Question

1-Search the EDGAR database to find a 10-K that reports a contingent liability. Write a paragraph summarizing one of the liabilities found in the financial statements. Did the company disclose the liability in the footnotes only, or did it recognize the liability in the financial statements?

2-What procedures might the auditors use to search for the contingent liabilities listed in part (1)? Explain the steps in the procedure in detail, as well as how they would provide the outcome desired.

What additional procedure could be performed? List the procedure, explain how it is performed, and discuss why it would be appropriate.

Answer 1

1-Search the EDGAR database to find a 10-K that reports a contingent liability. Write a paragraph summarizing one of the liabilities found in the financial statements. Did the company disclose the liability in the footnotes only, or did it recognize the liability in the financial statements?

As per the US GAAP any expense that is likely to arise in the future but at the condition of that it may arise or may not arise is treated as a contingent liability.

The liability that is contingent at this time can be reported in the financial statements If the below test is passed.

1. We can measure the actual expense with some accuracy is if the contingent liability turns into reality.
2. The chances of happening of the contingent liability is more than 50%.

So if in case all of the above listed tests are met then this is possible that the companies may report it contingent liability on the financial part.

There are some cases in which this contingent liability has been reported and this is because that the chance of happening of event is more than 50% and the loss can be calculated with the accuracy.

If in case the above listed conditions are not met then the companies may not be able to list such expenses in the financial statements and only show that at the footnote as an information.

2-What procedures might the auditors use to search for the contingent liabilities listed in part (1)? Explain the steps in the procedure in detail, as well as how they would provide the outcome desired.

1. Search for undisclosed information

This happens many times that the auditor are not informed about all of the facts that affects the company. So in such cases this is the auditor role to search any information that is not disclosed but will affect the company future.

The auditor may check the internal communications and get to know a lot about the company issues and may be able to check if there will be any contingent liability.

2. The materiality needs to be evaluated

The auditor need to evaluate the materiality of the events that he finds can be contingent. If the auditor thinks that the event is material and has a dollar value then he can consider that to be a contingent liability else he may leave that event since that is not material

3. Check the trend in the industry in which client operates.

This Is the most easy way to find out if there will be any liability based on the industry type client operates in .

If there are trend or changes in the policies by the government than this may be possible that there will be contingent liability to pay the government fees in future.

What additional procedure could be performed? List the procedure, explain how it is performed, and discuss why it would be appropriate.

• Trend analysis, this is the main procedure that involves going via the balance sheet and checking if any of the item that is in the balance sheet will cause a future contingent liability or not.
• Check for business of client, if the client is in a business that creates a contingent liability then the P&L should be checked. Suppose if the client sells some goods that have warranties than this is possible that the goods are returned in future and hence there has been a contingency.