AUDIT OF LIABILITIES AUDIT ASSERTION Existence AUDIT OBJECTIVE All recorded liabilities on the statement of financial AUDIT PROCEDURES - Performing purchases and accounts payable cut-off or Occurrence position are authentic debts due to creditors of the - Confirming liabilities from creditors entity. - Inspecting supporting documents - Performing analytical reviews Completeness All liabilities owed by the entity at the reporting date - GL/SL Reconciliation are included in the statement of financial position. - Performing purchases and accounts payable cut-off - Search for unrecorded liabilities - Performing analytical reviews Rights Liabilities reported in the statement of financial - Performing purchases and accounts payable cut-off and Obligations position represent obligations of the entity at the - Confirming liabilities from creditors reporting date. - Inspecting supporting documents - Search for unrecorded liabilities Valuation Liabilities are included on the statement of financial - Performing analytical reviews - GL/SL Reconciliation and Allocation position at the appropriate amounts. - Confirming liabilities from creditors - Inspecting supporting documents - Testing the accuracy of interest and amortization - Evaluating valuation of liabilities denominated in foreign currencies Presentation Liabilities and related accounts are properly classified, - Performing analytical reviews - Reviewing compliance with terms of debt agreements and Disclosure described and disclosed in the FS including notes, in - Evaluating proper FS presentation and adequacy of disclosure accordance with the applicable PAS/PFRS. - A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits, which can be classified as current or noncurrent. - Important feature of liabilities (which have a significant effect on the related audit procedures) is that these are represented only by documentary evidence which originates mostly from third parties in their dealings with the entity. - In the audit of liabilities - the objective of the auditor is the same regardless of the classification. What is the focus of the audit of liabilities? 1. Primarily, checking the understatement (even overstatement) as well as omissions of disclosure - material omission or misstatement will affect the fairness of the FS. (affets completeness assertion) 2. Off-Balance Sheet Financing: commitments, guarantees and other potential obligations not recorded on the balance sheet. (unrecorded or undisclosed liabilities) SUBSTANTIVE PROCEDUERS FOR AUDIT OF LIABILITIES SUBSIDIARY LEDGER/GENERAL LEDGER RECONCILIATION Purpose 1. To see if liabilities in total appearing in the FS conforms or reconcile with its breakdown. 2. Starting point of all other substantive procedures. How to perform? 1. Obtain a copy of AP GL and SL. 2. Test the clerical accuracy (footing and cross footing) 3. Reconcile SL and GL, any material difference, investigate the reconciling items, particularly any unusual non-standard journal entries. PURCHASES AND ACCOUNTS PAYABLE CUT-OFF TESTING Purpose To verify whether the transaction is completely recorded in the proper accounting period. How to perform? 1. Obtain and examine invoices from suppliers and other entities and other documentation supporting transactions recorded in the purchase journal and cash disbursements journal immediately before and after the reporting date. Determine if the transactions are properly recorded in the proper period; and 2. Review cut-offs in related areas such as purchases and inventories, paying particular attention to goods in transit. CONFIRMATION OF LIABILITIES FOR ACCOUNTS PAYABLE AP Confirmation is less necessary as compared to AR Confirmation. It can be verified usine the external evidences and supporting documents (SOA, Contracts) from the entity's creditors. However, there are instances that AP confirmation is necessary when the following conditions exist: 1. Controls over the recording of vendor's invoices and receiving reports are ineffective. 2. There are few transactions involving large amounts; or 3. There are numerous old balances. Upon receipt of confirmation replies, the auditor should reconcile the information confirmed by the creditor to the accounting records and follow up and resolve any differences noted. FOR NOTES PAYABLE As compared to AP, NP is supported by a promissory note and may be given for a variety of reasons, example: 1. Purchase of merchandise in the ordinary course of the business. 2. In the settlement of a long outstanding amount; 3. In return for loans form affiliates, shareholders, banks or other financial institution; or 4. To raise money in the short-term money markets (Commercial paper). In NP verification and its related accounts (interest expense and interest payable), the auditor may either: 1. Confirm the notes payable; or 2. Review supporting documentation as to a. amounts owed b. terms c. collateral d. restrictions; and e. debtor's compliance with the loan provisions and identify liens, security interests, and assets pledged as loan collateral. Upon receipt of confirmation replies, the auditor should agree with the information confirmed by the creditor to the accounting records and follow up and resolve any differences noted. INSPECTION OF SUPPORTING DOCUMENTATIONS How to perform? FOR ACCOUNTS PAYABLE Vouch entries in the Voucher Register or in the Purchases Journal to supporting vouchers, invoices, receiving reports and purchase orders. FOR LEASE LIABILITY 1. Examine the lease contract and determine whether a. Is it really a lease transaction? (Right to Use Asset has been provided by a lessor to a lessee) b. Is appropriately classified as finance or operating leases. 2. Determine whether finance/capital lease obligations are appropriately recorded and reqired disclosures are made. FOR NOTES PAYABLE AND OTHER OBLIGATIONS (SHORT-TERM OR LONG-TERM) 1. Extract information relevant to the disclosures of notes payable and other obligations in the financial statements. 2. Contact lender and/or legal counsel of the entity, as appropriate, with respect to interpretation of loan agreement terms, restrictions and any other information that may be sought regarding special provisions of notes or loan agreements. 3. Examine the client;s copies of loan agreements (ex: Promissory Notes) or other short-term lending arrangements (ex: Factoring) to obtain an understanding of the pertinent provisions which include: a. amount of loans authorized b. interest rates c. due dates/maturity period d. assets pledged e. restrictions imposed (if any) SEARCH FOR UNRECORDED LIABILITIES How to perform? It is important to remember that this procedure may only be conducted after the reporting date and the auditor performs the following procedures: 1. Examine files of unpaid or unrecorded invoices, unmatched purchase orders and unmatched receiving reports and trace them to the related journal (ex: Purchase Journal) to determine it was properly recorded. 2. Examine the significant recorded purchases between the reporting date and the date of search for unrecorded liabilities to determine if this purchase should be properly included in the current year FS. 3. Obtain and review minutes of the meetings and inspect contracts to identify unrecorded liabilities such as liabilities on pending litigations. 4. Review cash disbursement subsequent to the reporting date (subsequent payment testing) and check whether this may represent a liability that should be reported on the current year; and 5. Request the client to make an appropriate adjustment entry for any unrecorded liability identified by the auditor. TEST THE ACCURACY OF COMPUTATION OF INTEREST EXPENSE, INTEREST PAYABLE AND AMORTIZATION OR PREMIUM AND DISCOUNT How to perform? 1. Obtain the interest rate (nominal or effective) and perform recomputation. 2. For long-term debts like bonds payable, in the initial issuance (determining the discount or premium), prepare an amortization table and compare it with the amounts recorded. If recurring audit, the auditor may use the prior year working paper. LIABILITIES DENOMINATED IN FOREIGN CURRENCIES As required by PAS 21 - The Effects of Changes in Foreign Exchange Rates, monetary liabilities in foreign currency should be translated using the closing rate at the reporting date. How to perform? 1. Obtain the closing rate and reperform the translation of the foreign currecy denominated payable. 2. Ensure that any foreign currency transaction gain or loss should be reported as part of P/L. REVIEW COMPLIANCE WITH THE TERMS OF DEBT AGREEMENTS How to perform? 1. Review the entity's compliance with the terms, restrictive covenants or other provisions of debt agreements to determine whether a default or violation of any debt covenant has occurred. If there has been a default or violation of any debt covenants, the auditor should ensure that this is properly disclosed in the notes to FS and the item should be appropriately presented as current liability in the Balance Sheet. PERFORM ANALYTICAL REVIEW PROCEDURES Testing the reasonableness of liabilities and related accounts. How to perform? 1. Comparison of this year's final balance from previous years audited balances. 2. Comparison of the relationship between current year accounts payable balances and the current year purchases with the previous year's figure. 3. Comparison of actual closing balances of loans and borrowings with the corresponding budgeted figures, if available. 4. Comparison of significant ratios relating to loans and borrowings, with similar ratios for other firms in the same industry, if available. 5. Comparison of significant ratios or loans and borrowings with the industry norms, if available. 6. Comparison of the relationship between current year AP and current year total current liabilities with previous year's figures. 7. Comparison of the relationship between the current year purchase discount and the current year total purchases with the previous year's figures. 8. Comparison of the current year interest expense to the product interest expense and average principal of debt outstanding; and 9. Comparison of current year finance lease expense with the corresponding previous year's figures. After performing some comparisons, the auditor should investigate any significant differences, unexpected changes or the absence of expected changes. EVALUATE THE PROPER FS PRESENTATION AND ADEQUACY OF DISCLOSURE OF DEBT AND RELATED TRANSACTIONS How to perform? 1. Review the proper presentation (current vs. noncurrent, trade vs. nontrade) 2. Ensure that any debit balances on AP or other liabilities (either due to overpayment to suppliers, errors or irregularities) should be appropriately presented as nontrade receivable through reclassification entry in the audit working papers. 3. Review completeness of disclosure in accordance with the applicable PFRS. 4. For contingent liabilities, the auditor should examine that the following have been disclosed: a. Brief description of the nature of each contingent liability; b. estimate of the financial effect or a statement that such estimate cannot be made; c. uncertainties which may affect the future outcome; and d. possibility of any reimbursement. ADDITIONAL AUDIT CONSIDERATIONS ACCRUALS Normally, supporting documents such as invoices are not available at the time of recording of the accrual in the books. Since documents are not yet available, the following procedures should be observed by the auditor: 1. Considering the client's own sytem for capturing accruals. 2. Obtaining schedule of accruals, ensure that is cast correctly. 3. Perform recalculation. 4. Agree accruals to payments after year end. LITIGATION AND CLAIMS PSA 501 (Redrafted) requires that auditors should carry out procedures to become aware of material litigation or claims involving the entity. Audit procedures are as follows: 1. Inquire with the management and inhouse legal counsel; 2. Review minutes of the meetings with the entity's external legal counsel; 3. Examine legal expense accounts and related documents (invoice for legal expenses) 4. Use any information obtained from discussions with any inhouse legal department. CONTINGENCIES PAS 37 requires the contingent liabilities be disclosed (if possible) while contingent assets disclosed (if probable, if possible, ignore). The auditor must review client's records and FS for proper disclosure of contingencies. Auditor is more concerned with contingent liability (loss) because management may not wish to disclose them. For contingent asset (gain), auditor should also check for premature recording of gain. E.g. Recording of proceeds from a lawsuit the client anticipated winning before the lawsuit is resolved. EARLY RETIREMENT OF RESTRUCTURING OF DEBT Review an early retirement of debt or restruturing of debt to determine whether a gain or loss on the transactions should be recognized, and if so, that it has been appropriately calculated, accounted for, and disclosed in accordance with the applicable PFRS. SUBSEQUENT EVENTS Review refinancing agreements and liability transactions subsequent to the reporting date to determine the effects on the balance sheet classification or on disclosure.
