Auditing borrowings and loan covenants
How to audit a client's loans: recognition, bank confirmations, reading agreements for covenants, breaches, classification and the link to going concern.
By Achekam · · 4 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
The loan balance itself is usually the easy part of the audit. The bank statement shows the capital outstanding, the bank confirms it, and the figure agrees. The harder questions sit in the loan agreement that nobody on the team has read: the covenants the client promised to meet, the events that let the bank call the loan in, and the security the client gave.
For many clients in South Africa, Nigeria and Kenya, a bank facility is the single most important contract they have. Testing the balance without reading the agreement is like counting the stock without checking who owns it. Here is how to audit borrowings and covenant compliance end to end.
Recognition and measurement
The IFRS Foundation's summary of IFRS 9 explains that an entity recognises a financial liability when it becomes party to the contractual provisions of the instrument, and measures it at initial recognition at fair value, adjusted, for an item not at fair value through profit or loss, for transaction costs directly attributable to its issue. For a term loan, that means arrangement fees and similar costs are part of the initial measurement rather than an expense on the day.
The same summary explains when a financial asset is measured at amortised cost: when it is held to collect contractual cash flows that are solely payments of principal and interest. That is how the lender sees the same facility. On the borrower's side, check which measurement basis the client's accounting policy applies, and recompute the balance from the agreement:
- opening capital and drawdowns in the year;
- interest charged, recalculated from the rate and terms in the agreement;
- arrangement fees and their treatment;
- repayments, agreed to the bank statement;
- closing capital and accrued interest.
Also look at loans that do not come from a bank. Loans from directors or shareholders often have no written terms at all, which raises its own questions; see our article on loans from directors and shareholders.
Confirming balances with lenders
ACCA lists the bank letter among the tests that give evidence of existence. A bank confirmation does more than confirm a balance: it typically covers all facilities, security held, bank guarantees issued and accounts the team may not know about.
Plan the confirmation early, send it to cover year end, and compare every line of the reply with the client's records. A facility on the confirmation that is not in the books is a finding in itself.
Reading the agreement for covenants
Read every significant facility agreement, and its amendments, and note:
- Financial covenants, such as interest cover, debt to equity, minimum net worth or a current ratio, with their exact definitions.
- Reporting covenants, such as audited statements within a set time after year end, or monthly management accounts.
- Restrictions, such as limits on dividends, further borrowing or disposals.
- Events of default and what the lender may do, including demanding immediate repayment.
- Security given: bonds over property, cessions of debtors, pledges of shares.
Recalculate each financial covenant from the audited figures, using the agreement's definitions rather than the client's own calculation. Definitions often exclude or add items in ways that change the answer.
Breaches, classification and going concern
If a covenant was breached at year end, three questions follow.
Did the lender waive it, and when? A waiver obtained after year end is evidence about the lender's intentions but may not change how the loan is classified. Obtain the waiver letter itself.
Is the classification right? A breach can change whether the loan is presented as current or non-current. Check the requirements of the framework the client reports under, and the exact terms of the agreement and any waiver.
What does it mean for going concern? ACCA lists indicators that an entity may not be a going concern, including indications that the bank is withdrawing financial support and major debt repayments the entity cannot meet. A breach, or a covenant close to breach, is a reason to look harder at forecasts and facilities. For the audits it applies to, also check the IAASB's ISA 570 (Revised 2024). Our guide to evaluating going concern covers the wider assessment.
Confirmations and adjustments in Achekam
In Achekam, staff plan external confirmations and prepare the requests, and a different person approves them before they go out. Each respondent, such as the bank, answers through a single-use link. Achekam does not send the requests itself: staff send them and record how they were sent, which keeps the firm in control of the route to the lender.
The borrowings and finance cost lines in the lead schedules are built from the engagement's trial balance and trace back to its lines. Where the interest recalculation or the confirmation reveals an error, staff record an audit adjustment on the line with a reason, and the matter can be raised as a finding from the working paper and later closed or withdrawn.
When small misstatements matter
ACCA explains that some misstatements may be evaluated as material even when they are below overall materiality, giving as examples misstatements that affect regulatory compliance, debt covenants, earnings trends, key ratios or management compensation.
Covenants are the textbook case. A small error in accrued interest or a misclassified expense may be trivial against materiality but move interest cover from just above the covenant to just below it. When the client is close to a covenant, evaluate every uncorrected misstatement for its effect on the covenant calculation, not only on profit.
IFRS 9's summary on the IFRS Foundation's standards page sets out the recognition and measurement principles referred to above, and is the place to confirm the client's accounting for any fees or modifications to the loan.
For your next audit with a bank facility, ask for the full agreement, every amendment and the covenant certificates sent to the lender during the year, at planning. Reading them early tells you where the pressure on the numbers will be.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
