Outstanding Liabilities | Common Items | Audit Procedure and Auditor Duty

Auditor duty in verification of Outstanding Liabilities

At the close of the year, there may be some outstanding liabilities for expenses, which must bring into accounts to arrive at the correct profits. If any of these items is not included in the Profit and Loss Account of the current year, the profit arrived at will be overstated. Therefore, the auditor should see that all such liabilities are brought into account before the current year’s profit is arrived at.

Outstanding Liabilities - Common items, Audit Procedure, Auditor duty

Image: Outstanding Liabilities – Common items, Audit Procedure, Auditor duty

If he fails to do so, he may be held liable for the dividends being declared out of capital due to the omission of certain liabilities. But it may not be easy for an auditor to know whether all the liabilities have been brought into accounts or not. In case of regular expenses like rent, the auditor can easily find out such liabilities.

Moreover, he can learn about the existence of such outstanding liabilities by experience. The auditor should obtain a certificate from the responsible officer that there are no expenses incurred, which have not been brought into accounts during the current year.

The auditor should scrutinize the nominal accounts like wages, salaries, rent, rates, taxes, interest, discount, etc. in order to verify that all expenses accrued up to the date of the Balance Sheet have been duly accounted for. He should go through the Cashbook payments and the purchases of the first few months of the next year in order to see that expenses of the period under audit paid in subsequent year. If so, he should bring this fact to the notice of his client.

The auditor should compare the total expenditure with the previous year and if there is an appreciable difference, he should enquire into the matter. He should also scrutinize the Purchases Book to see whether there is any suppression of purchases.

The outstanding expenses and outstanding liabilities can be brought under two heads as shown below:

  1. Unearned Income, and
  2. Unpaid Expenses.

1. Unearned Income

Unearned income refers to income, which might have been received during the current year, though a part or the whole of it is not applicable to the current year but will be earned during the following year. Rent received in advance, interest received in advance, etc. can be cited as examples here. Hence an unearned income, which is not applicable to the year under audit, should not be credited to the Profit and Loss Account of the current period it should be shown as a liability in the Balance Sheet.

The auditor should examine the vouchers and ascertain the amount which is to be credited to the Profit and Loss Account of the current year and the amount which is to be carried forward and will be earned during the subsequent period.

2. Unpaid Expenses

Unpaid expenses are those that are incurred during the current year but for which payment has not been made in the year under audit but will be made in the next year. In case of unpaid expenses, Profit and Loss Account should be debited with the amount and credited with the unpaid expenses and should be shown in the liability side of the Balance Sheet.

The auditor should examine vouchers, receipts, invoices, demand notes, etc., with a view to ascertain whether the expenses ought to have been debited to the current year’s Profit and Loss Account and that no payment has been made.

Common items of Outstanding Liabilities and Audit Procedure

Some of the common items of outstanding liabilities are discussed below:

1. Wages and Salaries:

Generally the books are closed on the last day of the month. But items such as wages and salaries of current month are paid during the first week of the next month. As far as last month of the year is concerned no payment will be made in the current year and so wages and salaries of the last month will not be debited to the Profit & Loss Account of the current year. Thus the profits revealed by the Profit & Loss Account would be more than what actually it is. Therefore it is proper that such wages and salaries must be brought into account before arriving at the correct profit.

In such a case, wages and salaries account should be debited and outstanding liabilities account should be credited for the outstanding wages and salaries. Further, he should see that Profit & Loss Account has been debited with twelve month’s wages and salaries.

2. Rent, Rates, Taxes, Electricity, Water, etc.:

In order to arrive at the correct profit or loss, outstanding liabilities in respect of rent, rates, taxes, electricity, water, etc. must be brought into account. Otherwise, the profit arrived at will be more than what it actually is. In such cases, the auditor should inspect the ledger accounts, demand notes, receipt, etc. to find out what period is covered so that he can adjust the accounts for amounts payable during the year under audit.

3. Audit Fee

People differ in their views regarding the treatment of audit fee. Some argue that auditor’s work is commenced after the close of the books and so audit fee should be treated as expense of next year. It should not be debited to Profit & Loss Account of the period under audit.

But another argument about audit fee is that the auditor is paid for the audit of the accounts of the period under audit, so it is appropriate to debit the Profit & Loss Account of the period under audit though it has not been paid by the close of the year.

Though both the arguments appear to be sound, the following treatment is considered to be fair and reasonable.

  1. If the audit work is commenced before the closing of books, the audit fees should be treated as outstanding liability.
  2. If the auditor commences his work after the close of the book, it should be treated as expense of next financial year.

4. Purchases

Sometimes it happens that goods are received from the supplier at the close of the year but relative invoice is not received from the supplier. As purchase invoice is not received, no entry is made in the Purchases Book. For such purchases, the purchase account should be debited and credited to outstanding liabilities account. The auditor should compare the Purchases Book with the Goods Inward Register of the last month of the period under audit.

5. Freight & Carriage

If the clearing and forwarding agents do not render their accounts before the close of the period under audit, freight and carriage should be ascertained at the close of the year and brought into accounts. It is the duty of the auditor to see that no part of freight and carriage is left unrecorded.

6. Commission Payable

Salesmen and agents may be given commission on the basis of sales made by them. Normally, they are allowed to withdraw some amount against the commission from time to time, which are adjusted against the commission outstanding at the end of the year.

At the date of the Balance Sheet, the amount due to the salesmen and agents should be calculated (after deducting the withdrawals already allowed) and only that amount should be shown as outstanding liability. If the agents have overdrawn their account the excess amount should be considered as advance given to them and should be shown as a loan to the agents on the asset side.

7. Interest on Loans and Debts

If on the date of Balance Sheet, interest on loans and debts is due but not paid, it must be shown as an outstanding liability. In such cases, it-is the duty of the auditor to examine the past year’s account, rate of interest, interest paid so far, and the agreement. He should examine the ledger account to see how much interest is yet to be paid. He should see whether proper entries are made in the books of accounts.

8. Royalty Payable

Sometimes, it so happens that the royalty may remain unpaid to a party. In such a case, the auditor should check whether proper provision is made regarding royalty due but not paid by the end of the period under audit.

9. Miscellaneous Expenses

The amount of expense exceeding Rs. 5000 or 1% of the total revenue whichever is higher, is required to be shown under a separate account. Other expenses need not be segregated and can be included under the head “miscellaneous expenses” or ” general expenses”.

Conveyance, subscription and other petty expenses are included under this head. Any expenses, included under the head but which is yet to be paid for is to be shown as outstanding liability in the balance sheet.

Income received in advance is also an outstanding liability. If the outstanding liabilities are not included or under stated in the financial statements, the real profits may be inflated. If the outstanding liabilities are over stated, it may be with an intention of suppressing the real profits. Therefore, it is the duty of the auditor to ensure that the outstanding liabilities are brought into the books.

Guidelines for auditors in Audit of Outstanding Liabilities

While examining the outstanding liabilities, the auditor shall consider the following:

1. The outstanding expenses are to be verified with the supporting vouchers such as documents, correspondence, etc.

2. The income received in advance is to be verified with the counterfoil of receipt, correspondence, etc.,

3. The comparison of the outstanding liabilities of the previous year with the year under audit may help the auditor to find out over-provision, under-provision or non-provision of outstanding liabilities.

4. The auditor should verify randomly the payments made with regard to outstanding liabilities in the subsequent accounting year.

5. The auditor should verify the calculation of expenses outstanding and ensure that the amount is correctly arrived at (e.g., interest payable, commission payable etc). If the amount outstanding is to be estimated, the auditor should ensure that a reasonable method is applied to arrive at the estimation.

Leave a Reply

Recent Posts

Related pages

dupont financial ratiosfixed installment methodmixed economy of welfarecharacteristics of negotiable instrumentwager defmulti domestic strategycredit crisis meaningthe percent of sales method can be used to forecastsecuritization process in indianet present value vs internal rate of returnhow to prepare a sales budgetexceptions of privity of contractcaveat emptor exampleservicescape designwhat is the definition of arrearsdefine cheque and its featuresicici bank functionswhat does cif and fob mean in shipping termschit fund businessitinerant retailercapital gearing ratiodifference between formal and informal communicationdissolution of partnership definitiondischarge by accord and satisfactiondifferences between stocks and bondscalculate leverage ratioprobability samples are advantageous to the researcher becausedemerits of joint stock companyspot markets versus futures marketsicici bank achievementsoverheads definitionformula for material price varianceseniority promotionpayback calculation formulasubcultures of indiabearer debentureswhat do you mean by marginal costingdefine overhead ratetypes of middlemensole traders meaningroles and responsibilities of salesmanvadodara stock exchangeinventory turnover days interpretationdistinguish between formal and informal organisationrules when writing a precisjudgement sampling definitionwhat is cash flow and fund flowretail industry current ratiokinds of warehousingformula for debtors collection periodexamples of a vertical mergerpartner by estoppelwhat statement about primary and secondary markets is truepromissory note makeradvantages of autocracycharging depreciationforecasting methods for managementstrengths and weaknesses of random samplingfigurehead in managementarr ratemeaning of misfeasancedecentralized purchasingproject payback period calculatorfactors to be considered in capital budgetingprofibility indexdisadvantages of monopolydictatorial leadership examplesadvantages and disadvantages of listing on the stock exchangewhat is the difference between an acquisition and a mergercalls in arrearsmultidomestic companieswhat is job specialization what are its advantages and disadvantagesconglomerate merger examplesbill of lading in international tradedisadvantages of decentralizationdirect materials used formula