How do you undertake the verification of following Liabilities. (3×5) a. Preference Share capital b. Loans c. Trade creditors d. Contingent liabilities e. Outstanding liabilities

Verification of Liabilities in Advanced Auditing

Liabilities represent obligations of a business that require future economic sacrifices. Auditors must verify these liabilities to ensure their existence, accuracy, and completeness in the financial statements. Below is a detailed explanation of how to verify different types of liabilities as per Tribhuvan University’s syllabus.

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a. Verification of Preference Share Capital

Objective

To ensure that preference share capital is properly authorized, issued, and recorded in the books of accounts.

Verification Procedures

1. Examine the Company’s Memorandum and Articles of Association (MOA & AOA)

   • Verify the authorized capital, types of shares (ordinary, preference), and their rights (dividend rate, repayment priority, voting rights).
   • Check if the issue of preference shares complies with legal requirements (e.g., Companies Act, 2063).

2. Check the Board Resolution and Share Issue Records

   • Obtain and verify the board resolution authorizing the issue of preference shares.
   • Examine the share application, allotment, and call records to ensure proper documentation.

3. Verify the Share Certificate

   • Obtain and inspect share certificates issued to preference shareholders.
   • Ensure that the names, share numbers, and amounts match the company’s records.

4. Check the Share Ledger and Share Register

   • Verify the share ledger to confirm the number of shares issued and their details.
   • Cross-check with the share register to ensure consistency.

5. Examine Dividend and Redemption Records

   • For cumulative preference shares, verify that dividends are paid before ordinary dividends.
   • For redeemable preference shares, ensure compliance with legal requirements (e.g., redemption within a specified period).
   • Check if any preference shares are unpaid and follow up for collection.

6. Confirm with Shareholders (if necessary)

   • In cases of doubt, send confirmation letters to preference shareholders to verify their holdings.

7. Check for Underwriting and Over-Subscription

   • If shares were underwritten, verify the underwriting agreement and ensure proper accounting.
   • If oversubscribed, check if excess applications were refunded or allotted proportionately.

8. Review the General Ledger and Trial Balance

   • Ensure that preference share capital is correctly recorded in the Share Capital Account and Share Premium Account (if applicable).
   • Verify that the total preference share capital matches the balance sheet.

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b. Verification of Loans

Objective

To ensure that loans (both short-term and long-term) are genuine, properly authorized, and correctly disclosed in the financial statements.

Verification Procedures

1. Short-Term Loans (Bank Overdrafts, Trade Creditors, Short-Term Borrowings)

1. Obtain Loan Agreements and Sanction Letters

   • Verify the terms of the loan (interest rate, repayment schedule, collateral, if any).
   • Check if the loan was approved by the board or authorized signatories.

2. Confirm with Lenders (Positive Confirmation)

   • Send confirmation letters to banks and financial institutions to verify the outstanding loan balance.
   • For trade creditors, send debtor confirmation letters to verify trade payables.

3. Examine Bank Statements and Passbooks

   • Obtain and reconcile bank statements with the company’s cash books.
   • Verify that all loan transactions (drawals, repayments, interest payments) are properly recorded.

4. Check for Unrecorded Liabilities

   • Review bank reconciliations to identify any unrecorded loans or overdrafts.
   • Examine unpresented cheques and uncleared deposits to ensure no liabilities are omitted.

5. Verify Interest and Repayment Terms

   • Ensure that interest is calculated and recorded correctly.
   • Check if any loans are in default and whether proper disclosures are made.

2. Long-Term Loans (Term Loans, Debentures, Bonds)

1. Examine Loan Agreements and Trust Deeds

   • Verify the terms of long-term loans (interest rate, repayment schedule, covenants, security).
   • Check for any restrictive covenants (e.g., debt-to-equity ratio, dividend restrictions).

2. Confirm with Lenders (Debenture Holders, Banks, Financial Institutions)

   • Send confirmation letters to lenders to verify the outstanding loan balance.
   • For debentures, verify with debenture trustees or holders.

3. Check for Proper Authorization

   • Ensure that long-term loans were approved by the board of directors and shareholders (if required by law).
   • Verify compliance with the Companies Act regarding maximum borrowing limits.

4. Review Interest and Amortization Schedules

   • Ensure that interest is accrued and paid correctly.
   • For amortizing loans, verify that principal repayments are recorded properly.
   • Check if any loans are convertible into equity and whether proper accounting is done.

5. Examine Collateral and Security Documents

   • Verify that fixed assets or other securities pledged as collateral are properly recorded.
   • Ensure that the market value of collateral is sufficient to cover the loan.

6. Check for Discounting of Bills and Loans

   • If loans were raised by discounting bills, verify the discounting agreement and ensure proper accounting.

7. Review Disclosure in Financial Statements

   • Ensure that all long-term loans are classified correctly (current vs. non-current).
   • Check if related party loans are disclosed separately.

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c. Verification of Trade Creditors

Objective

To ensure that trade creditors (accounts payable) are complete, accurate, and properly authorized.

Verification Procedures

1. Obtain and Examine Purchase Invoices and Vouchers

   • Verify that all purchase invoices are properly authorized and recorded.
   • Check for duplicate payments or unrecorded liabilities.

2. Send Creditor Confirmation Letters (Negative or Positive Confirmation)

   • Send creditor confirmation letters to suppliers to verify the outstanding balance.
   • If responses are not received, perform alternative procedures (e.g., examining subsequent payments).

3. Reconcile Purchase Ledger with General Ledger

   • Ensure that the total of the purchase ledger matches the trade creditors control account in the general ledger.
   • Check for unreconciled differences and investigate discrepancies.

4. Examine Goods Received Notes (GRN) and Purchase Orders

   • Verify that goods were actually received before recording liabilities.
   • Check for unrecorded liabilities where goods were received but invoices are pending.

5. Check for Discounts and Early Settlement

   • Ensure that trade discounts and cash discounts are correctly applied.
   • Verify that early settlement discounts are properly recorded.

6. Review Cut-off Procedures

   • Ensure that liabilities for goods received before year-end but invoiced later are recorded.
   • Check for goods returned and ensure that credit notes are properly processed.

7. Examine Bank Reconciliation Statements

   • Verify that payments made before year-end but recorded later are correctly adjusted.
   • Check for uncleared cheques that may affect trade creditors.

8. Check for Related Party Transactions

   • Ensure that transactions with related parties are disclosed separately.
   • Verify that favourable terms (e.g., extended credit periods) are not given to related parties without proper authorization.

9. Review Aging of Trade Creditors

   • Prepare an aging schedule of trade creditors to identify overdue payments.
   • Check if any creditors are doubtful and whether provisions are made.

10. Examine Post-Balance Sheet Transactions

    • Check for payments made after year-end that should have been recorded as liabilities.
    • Verify if any new creditors arose after the balance sheet date.

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d. Verification of Contingent Liabilities

Objective

To ensure that contingent liabilities (potential obligations) are properly disclosed in the financial statements as required by IAS 37 (Provisions, Contingent Liabilities, and Contingent Assets).

Verification Procedures

1. Understand the Nature of Contingent Liabilities

   • Contingent liabilities arise from uncertain future events (e.g., pending litigation, guarantees, warranties).
   • They are not recognized in the balance sheet but disclosed in the notes if probable.

2. Review Legal Documents and Contracts

   • Examine contracts, guarantees, and legal agreements to identify potential contingent liabilities.
   • Check for warranties, product recalls, or environmental liabilities.

3. Consult with Management

   • Discuss with management about pending litigations, claims, or guarantees.
   • Ask about unasserted claims (where a claim exists but has not been formally made).

4. Obtain Legal Opinions (if necessary)

   • If there are complex legal issues, obtain a legal opinion to assess the probability of liability.
   • Example: Tax disputes, employment claims, or environmental fines.

5. Check for Guarantees Given

   • Verify guarantees given to banks or third parties (e.g., performance guarantees, loan guarantees).
   • Ensure that contingent liabilities arising from guarantees are disclosed.

6. Review Warranty and Product Liability Records

   • Check warranty claims and estimate potential liabilities.
   • Ensure that provisions are made if the liability is probable and measurable.

7. Examine Pending Litigations

   • Obtain a list of pending litigations from management.
   • Assess whether the outcome is probable, possible, or remote.
   • If probable, ensure proper disclosure; if remote, no disclosure is needed.

8. Check for Government Grants and Subsidies

   • If the company has received government grants, verify if any repayment obligations exist.
   • Ensure that contingent liabilities arising from such grants are disclosed.

9. Review Insurance Policies

   • Check if insurance covers potential liabilities (e.g., property damage, legal claims).
   • If not fully covered, assess the uninsured portion as a contingent liability.

10. Ensure Proper Disclosure in Financial Statements

    • Contingent liabilities should be classified as:
      • Probable and measurable → Disclosed in the balance sheet (as a provision).
      • Possible but not probable → Disclosed in the notes.
      • Remote → No disclosure required.
    • Example disclosure:

      "The company has given a guarantee to a bank for a loan amounting to Rs. 50 million. This is disclosed as a contingent liability in the notes."

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e. Verification of Outstanding Liabilities

Objective

To ensure that all outstanding liabilities (accrued expenses, unpaid bills, employee benefits) are complete, accurate, and properly recorded.

Verification Procedures

1. Examine Accrued Expenses

   • Verify unpaid salaries, wages, rent, interest, and taxes.
   • Check payroll records to confirm outstanding salaries.
   • Review rent agreements to ensure rent accruals are correct.

2. Check for Unpaid Invoices and Bills

   • Obtain a list of unpaid invoices from the accounts payable department.
   • Verify that all invoices are properly authorized and recorded.
   • Ensure that no invoices are omitted due to errors or fraud.

3. Review Employee Benefits (Provident Fund, Gratuity, Bonus)

   • Verify provident fund contributions and ensure they are accrued.
   • Check gratuity calculations and ensure proper provisioning.
   • Confirm bonus liabilities based on company policy.

4. Examine Tax and Statutory Deductions

   • Verify income tax, VAT, and other statutory deductions.
   • Ensure that TDS (Tax Deducted at Source) is correctly recorded.
   • Check for unpaid VAT returns and penalties.

5. Check for Dividends Declared but Unpaid

   • Verify dividends declared but not yet paid to shareholders.
   • Ensure that dividend liabilities are recorded in the books.

6. Review Bank Reconciliation and Uncleared Cheques

   • Check for cheques issued but not yet cleared (outstanding liabilities).
   • Ensure that unpresented cheques are properly accounted for.

7. Examine Prepaid Expenses (if any)

   • Some prepaid expenses may have unexpired portions that should be treated as liabilities.
   • Example: Prepaid insurance where a portion remains unexpired.

8. Check for Commitments and Contingencies

   • Verify future commitments (e.g., lease obligations, capital expenditure commitments).
   • Ensure that contingent liabilities are properly disclosed.

9. Perform Cut-off Testing

   • Ensure that expenses incurred before year-end but paid later are recorded as liabilities.
   • Check for expenses paid in advance that should be adjusted.

10. Review Management Representation Letter

    • Obtain a management representation letter confirming that all liabilities are recorded.
    • Ask management to confirm completeness of outstanding liabilities.

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Final Notes on Verification of Liabilities

• Internal Controls: Assess whether the company has strong internal controls over liability recording.
• Analytical Procedures: Compare liability trends with previous years to detect anomalies.
• Substantive Procedures: Use confirmation, vouching, and analytical review to verify liabilities.
• Fraud Considerations: Be alert for understatement of liabilities (common in fraud cases).

By following these procedures, auditors can ensure the completeness, accuracy, and proper disclosure of liabilities in the financial statements, complying with Nepali accounting standards (NAS) and international auditing standards (ISA).