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Verification and Valuation of Liabilities – Part 2

Key Takeaways:

  • Understand how auditors verify and value different types of liabilities on the balance sheet.
  • Learn practical approaches and principles for contingent liabilities and outstanding expenses.
Verification and Valuation of Liabilities – Part 2
Verification and Valuation of Liabilities – Part 2
(Auditing)

Source: Pixabay

Liabilities shape the financial reality of every business. In auditing, verifying and valuing liabilities demands precision and skepticism where liabilities can be understated, overstated, or misclassified, impacting stakeholders’ decisions.

Verification of Liabilities

a. Capital

Capital represents the owners’ stake in the business. When verifying capital, auditors examine the entries in the capital account, review supporting documentation (such as the partnership deed or articles of association), and reconcile balances with statutory records.

  • Check board or partner resolutions authorizing capital changes.
  • Review supporting documents for capital introduced or withdrawn.
  • Ensure compliance with legal provisions (Companies Act, Partnership Act).

b. Loans

Loans may be secured or unsecured. Auditors verify loan balances by:

  • Examining loan agreements and ensuring terms are followed.
  • Confirming balances directly with lenders (bank confirmations).
  • Checking if interest and repayments are correctly recorded.
  • Ensuring adequate disclosure of secured loans, including nature of security.

c. Creditors

Creditors are amounts owed for goods or services received. Verification steps include:

  • Obtaining a schedule of creditors and matching it with ledger accounts.
  • Sending direct confirmations to a sample of creditors.
  • Reviewing post-balance sheet payments—have creditors been paid after year-end?
  • Checking for any long-outstanding creditors requiring special attention (possible write-offs or disputes).

d. Provisions

Provisions are recognized for known liabilities, but with uncertain timing or amount. Auditors must:

  • Review calculation basis for provisions (such as provision for doubtful debts).
  • Ensure adequacy and appropriateness of provisions through management explanations and documentation.
  • Check compliance with accounting standards (AS 29 – Provisions, Contingent Liabilities and Contingent Assets).

Valuation Principles for Contingent Liabilities

Contingent Liabilities

Contingent liabilities are possible obligations, dependent on future events. For auditors, the challenge is to ensure proper disclosure and assess the likelihood of the liability materializing. Consider examples like pending lawsuits, guarantees, or disputed claims.

  • Review management representations and legal opinions.
  • Evaluate the probability of outflow—remote, possible, or probable.
  • Check that only probable outflows are provided for; possible but not probable are disclosed in notes.
Type of Liability Verification Method Valuation Principle
Capital Document review, statutory records Actual balances, legal compliance
Loans Agreement review, bank confirmation Outstanding principal plus accrued interest
Creditors Ledger reconciliation, confirmations Outstanding amounts payable
Provisions Calculation review, adequacy assessment Estimate based on best available information
Contingent Liabilities Legal review, management representations Disclosure unless outflow is probable

Practical Illustrations with Balance Sheet Extract

An auditor looks for patterns, consistency, and justification. Every liability tells a story.
Are you reading it closely?

Liabilities Amount (Rs.) Verification Steps
Capital 20,00,000 Check partnership deed; confirm with partners
Secured Loans 10,00,000 Bank confirmation; review security documents
Unsecured Loans 2,00,000 Scrutinize loan agreements
Sundry Creditors 5,00,000 Review supplier statements; confirmations
Outstanding Expenses 1,00,000 Cross-check with expense ledgers, accruals
Provision for Tax 1,50,000 Review tax computation, prior assessments
Contingent Liabilities (guarantee) Not Quantified Ensure disclosure in notes

How to Verify Outstanding Expenses?

Outstanding Expenses Verification

Outstanding expenses are accruals for services received but not yet paid. Auditors should:

  • Review expense ledgers for items unpaid at balance sheet date.
  • Verify supporting documentation—bills, contracts, and agreements.
  • Ensure correct calculation based on services received up to year-end.
  • Check for double-counting or omission by reconciling with prior year and post-year payments.
  • Discuss with management the basis for estimation, especially for recurring expenses (salaries, rent, utilities).

Consider this:
What if the outstanding rent is understated?
Financial statements would overstate profit and understate liabilities, misleading users.
This is why direct, methodical verification matters as accuracy builds trust.

Every liability, whether capital, loans, creditors, provisions, or contingent, requires careful scrutiny. Remember, auditors must combine technical skill with persistent inquiry. Always ask: Does this liability truly exist, is it valued fairly, and is it disclosed properly? That’s the heart of trustworthy auditing.



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