Question

Explain the search for unrecorded liabilities. What are the testing procedures? Which assertions is it testing? What is the purpose of this test?

Answer 1

A search for unrecorded liabilities is a fundamental, almost universally applied procedure in all audits. The scope of such a search frequently includes a sampling of subsequent cash disbursements, which is an example of testing one population for understatement by sampling through a “reciprocal” population where unrecorded or otherwise missing balances or transactions are likely to reside.

When there is a longer-than-usual time interval between recording payables and cutting the checks—a common circumstance with financially troubled entities or during periods of economic stress—an auditor should consider merging the populations from the post–balance sheet payables journal (or whatever it is called) and the disbursements journal and eliminate duplicates before sampling .

Lastly, auditors should consider whether the client has an unentered invoice file that needs to be examined for possible underaccruals. If the business does not maintain physical control of the unentered invoices, then extended audit procedures such as payables confirmations are probably warranted. One certainly should not wait until near the end of the audit to make that decision.

Testing Procedure step by step

Step1 Inquire for Financials-Understand how client track unrecorded liability.And Document the information received from client.

Step 2Inspect Documents-Ask and Check the unmatched vendor and invoice file/report .Check thoroughly whether at year end all liabilities has been recorded properly or not.If find any unadjusted entry then make an adjustment entry and complete the data.

Step 3Inspect Records-Check cash book and cash flow statement and whether at year end entries has been complete in all respects.

Many auditors have long believed that, whatever the selected procedure, a search for unrecorded liabilities should invariably be performed on a population that extends through the last day in the field (i.e., the report date). Under the principles of risk-based auditing, however, it is generally inefficient, and therefore unnecessary, to do so; rather, one should define the risk period during which unrecorded liabilities are likely to appear. Perhaps a more serious consequence of choosing a post–balance sheet test period that extends too far beyond the risk period is that it will cause any projected error to be overstated and unreliable. This is particularly true when findings (exceptions) are concentrated in the early part of the test period, which is normally expected to be the case except in the weakest of control environments.

The appropriate length of such a period should ordinarily depend on an auditor’s risk assessment, based on the client’s observed pattern of recording payables or making payments and current financial health under prevalent economic conditions. Auditors should be cognizant that such conditions may likely have slowed down the client’s cash flows so that 1) the client’s staff may have been reduced or 2) for reasons of slow cash inflow, payables are processed and paid slower than in the past. Accordingly, during periods of economic stress, an auditor should consider for certain clients whether the “risk period” for defining the population for sampling should be lengthened from what it may have been in the past for certain clients.