Question

As the auditor of Maisha Clouds, a software firm in Colchester, Simon Accountants is concerned about the liability accounts of the company. Following some unusual changes in the liability accounts, the amount of total liability has decreased by 12% compared to that in the previous year. Yet the company has experienced a growth in terms of scope and scale of operations. The auditors are somewhat sceptical and wish to check whether there are any unrecorded liabilities.
	Required:
	a.	Discuss FIVE audit procedures for unrecorded liabilities. Support your answer with example(s).
Marina Accountants is the auditor for Byron Bay Manufacturers Limited in 2019 for the year ended on December 31, 2018. Byron Bay has a policy of returning goods when customers are dissatisfied with a product within a particular period beyond the date of purchase. The cost of refunds is probable and is estimated to be £950,000 on December 31, 2018. Although this amount is considered material, the company, however, did not make any provision in the statements.
	Required:
	b.	Discuss what Marina Accountants should recommend Byron Bay in such circumstances.
c.	Discuss FOUR directions of UK GAAP regarding the treatment of contingent liabilities.
	d.	Discuss the criteria for treating contingencies. Support your answer with example(s).

Answer 1

a.

Audit Procedure for Unrecoreded liabilities

"Liabilities is the present obligation of the entity arising from the past events". These are the procedure to be followed for auditing of unrecorede liability:

- Vouch a sample of cash disbursement which is recorded just after year end and to receive report and the vendor invoices.

- In searching for unrecorded payables , auditor would look at the disbursement which is to be made after year end and auditor check these are recorded as payable at the year end

- Auditors should track a sample of purchase order and related receiving report to the purchase journal and the cash disbursement which ensure auditor that purchases were properly recorded

- There is analytical procedure in which acounts payable turnover is important and unusual relation should be investigated by the auditor

- The auditor should track subsequent payments to recorded payables and match cheque issued subsequent to year end with the related payable and the cheque which are not matched may represent unrecorded liability at the year end.

b.

Dealing with material items

A n item is considered to be material if its inclusion or omission significantly impact the decision of the users of financial statement , the item which have very little impact on users decision are treated as immaterial item and otherwise material item

- material item should be properly reported in the financial statement such item should be handled in most convenient and easiest manner

- for accessing materiality of an item accountant not only take into account the individual amount but also cummulative effect in immaterial amount

- materiality depends upon dollar amount as well as nature of item or event

- In the above case amount is big so it is to be considered as material item because it impact the financial statement of the firm

c.

Direction of UK GAAP regarding treatment of contingent liability

- Basically contigent liabilities and assets are not recognized as liabilities or assets , however contigent liabilty should be disclosed if the possibility of outflow of economic benefit to settle the obligation is more than the remote

- A contigent assets should be disclosed if inflow of economic benefit is probabel

- Provision are measured at the best estimate of the amount required to settle the obligation at reporting date and should taken into account the time value of money where it is material

- Section 21.17 allow companies not to disclose certain detail in relation to provision contigent liabilities and assets on the basis it would be prejudical to a dispute

d.

Criteria for treating contingent liability

The contigent liabillity should be recorded by taking following consideration

- There must be possible present obliigation from a past event

- The outflow of economic resources to settle the obligation is not probable ( only possible)

- Such a possibility of an outflow of resources is not remote

- The amount of obligation can be reasonably measured

- No reliable estimates can be made for legal obigation as there is no prior procedure to enable the company to make such an estimate