VERIFICATION OF LIABILITIES

1.0 Liabilities are obligations owed by a business enterprise to outsiders as

a result of trading transactions or insiders by way of capital
contributions.
There is a tendency to understate the former in order to enhance the
profit performance of the organization. Also, the latter may be
overstated in order to improve the stake of the owners in the business
by creating fictitious assets on the other side of the Statement of
Financial Position.
Hence, the usual objectives in verifying liabilities are:
(i) That all relevant liabilities have been included at reasonable
value without any material omission or understatement
(ii) That increases in capital contribution by the owners arise from
genuine cash contribution by them or from retention of past
profits.
(iii) That all contingent liabilities have been identified and treated in
line with acceptable standard practice.

2.0 COMPOSITION OF LIABILITIES

Liabilities can be broadly classified into the following:
 Trade Payables
 Accruals and Provisions
 Other Liabilities
 Share Capital (Ordinary and Preference Shares)
 Debentures
 Contingent Liabilities and Off Balance Sheet Engagements

2.1 VERIFICATION OF ACCOUNTS PAYABLE

Trade accounts payable usually constitute a significant proportion of
current liabilities. The detailed procedures are:
 Obtain schedule of accounts payable as at financial year end.
 Cast the schedule and agree total to the general ledger.

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  Review accounts of suppliers with significant closing balances
and select few items for transactions testing.
 Carryout transaction testing by checking selected items for
proper initiation, checking and approval, receipt of items ordered
into store etc. Confirm compliance with internal control
procedures.
 Do cut off test by selecting few transactions before and shortly
after the cut-off-date. Trace the items to supporting documents
and stores records to confirm proper implementation of the cut
off procedures.
 Select few creditors across the different categories of creditors
and circularize them for formal confirmation of amount owed to
them in their records. Request reconciliation for creditors with
differences between ledger balances and amounts confirmed.
 Extract creditors’ ledgers with debit balances and review
transactions on the ledger to be arising from genuine
transactions. Confirmed debit balances should at the end of the
exercise be reclassified to Accounts Receivable to conform with
IAS No1.
 Generate a schedule of adjusted/confirmed accounts payable for
disclosure in the financial statement. Note also items that require
special disclosure.

2.2 VERIFICATION OF ACCRUALS AND PROVISIONS

In line with accrual concept, expenses incurred within a financial year
but not yet settled or paid have to be accrued for in the financial
statement. Also, there is usually provision for potential loss in the value
of certain assets like debtors, other assets, investments etc. Hence,
accrual and provision amounts are debited to the profit and loss
accounts and an equivalent amount of liability set up.
The verification procedures are:
 Obtain schedule of accruals and provisions
 Check arithmetical accuracy and confirm total agree with the
general ledger balance.

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  Check accrual items for completeness and accuracy by reviewing
basis of computations e.g. salaries and wages payments, utility
payments-light and telephone bills etc. Confirm that all needed
accruals have been made.
 For provisions, check computation of amount provided and
ensure compliance with the company’s accounting policies,
acceptable standard practice and established industry practice
e.g. in the banking industry, the need to comply with Prudential
Guidelines.
 Accrual adjustment sometimes related to income received in
advance but not yet due. Hence, need to be treated as deferred
income. It can also relate income due on investments on loans
granted but not yet received. Accruals can be made for such
income subject to compliance with prudence or conservatism
concept.
 Note that accrual may be needed also for transaction
consummated and contracted before the year end but yet to be
executed as at the date of the financial statement.
 Prepare revised schedule of Accruals and Provisions.

2.3 VERIFICATION OF OTHER LIABILITIES

Other liabilities usually comprise other financial obligation owed by the
business other than those arising from trading activities. It will usually
include items like tax payable, dividend payable, deferred income etc.
The verification of other liabilities will entail the following step:
 Obtain schedule of other liabilities
 Check arithmetical accuracy and confirm total agree with balance
in the General Ledger.
 Trace significant items on the list to originating documents.
Confirm genuineness of transactions and correctness of amounts
stated.
 Pursue issues of other liabilities due but not included e.g. Credit
balances in the ledger under asset codes.
 Prepare adjusted schedule of other liabilities.

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2.4 VERIFICATION OF SHARE CAPITAL
Companies usually issue two main types of shares namely Preference
Shares and Ordinary Shares. For each class of shares a shareholder
register in hard copy or soft form will be maintained. The Register will
show the full name of the shareholder, number of shares held and the
nominal value of the shares. Where a certificate of shareholding has
been issued, the share certificate number will also be indicated.
After initial issue of shares, shareholding status only change
occasionally as a result of additional share issue or capitalization of
earning through bonus issue of shares.
The verification procedure will entail:
 Obtain shareholding schedule for the different classes of shares.
 Cast the schedule and confirm total agree with the general ledger
balance for each class, request reconciliation for observed
discrepancy.
 Select a few items for testing by tracing to subscription
documents and the shareholders register confirm that
established internal control procedures were duly followed.
 For recent movement in share issues, trace transactions to
originating documents and confirm genuineness as to
authorization, checking/approval, receipt of proceeds of share
issue etc.
 For quoted companies, obtain shareholding listing from the
registrars and compare with in-house shareholders register.
 Confirm compliance with relevant laws and guidelines on the
recent share issue and total capital.
 For preference shares, check issue document and confirm that
stated terms with respect to the shares being participating
convertible etc are being complied with.
 Generate revised schedule of paid up capital for each class of
shares.

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2.5 VERIFICATION OF DEBENTURES
Debenture is a document acknowledging loan to a company. It will
normally contain details about the loan such as the nominal amount,
the rate or interest, repayment arrangements and covenants
restricting activities of the company before the loan is fully repaid.
The verification procedure will generally include:
 Obtain schedule of debenture holders
 Agree total to the general ledger.
 Select few items for tracing to issue documents, Debenture
Holders Register and bank accounts for recent issues
 Review debenture issue documents and extract restrictive
covenants there-in. Check that the covenants are being obeyed
particularly in the current financial year.
 Check status of interest payment on the debentures and ensure
interest due but not yet paid are accrued for.
 Generate adjusted schedule for Debentures.

2.6 VERIFICATION OF CONTINGENT LIABILITIES AND OFF

BALANCE SHEET ENGAGEMENTS
Contingent liabilities are obligation that are not yet matured as at the
financial year end but that may become real at some future date due
to the occurrence or failure to occur of an uncertain event. Such event
can broadly give rise to a gain or a loss.
Off balance sheet engagements are transactions entered into now that
will not give rise to immediate cash flow. Cash flow may however occur
in the future. E.g. Guarantees, Indemnities, Performance Bonds etc
The verification procedures for these items are:
 Obtain schedule of contingent liabilities and off balance sheet
engagements
 Request for basis of arriving at the values. Review
reasonableness of assumption/amounts stated as contingent
liabilities. Where it relates to cases in court, read legal opinion
obtained on the possible outcome of the cases and decide
whether to accept or adjust amount stated as contingent liability.

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  Review Board Minutes for discussions and decisions reached on
relevant issues
 Confirm from directors other cases of contingent liabilities (if
any) other than those listed.
 For off balance sheet engagements, trace to originating
documents and confirm proper initiation, authorization and
recording of the transactions. Also confirm that income due on
items like performance bonds have been booked to date.
 Check for completeness/possible omission of items that should
have been included.
 Generate revised schedule of Contingent Liabilities and Off
Balance Sheet Engagements

3.0 REVIEW QUESTIONS

Question 1
You are the auditor of Kakawa Breweries Ltd. During the interim audit, you
observed that although the company’s Goods Received Notes (GRN) are pre-
numbered, there is no control to ensure that all GRNs are accounted for.
What steps will you take at the final audit to ensure that liabilities are
correctly stated?
Question 2
Explain how you expect an Auditor to verify the following items appearing in
the financial statements.
(i) Dividend proposed:
- On Ordinary Shares ₦450,000
- On Preference Shares ₦250,000
(ii) Contingency Reserve
- ₦750,000
(iii) Tax Payable ₦380,000

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Question 3
(a) List the general procedures for verifying liabilities
(b) List some liabilities that may be omitted
(c) How can the Auditor determine if all the liabilities are included.
(d) Define Provisions and Reserves

Question 4
State the audit tests you would carry out and the manner in which each of
the items should appear in the Statement of Financial Position of a limited
liability company or on notes attached thereto.
(a) Bonus Issue or Shares 500,000
(b) Preference Shares 1,000,000
(c) Contingent Liabilities 120,000

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