Search for unrecorded liabilities is the audit testing procedures that auditors perform to verify if the liabilities are understated by completely not recording it. Such tests of the search for unrecorded liabilities is performed by auditors to give an appropriate response to assess the risk of understatement of liabilities.
In industrial environment, search of unrecorded assets like searching for debtors or accounts receivable as being unrecorded is very unlikely than as to search for unrecorded liabilities like accounts payable or notes payable.
The reason is that management of the company normally intend to understate the liabilities or expenses rather than the understat assets or revenues. Since these are the key financial figure that link their performance.
This would mean that liabilities have more risk of being unrecorded than the accounts of asset. Auditors shall perform audit procedures for search for unrecorded liabilities in order to test completeness aspects of all the liabilities of books of account. This also helps to determine if liabilities shall be excluded or included from the current accounting period.
Examples of Search for Unrecorded liabilities
Here, we discuss what audit procedures need to be followed to search for two liabilities i.e. accounts payable and notes payable as:
In case of accounts payable, audit procedure is performed to test completeness assertion through following steps:
- First, samples are selected of transactions that are made after closing of books of account
- The auditor then proceeds to examine the sample payments by making verification with document evidence and assess if the liabilities existed on the date of balance sheet.
- The auditor also inquires with appropriate personnel on any unrecorded invoices.
In audit using sample, the risk of material misstatement is directly proportional to the selection of sample size. Hence, the auditor needs to exercise his professional judgement and competence. If risk of material misstatement is assessed as high by the auditor, the sample size selection should be enlarged and the auditor shall try to reduce the risk to an acceptable level.
The audit procedures in case of notes payable is similar to that of accounts payable. As it happens, the notes payable has large sum involved and hence, the risk of material misstatement in case of notes payable increases massively.
Substantive audit procedures need to be performed in case of notes payable. The auditor needs to confirm the existence and year end balances by making direct confirmation from the third parties. Further, the auditors should analyze board meetings minutes for authorization of debts and check if any debts have been unrecorded as such.
Audit Procedures to search for unrecorded liabilities.
Auditor should verify the unrecorded liability by applying the given audit procedures:
- The auditor shall verify purchase orders and all supporting documents with journal entries related to purchases and cash disbursals. This helps the auditor to assess if purchases have been properly recorded and with the correct amount.
- Analytical procedures are done in order to test the trend and look for unusual relations. The various accounting ratios as accounts payable turnover is important in the search for unrecorded liabilities. All the unusual relations shall be properly investigated by the auditor. While auditing accounts payables and looking for unrecorded portions, the auditor would need to look at cash disbursals after the year-end and verify they have been properly recorded as payables at the end of the year.
- The auditor shall audit and test all the audit trails leading the payments to liabilities that have been recorded. This can be done for payables that exist on the year-end balance sheet date. The auditor can clearly state that if cheques that cannot be matched to recorded payables would amount to unrecorded liability at year-end.
- The auditor shall carefully examine all the cash disbursements using the Cash disbursements cutoff test. This would help to reconcile the cash disbursements and accounts payable. The auditor shall also inspect the cheques issued and trace them to ledgers of accounts payable. Doing so would help the auditor to detect items that have been purchased before the end of the year but not recorded i.e. unrecorded accounts payables.
- In case the company employs a voucher system, all the requisition, receipts, and suppliers’ invoices shall be reconciled with purchase orders. The auditors should therefore in such companies employing voucher system, vouch for samples of invoices related to cash disbursals after the end of the year and compare with all the receipt reports and suppliers’ invoices. This helps the auditors to search for unmatched documents.
- The audit can also make direct confirmation from the vendors regardless of the balance dues at the end of the year.