Lecture 13 – Topic 6

Auditing and Assurance: Concepts and Applications 2

2nd Semester, SY 2020-2021

Presented by Jerome D. Marquez

Describe the auditor’s objectives for the substantive audit
of liabilities;

Describe the nature of the audit procedures to accomplish

the auditor’s objectives for the audit of liabilities; and

Prepare audit working papers to document audit

procedures for liabilities.
 Liabilities
Current Liabilities Long term Liabilities
• Accounts Payable • Mortgage Payable
• Notes Payable • Bonds Payable
Other Current Liabilities • Notes Payable – Long-term
• Withholding taxes payable
• Value added tax (VAT) payable
• Unclaimed salaries and wages
• Customers’ deposits
• Accrued expenses payable
• Income tax payable

MAIN ISSUES:
✓ The auditor places primary emphasis on verifying not only on
what is recorded, but also on WHAT IS NOT RECORDED.
✓ The auditor seldom finds amounts recorded as liabilities which are
not liabilities, but UNRECORDED LIABILITIES ARE NOT
UNUSUAL.
✓ Thus, the auditor’s procedures for liabilities is primarily a test for
understatement, called a “SEARCH FOR UNRECORDED
LIABILITIES.
✓ For liabilities recorded, the auditor should test for the reasonableness of
the amounts recorded and presented in the financial statements.
 Audit Objectives and Procedures
(Accounts and Notes Payable)
Occurrence or Existence
Determine that payables exist as of the
statement of financial position date.
Completeness
Determine that all transactions
relating to payables have been
properly recorded.
Rights and Obligations
Determine that payables represent
valid and legal claims of third
parties from the client.
Valuation or Allocation
Determine that payables are
recorded at the proper amount.
Presentation and Disclosure 1.
Determine that payables are
presented and disclosed according to
PAS/PFRS 2.
1. Obtain from the client a listing of accounts and notes payable as of
year-end and reconcile to the general ledger.
2. Vouch recorded liabilities to vendors’ statements.
3. Confirm recorded liabilities directly with suppliers and creditors.
Investigate difference in liabilities reported in the confirmations with
the recorded book amounts.
4. Examine bank confirmations for loans.
1. Perform purchases cutoff examination.
2. Test for unrecorded liabilities
3. Perform analytical procedures.
1. In addition to confirmation with suppliers and creditors, review
documentation in client’s file.
2. Examine subsequent payments to creditors.
1. Vouch accounts payable schedule.
2. Test computation of accrued or prepaid interest.
Scan list of payables to determine that each major type of obligation is
properly described and classified. Determine that contingent liabilities
are properly disclosed.
Obtain client’s representation letter.
Specific procedures in the working paper
includes:
1. Tracing of the subsequent payments
to cash disbursement vouchers;
2. The total balance of suppliers’
accounts are traced to the accounts
payable general ledger balance;
3. The balance for each supplier’s
account is confirmed; and
4. Balances per balances of total
suppliers’ account and subsequent
payments are footed.

Sample Working Paper for Accounts Payable

Optional but recommended when:
1. When control risk is high;
2. When there are individual creditors with relatively large balances; and
3. The client is experiencing difficulties in meeting its obligations.

When the auditor opted to do confirmation, it should be sent to:

1. Accounts with zero or small balances because they may be
understated that accounts with large balances;
2. Major vendors who do not send monthly statement, and the auditor
must control the preparation and mailing of the requests and should
received the response directly from the respondent
Sample forms of positive accounts
payable confirmation

For notes payable, the auditor can
have the client prepare an analysis
for the year. It should also reflect the
payee of the note, the date of the
note, interest rate, and the details of
any security or collateral
arrangement
The schedule may include the following:
a. Balance, beginning of the year;
b. Notes issued during the year;
c. Payments (principal) during the year;
d. Balance end of year;
e. Accrued interest payable, beginning of
the year;
f. Interest paid during the year;
g. Interest expense; and
h. Accrued interest payable, end of year.
Test for unrecorded liabilities
Audit of Other Current Liabilities
Audit of Other Current Liabilities
Audit of Other Current Liabilities
Audit of Other Current Liabilities
Audit of Other Current Liabilities
Audit of Other Current Liabilities
 Audit Objectives and Procedures
(Long-term Liabilities)
Occurrence or Existence 1. Obtain an analyses of long-term debt accounts and related interest,
Determine that long-term debts exist as premium and discount accounts.
of the statement of financial position 2. Review debt agreements and confirm with payees the principal
date. amount, maturity date, interest rate, etc.
3. Inspect bonds redeemed, retired or surrendered during the period.
Completeness 1. Trace authorization for issuance of debts to credits to the long-term
Determine that all transactions debt account.
relating to long-term debts have been 2. Vouch borrowing and repayment transactions and review transactions
properly recorded. to supporting documents occurring year-end.
Rights and Obligations 1. Review minutes of board meetings.
Determine that long-term debts 2. Review payments and renewals after the statement of financial position
represent valid and legal claims of date.
third parties from the client.

Valuation or Allocation 1. Recalculate interest expense and amortization of premium or discount

Determine that long-term debts are if any.
recorded at the proper amount. 2. Ascertain the amount of long-term debt maturing with one year.

Presentation and Disclosure 1. Evaluate presentation in the financial statement of the long-term debt.
Determine that long-term debts are Examine classification of obligation as either secured or unsecured.
presented and disclosed according to
PAS/PFRS
TEST YOUR SELF
On which assertion does the auditor focus in the audit of liabilities?

a. Accuracy
b. Completeness
c. Occurrence
d. Presentation and disclosure
Auditors may choose not to confirm accounts payable when

a. other reliable evidence are available to support the balances of

accounts payable.
b. significant number of transactions after the reporting period affect
the balances of
c. vendors are few in number but significant in amount.
d. the client adopts the non-voucher system for cash disbursements.
Which of the following audit procedures would be best for identifying
unrecorded liabilities?

a. Examine unusual relationships between ending accounts payable

and recorded purchases.
b. Reconcile vendors' statements to the file of receiving reports
processed just prior to the reporting date.
c. Review cash disbursement entries after the reporting date to
determine whether the payables arise from previous period
transactions.
d. Trace the recorded liabilities to the receiving report.
Several liability accounts were discovered to have unexpected balances and
several relationships (ratios) were considered not normal based on the
auditor's performance of analytical procedures.
These results would most likely indicate that

a. internal control system adopted by the client is not performing as

expected.
b. fraud exists in the relevant account balances.
c. additional audit tests of account balances are necessary.
d. the auditor has to communicate immediately with the client
management.
Which of the following audit procedures would best detect the existence of
unrecorded payables at the end of the reporting period?
a. investigating whether the recorded payables just prior to and subsequent to
the end of the reporting period are supported by receiving reports.
b. reviewing cash disbursements after the reporting period to determine
whether the obligations relate to transactions of the period under audit.
c. using analytical review procedures such as the ratio between ending
accounts payable and recorded cash payments on accounts payable.
d. Tracing the vendor's invoice with the entries in the cash disbursements
journal in the subsequent reporting period.
Which of the following is an example of an event after the reporting period
that may require disclosure in the notes to the financial statements, but not
adjustments to the financial statements?

a. A client's customer, who has been experiencing financial difficulty for

several months, declares bankruptcy. The customer's account balance has
been considered in the amount recognized as allowance for doubtful
accounts.
b. An explosion in the client's warehouse caused severe physical damage to
ten of the client’s employees. The explosion was found to be caused by
faulty electrical wiring in the plant. The client acknowledges obligation to
its injured employees.
c. The client completes an environmental cleanup. The liability for the
cleanup was appropriately recognized at the reporting date.
d. A portion of client's inventory, which was previously recognized as a loss
due to obsolescence, was disposed of.
Several liability accounts were discovered to have unexpected balances and
several relationships (ratios) were considered not normal based on the
auditor's performance of analytical procedures.
These results would most likely indicate that

a. internal control system adopted by the client is not performing as

expected.
b. fraud exists in the relevant account balances.
c. additional audit tests of account balances are necessary.
d. the auditor has to communicate immediately with the client
management.