbids.
• Confirm that dividends were deducted only from legally distributable reserves, usually retained earnings.
• Check the authorisation of the dividends paid.
• Check the calculations and that total dividends agree with the issued share capital at the relevant date.

The audit of statutory books

Most countries require companies to keep certain books or records in addition to the normal accounting records. They usually include:

• minutes of board meetings and general meetings;
• the register of members;
• the register of directors and their interests in shares and loan capital;
• the register of charges over assets; and
• copies of directors' service contracts and details of directors' pay. Work on this can be included in the payroll tests, and the auditor confirms that company law disclosure requirements are met.

The auditor confirms that the statutory records are kept and up to date. In Nigeria, the Companies and Allied Matters Act 2020 requires a company to keep these registers, and the auditor's right of access to the books and records extends to them. Minutes are valuable to the auditor for evidence of loans, dividends, directors' pay, contingencies and decisions that affect the accounts.

Directors' emoluments

Directors' emoluments may be small in relation to revenue or net assets, but shareholders and other users are very interested in how much of the company's wealth goes to directors. They are therefore material by nature and need careful attention. Listed companies in many countries must disclose details in a directors' remuneration report: salaries, bonuses, pension contributions, retirement benefits, non-cash benefits and other fees.

IAS 24 requires disclosure of key management personnel compensation, in total and for each of these categories: short-term employee benefits; post-employment benefits; other long-term benefits; termination benefits; and share-based payment. The audit procedures for related party disclosures under ISA 550 are not examined at this level.

Audit procedures for directors' emoluments:

• obtain a detailed schedule of emoluments for each director for the year;
• check the casting and agree the totals to the disclosures in the financial statements;
• seek confirmation from each director that the emoluments are complete;
• review the minutes of board meetings and of the remuneration committee, if there is one, for undisclosed emoluments, and review the cash book for unusual transactions that may reveal undisclosed pay;
• agree figures in the schedule to the payroll records and check the amounts paid per the bank statements to the payroll records;
• inspect returns to the tax authorities on directors' emoluments and see that they are consistent with the disclosures;
• perform analytical review against the previous year and the auditor's expectations based on knowledge of the business and each director's performance, and ask the reason for significant variations;
• inspect the directors' contracts to see that emoluments are in line with them; and
• consider the adequacy of the disclosure of directors' emoluments.

Risks specific to this area

Loans may be hidden by off-balance-sheet arrangements, so the auditor asks about guarantees and about borrowing by group companies. Equity may be misstated by dividends paid out of non-distributable reserves, by shares issued for non-cash consideration at inflated values, or by capital that has been paid up with funds borrowed from the company itself. Directors' pay may be disguised as loans, expenses or payments to companies they own.

Company law restricts loans to directors, so the auditor checks that any such loans are within the law and disclosed.

The auditor also considers whether the financial statements show the capital the company has, as required by the standards for equity: share capital, share premium, revaluation surplus, other reserves and retained earnings, with movements in the statement of changes in equity.

The statement of changes in equity is agreed to the reserve analysis and the cash flow statement. The dividend per share is recalculated from the number of shares in issue at the record date.

Worked examples

1. The covenant is broken, so the lender may demand repayment.
2. The loan may need to be classified as current, and the auditor considers the going concern assessment and disclosure.

1. ₦120 million is due within 12 months, so it is a current liability.
2. ₦480 million is non-current.

1. The dividend exceeds distributable reserves, so it is not lawful.
2. The auditor reports the matter to the board and considers the effect on the report.

1. Disclosure is incomplete by ₦18 million.
2. The auditor asks management to correct the disclosure.

How to score full marks

• Link loan tests to the agreement, the cash book and the lender's confirmation.
• Mention covenants and the current and non-current split.
• For equity say that work is limited if assets and liabilities are correct.
• For directors' pay say it is material by nature.

Common mistakes in the exam

• Forgetting covenants and the effect of a breach.
• Not mentioning the register of members.
• Checking dividends without checking distributable reserves.
• Leaving out minutes as a source for emoluments.

Quick revision

• Loans: list, agreement, repayments, interest, confirmation, covenants, current or non-current.
• Equity: authorised capital, issues, register, reserves, dividends.
• Statutory books kept up to date.
• Directors' pay: schedule, payroll, minutes, confirmation, contracts, disclosure.

Practice questions

Questions 1 to 10 are multiple choice. Questions 11 to 13 are written. Try each before opening the answer.

Model answers

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