Question

The risk associated with liabilities is that they are understated. Which of the following are true (select all that apply):

A) Reviewing invoices before and after year end is an effective substantive audit test for ensuring completeness.

B) Discussing pending legal cases with the legal department is an effective method of ensuring completeness for legal liabilities.

C. Using prenumbered receiving reports and accounting for all receiving reports completed during the period is an effective internal control for ensuring completeness.

D. Confirming accounts payable balances with vendors can be used to ensure that the balance is correct and not understated.   

Answer 1

D. Confirming accounts payable balances with vendors can be used to ensure that the balance is correct and not understated.
THIS STATEMENT IS TRUE

Understated liabilities

Next look at liabilities on the balance sheet and ask if the amount reported for each item seems accurate and complete. A company may try to understate its liabilities to appear stronger or to comply with its loan covenants.

For example, borrowers may forget to accrue liabilities for salary or vacation time. Some might underreport payables by holding checks for weeks (or months). This ploy preserves the checking account while giving lenders the impression that supplier invoices are being paid.

Other borrowers might hide bills in a drawer at year end to avoid recording the payable and the expense. This scam mismatches revenues and expenses, understates liabilities and artificially enhances profits. Delayed payments can also hurt the company’s credit score and cause suppliers to restrict their credit terms.