Question

Please explain in detail how to Search for unrecorded liabilities. Please provide example.

Answer 1

If the business does not maintain physical control of the unentered invoices, then extended audit procedures such as payables confirmations are probably warranted. 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 (IDEA or Excel software should be able to do this easily). Lastly, auditors should consider whether the client has an unentered invoice file that needs to be examined for possible under accruals. One certainly should not wait until near the end of the audit to make that decision.

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. 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 (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.

• Vouch for a sample of cash disbursements recorded just after year-end to receiving reports and vendor invoices. In a voucher system, a voucher is not prepared until the requisition, receiving a report, and the seller invoice is reconciled with the purchase order. Auditors search open files for unmatched documents.

• In searching for unrecorded payables, the auditor would look at disbursements made after year-end to see if they should have been, and were, properly recorded as payables at year-end.

• Tracing a sample of purchase orders and the related receiving reports to the purchases journal and the cash disbursements journal will enable the auditor to determine that the purchases were properly recorded.

• Analytical procedures. Accounts payable turnover is very important.  Unusual relations should be investigated.

• Cash disbursements cutoff test. Test if cash disbursement and accounts payable reduction are reconcilable. Inspect the last cheque written and trace it to the accounts payable subsidiary ledger. Reviewing subsequent cash disbursements enables the auditor to detect items purchased before year-end but not yet recorded, i.e., unrecorded accounts payable.

• Trace subsequent payments to recorded payables. Match cheques issued subsequent to year-end with the related payable. Cheque should be issued only for payables that existed on the balance sheet at year-end. Any cheque that cannot be matched may represent an unrecorded liability at year-end.

• If confirmations are used, small and zero balances should be sampled as well as large balances.
• For example, if orders are placed with a vendor on a consistent basis, a confirmation should be sent to the vendor regardless of the balance due at year-end.