1.0 INTRODUCTION
In general terms, liabilities refer to obligations that result
from past
transactions to pay for assets or rendering of services.
Liabilities can be
classified into two major groups as follows:
(i) Current liabilities – liabilities or debts that are payable
within a
short period of time, usually, within one year;
(ii) Long-term liabilities – liabilities that are payable within a long
period of time, usually, more than one year.
Auditing procedures relative to liability verification require
attention.
This note will, therefore, consider the following topics:
(i) Balance sheet grouping of liabilities;
(ii) Objectives of liability verification;
(iii) Comparing what the auditor looks for in the verification of
assets
and liabilities;
(iv) Audit programme for liabilities.
2.0 OBJECTIVES
At the end of this note, you should be able to:
· outline the classification of liabilities in the balance sheet
· state the objectives of liability verification
· differentiate the concern of the auditor in liability verification
from what he looks for in the audit of assets
· enumerate the audit programme for liabilities.
3.0 MAIN CONTENT
3.1 Balance Sheet Grouping of Liabilities
A balance sheet will contain many liabilities grouped under
various
headings. The headings are as follows.
(a) Share Capital;
(b) Reserves;
(c) Creditors (long-term): amounts falling due after more than one
year. Examples are the followings:
(i) Debenture loans
(ii) Bank loans and
overdrafts;
(iii) Payments
received on account;
(iv) Trade
creditors;
(v) Bills of
exchange payable;
(vi) Amounts owed
to group companies;
(vii) Amounts owed
to related companies;
- Other credits
including taxation
- Accruals and
deferred income
(d) Provision for liabilities and charges such as:
(i) pension and
similar obligations;
(ii) taxation,
including deferred taxation;
(iii) other
provisions;
(e) Creditors (current liabilities): amounts falling due within
one year
(f) Contingent liabilities: liabilities which may happen as a
result of
some event which may or may not occur. For example, litigation.
Thus, the auditor has the duty to verify the following.
(a) The existence of liabilities shown in the balance sheet;
(b) The correctness of the amount of money of such liabilities;
(c) The appropriateness of the description given in the accounts
and
the adequacy of disclosure;
(d) All existing liabilities are actually included in the
accounts.
3.2 Objectives of Liability Verification
The audit objectives of liabilities are as follows:
(a) to determine the adequacy of internal control for the
processing
and payment of suppliers’ invoices;
(b) to prove that the amount shown on the balance sheet is
supported
by accounting records;
(c) to determine that all liabilities existing at the balance
sheet date
have been recorded;
(d) to ensure that adequate provision has been made for any known
and unknown (contingent) liabilities.
3.3 Verification of Assets versus
Verification of Liabilities
In the verification of assets, the auditor is guarding against
overstatement
of asset values, while in the audit of liabilities; the auditor
wants to make sure that liabilities are not understated.
Let us note the following:
(a) liability is a matter of fact whereas valuation of assets is a
matter
of opinion;
(b) understatement of liabilities is usually accompanied by
understatement
of expenses and over-statement of net profit;
(c) over-statement of asset values results partly from improper
entry
in the accounting records, that is, by recording fictitious
transactions.
3.4 Verification Procedures
It is not possible to detail the procedures for verifying all
possible
liabilities. However, some general principles can be discerned,
and
these should be applied according to the particular set of
circumstances
met with in practice. These are as follows.
(a) Schedule: request or make a schedule for each liability
or class
of liabilities. This should show the make up of the liability with
the opening balance, if any, all charges, and the closing balance.
(b) Cut-off: verify cut-off. For example, a trade creditor
should not
be included unless the goods were acquired before the year end.
(c) Reasonableness: consider
the reasonableness of the liability.
Are there circumstances which ought to elicit suspicion?
(d) Internal control: determine, evaluate and test internal
control
procedures. This is particularly important for trade debtors.
(e) Provisions date clearance: consider the liabilities at
the previous
accounting date. Have they all been cleared?
(f) Terms and conditions: this applies principally to
loans. The
auditor should determine that all terms and conditions agreed
when accepting a loan have been complied with.
(g) Authority: the authority for all liabilities should be
sought. This
will be found in the company minutes or directors’ minutes and
for some items the authority of the memorandum and articles
may be needed.
(h) Description: the auditor must see that the description
in the
accounts of each liability is adequate.
(i) Documents: the auditor must examine all relevant
documents.
These will include invoices, correspondence, debenture deeds,
etc, according to the type of liability.
(j) Security: some liabilities are secured in various ways,
usually by
fixed or floating charges. The auditor must enquire into these
and ensure that they have been registered.
(k) Vouching: the creation of each liability should be
vouched, for
example, the receipt of a loan.
(l) Accounting policies: the auditor must satisfy himself
that
appropriate accounting policies have been adopted and applied
consistently.
(m) Letter of representation: obtain from debtors a letter
of
representation covering debts.
(n) Interest and other ancillary evidence: the evidence of
loans
tends to be evidenced by interest payments and other activities
which stem from the existence of the loans.
(o) Disclosure: all matters which need to be known to
receive a true
and fair view from the accounts must be disclosed. The
Companies Acts provisions must be complied with.
(p) External verification: with many liabilities, it is
possible to
verify the liability directly with the creditor. This action will
be
taken with short-term loan creditors, bank overdrafts and by a
similar technique to that used with debtors, the trade creditors.
(q) Materiality: materiality comes into all accounting and
auditing
decisions.
(r) Post-balance sheet events: these are probably more
important in
this area than in any other.
(s) Accounting standards: liabilities must be accounted for
in
accordance with the accounting standards.
(t) Risk: assess the risk of misstatement.
3.5 Audit Programme for Liabilities
From the foregoing, audit programme for liabilities can be
summarised
as follows.
(a) Perform a review of credibility;
(b) Review and evaluate internal control;
(c) Perform cut-off procedures;
(d) Obtain or prepare trial balance of account payables
(liabilities) as
of the balance sheet date and reconcile with the ledger;
(e) Select and confirm creditors;
(f) Search for unrecorded account payables;
(g) Determine proper balance sheet presentation of liabilities;
(h) Obtain from client, a letter of representation, covering
liabilities.
4.0 CONCLUSION
In this note, you are now aware of the audit programme for
liabilities.
The auditor is concerned with material misstatement of
liabilities,
whether it is over-stated or under-stated.
5.0 SUMMARY
In this note, you have learnt the following:
· that liabilities can be classified into two – current liabilities
and
long-term liabilities;
· the grouping of liabilities in the balance sheet;
· the objectives of liability verification;
· that in the audit of assets, the auditor guards against
overstatement
of asset values;
· that in the verification of liabilities, the auditor ensures,
particularly, that liabilities are not understated;
· the verification procedures and programmes for liabilities.
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