Covenant
Compliance
Checker
Test up to 10 financial covenants, calculate headroom or breach deficit, and generate an ISA 570 going concern working paper — ready for your engagement file.
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Frequently asked questions
Why do financial covenants matter for the audit?
Covenant breaches are a significant going concern indicator under ISA 570.A3. When a borrower breaches a financial covenant, the lender may have the right to demand immediate repayment. If the breach is not waived before the financial statements are authorised for issue, IAS 1.74 requires the related borrowing to be reclassified as a current liability — potentially triggering a net current liability position and going concern risk. Auditors are required to perform procedures to identify covenant breaches and assess their implications for the audit opinion.
How is Net Debt/EBITDA calculated and what is a typical threshold?
Net Debt/EBITDA = (Total debt − cash and cash equivalents) / EBITDA. The result shows how many years of earnings (before interest, taxes, depreciation and amortisation) would be required to repay net debt. Common covenant thresholds range from 2.5x to 4.0x depending on industry and credit rating. Investment-grade companies typically target below 2.5x. A threshold of 3.0x means the entity's net debt must not exceed three times its annual EBITDA. The exact definition of EBITDA in the loan agreement often differs from the accounting figure — auditors must use the contractually defined metric.
What happens when a covenant is breached?
When a financial covenant is breached: (1) the lender typically has the right to accelerate repayment of the loan; (2) under IAS 1.74, the debt must be reclassified as current if the breach is not waived before the financial statements are authorised; (3) cross-default clauses in other debt instruments may be triggered; (4) the breach is a going concern indicator under ISA 570.A3 — the auditor must assess whether there is substantial doubt about going concern; (5) IFRS 7.B10A requires disclosure of defaults on principal, interest, or covenant terms. The auditor should obtain evidence of any waiver agreed before the reporting date.
What is the interest coverage ratio and how is it used in covenants?
The interest coverage ratio (ICR) = EBIT / Interest expense. It measures how many times the entity can cover its interest payments from operating earnings. Common covenant thresholds require ICR ≥ 2.5x or ≥ 3.0x. A ratio below 1.0x means interest payments exceed operating earnings — a strong going concern indicator. The exact definitions of EBIT and interest in the loan agreement should be used, as 'adjusted EBIT' (excluding exceptional items) is common. The ICR is closely watched by lenders as a measure of debt serviceability and is typically tested quarterly for leveraged transactions.
What disclosures are required for covenants under IAS 1 and IFRS 7?
IAS 1.136 requires disclosure for each class of borrowings: the terms and conditions, including covenant requirements. IAS 1.74 requires that if the entity has breached a covenant on a long-term borrowing and the breach has not been waived before the balance sheet date, the liability is classified as current. IAS 1.75 requires disclosure of: the nature of the covenant breach, the carrying amount of the related borrowing, and whether the lender has agreed to waive the covenant. IFRS 7.B10A requires disclosure of any defaults on principal, interest, sinking fund, or redemption provisions during the period, and the carrying amount of borrowings in default.
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