Definition:
Search for unrecorded liabilities is the audit testing procedure that auditors perform to verify if there are liabilities that exist at the reporting date and are not recorded in the company’s financial statements. Auditors perform such tests of the search for unrecorded liabilities to give an appropriate response to assess the risk of understatement of liabilities.
In the industrial environment, searching for unrecorded assets like debtors or accounts receivable as being unrecorded is improbable to search for unrecorded liabilities like accounts payable or notes payable.
The reason is that the management of the company typically intends to understate the liabilities or expenses rather than the understated assets or revenues since these are the critical financial figures that link their performance.
This would mean that liabilities have more risk of being unrecorded than the accounts of assets. Auditors shall perform audit procedures to search for unrecorded liabilities to test the completeness aspects of all the liabilities of books of account.
It 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:
In the case of accounts payable, an audit procedure is performed to test completeness assertion through the following steps:
- First, samples are selected of transactions that are made after the closing of books of account.
- The auditor then proceeds to examine the sample payments by verifying with documentary evidence and assessing if the liabilities existed on the balance sheet date.
- The auditor also inquires with appropriate personnel on any unrecorded invoices.
In an audit using a sample, the risk of material misstatement is directly proportional to selecting the sample size. Hence, the auditor needs to exercise his professional judgment and competence.
Suppose the auditor assesses the risk of material misstatement as high. In that case, the sample size selection should be enlarged, and the auditor shall try to reduce the risk to an acceptable level.
The audit procedures in the case of notes payable are similar to that of accounts payable. As it happens, the notes payable have a 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 the case of notes payable. The auditor needs to confirm the existence and year-end balances by making direct confirmation from third parties.
Further, the auditors should analyze board meeting minutes for authorization of debts and check if any debts have been unrecorded as such.
Audit Procedures to search for unrecorded liabilities.
The 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 to test the trend and look for unusual relations. The various accounting ratios, and accounts payable turnover, are essential in searching for unrecorded liabilities. The auditor shall adequately investigate all the distinctive ties. 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 adequately recorded as payables at the end of the year.
- The auditor shall audit and test all the audit trails leading to the payments to liabilities that have been recorded. This can be done for payables on the year-end balance sheet date. The auditor can clearly state that cheques not 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 accounts payable ledgers. Doing so would allow the auditor to detect items purchased before the end of the year but not recorded, i.e., unrecorded accounts payables.
- If 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 a voucher system, vouch for samples of invoices related to cash disbursals after the end of the year and compare them with all the receipt reports and suppliers’ invoices. This helps the auditors to search for unmatched documents.
- The audit can also confirm directly from the vendors regardless of the balance dues at the end of the year.
