Question

During the audit of a manufacturing client, you are instructed to do vertical and horizontal financial statement analyses. In your analyses, you notice little increase in the client’s overall long-term liabilities. However, you remember that a note was extended to the client by a bank in the region, and you cannot find where the note is reflected on the financial statements. When you ask the controller about the loan, he claims that the debt has been forgiven by the regional bank, but upon claiming that creditors have forgiven existing debt is one way to understate liabilities. Describe several other ways a company might try to understate liabilities.

Answer 1

A company might try to understate liabilities by following ways:

1)The company my not show any show cause notices which have not matured into demands, as contingent liabilities. These may be material and important.

2)Not disclosing product and other liability claims, warranty liabilities, product returns/ discounts, liquidated damages for late deliveries etc and all litigation.

3)The company may have sold some subsidiaries/ businesses and may have agreed to takeover and indemnify all liabilities and contingent liabilities and contingent liabilities of the same prior to the date of transfer. These may not be reflected in the books of the company.

4)Not disclosing environmental problems/claims/third party claims.

5)Future lease liabilities not disclosed.