Final answer:
The most effective method of verifying a company's bond sinking fund transactions and year-end balance is by confirmation with the bond trustee, the party responsible for overseeing bond issuances and managing the sinking fund.
Step-by-step explanation:
When auditing a company's bond sinking fund, the most efficient way to verify both the transactions that occurred during the year and the year-end balance is through option (b) Confirmation with the bond trustee. Bond trustees are financial entities responsible for overseeing the issuance and the timely repayment of the bonds. The trustee ensures that the issuer adheres to the terms of the bond agreement and is also responsible for managing the sinking fund. As the neutral third party with complete information, confirming details with the bond trustee is reliable and comprehensive. Thus, they hold the most accurate and detailed records that pertain to bond retirements, interest payments, and sinking fund balances.
Confirmation of retired bonds with individual holders would be impractical and insufficient to gain a complete picture. Re-computation of interest expense and amortization provides an internal check but does not verify the actual transactions. Examination and count of the bonds retired might confirm the retirement but does not provide complete information on the overall sinking fund balance. The bond trustee, therefore, is the most authoritative source for confirmation.
For additional context, when firms issue bonds, they are effectively borrowing money from investors, promising to repay the principal along with interest. Failure to make promised payments can lead to legal action, but bondholders are not always guaranteed full repayment if the firm lacks sufficient assets. Establishing a sinking fund is one way to manage the repayment of these bonds.