Question

When auditors test liabilities, the primary risk they address is that of

A. Understatement

B Overstatement

Answer 1

Answer: Option A. Understatement

Understatement is primary risk auditors address when test of liabilities

Auditor mainly focus on whether understatement of any liabilities have been taken place. Like unrecorded of liability is one of the example of Understatement of liabilities.

Management may not won't show actual liabilities (if they are comparatively high) due to following reasons:

1. For Investor point of view. If liabilities are understated then investor can easily invest in the company's share on the basis of that the company is having less or average amount of liabilities. & vice versa if liabilities are showned actuals then it may be higher as per investor point of view thus lead to investor may not think for investing in the company.

2. Majorities of companies may not to have high debt ratio as it shows high risk. A higher debt ratio is a sign of adverse ratio, thus company try to understate liabilities.

Therefore, Auditor first check whether any understatement of liabilities there or not by performing audit procedures. Auditor may exercise liabilities on sample basis or Substantive basis depending upon the nature, timing & extend of audit procedure.

However Auditor also performs audit whether overstatement of liabilities taken place or not. Rare case it may happen with the company.