Problem
Recently, SPI-X has realized all this new work they have received has put their cash flow into a negative amount and the year-end is only a few weeks away. The company needs the cash to get through this temporary situation. However, the company did receive several loans during COVD to help with working capital and new loans would be outside the companies Debt to Equity ratio required as part of their loan covenants. The company had a shareholder meeting and they decided that they would use SPI-L purchase inventory and with this transaction this company could use the sale as collateral to go to a different institution and receive a loan. The money was then lent back to SPI-X. The intent is to buy back the inventory plus financing and any others costs to SPI-L.
Task
a) By using SPI-L to purchase the inventory how does that help SPI-X maintain its debt-to-equity ratio and receive the monies needed to get through the cash crunch. Explain.
b) As the auditor for the upcoming year, and you see these transactions what are some procedures you would consider and specifically what tests of controls and/or substantive procedures would lead you to detect this plan?