DIRE DAWA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING
Unit 6: Audit of Liabilities
Definition of Liabilities
According to Business Dictionary has defined the liability in two different view:
Finance: A claim against the assets, or legal obligation of a person or organization, arising out
of past or current transactions or actions. Liabilities require mandatory transfer of assets, or
provision of services, at specified dates or in determinable future.
Accounting: Accounts and wages payable, accrued rent and taxes, trade debt, and short and
long-term loans. Owners' equity is also termed a liability because it is an obligation of the
company to its owners. Liabilities are entered on the right-hand of the page in a double-entry
bookkeeping system.
Current Liabilities
• Current (or short-term) liabilities are liabilities that a company is required to settle
within the next twelve months or which it expects to settle within its normal operating
cycle.
• Liabilities are financial obligations which require transfer of assets (mainly cash) for
settlement. They are classified into current and non-current liabilities based on the
urgency of their settlement. Comparison of current liabilities with current assets helps
creditors, debt-holders and investors assess a company’s liquidity position.
• List of typical current liabilities: Accounts payable, Salaries payable, Short-term debt
payable, Short-term notes payable, Current lease liability, Interest payable, Current tax
payable, Accrued expenses and Dividends payable
Accounts payable, salaries payable, accrued expenses and current tax payable are classified as
current liabilities because they are expected to be paid off within a normal operating cycle.
These liabilities are reported as current even if the company expects them to be paid after 12
months.
Short-term debt payable, short-term notes payable and current lease liability represent that
portion of the relevant long-term liability which is due within next 12 months.
Interest payable is normally a current liability because it is due with 12 months.
Dividends payable is a current liability because corporate laws normally require them to be paid
within a certain period after declaration date.
What are the items reported as current liabilities?
1. Accounts Payable: These are the amounts that are due to vendors (all sales person) who have
supplied goods or services. The accounts payable are supported by the vendor invoices that have
been approved and processed, but have not yet been paid.
2. Deferred (delayed) Revenues: This reports the amounts that a customer has prepaid and will
be earned by the company within one year of the balance sheet date. An example is a retailer's
unredeemed (get back by paying) gift cards.
3. Accrued compensation: Included in this are payroll related items such as the amounts due to
employees and the amounts to be remitted for payroll taxes.
4. Other Accrued Expenses or liabilities: This reports the amounts that the company owes (be in
debt) for items not recorded in accounts payable or accrued compensation. Examples include the
interest expense that the company has incurred (but has not yet paid) and repairs that took place
but the vendor's invoice has not been fully processed.
5. Accrued income taxes and perhaps some deferred income taxes.
6. Short-term notes: These include the loans from banks that will become due within one year of
the balance sheet date.
7. The current portion of long-term debt: The principal payments of a mortgage (credit /
finance) loan or an equipment loan that must be paid within one year of the date of the balance
sheet are reported in this item.
To be reported as a current liability the item must be due within one year of the balance
sheet date. However, there is no requirement that the current liabilities be presented in the order
in which they will be paid. Hence, the current portion of long-term debt might be listed last, but
the principal payment might be due within several days of the balance sheet date.
Definition of Accounts Payable
When a company purchases goods on credit which needs to be paid back in a short period of
time, it is known as Accounts Payable. It is treated as a liability and comes under the head
'current liabilities'. Accounts Payable is a short-term debt payment which needs to be paid to
avoid default.
For example, we consume electricity, telephone, broadband and cable TV network. The bills get
generated towards the end of the month or a particular billing period. It means that the service
provider gave you some service and sends the bill which needs to be paid by a certain date or
else you will default. This becomes Accounts Payable.
For example (company's point of view) Company “A” purchases goods from company “B” on
credit. The amount raised needs to be paid back in 30 days. 
Company “B” will record the same sale as accounts receivable and company “A” will record
the purchase as accounts payable. This is because company “A” has to pay company
“B”. Under the accounting (Accrual) methodology, this will be treated as a sale even though
money has not exchanged hands yet. The accounts department needs to be extremely careful
while processing transactions relating to Accounts Payable. 
Here, time is the essence considering it is a short term debt which needs to be paid within a
specific period of time. Along with that accuracy is the key, which involves the amount that needs
to be paid along with the name of the supplier. Accuracy is important because it will impact the
company's cash position.
Accounts Payable Control:
Accounts payable controls are used to mitigate (alleviate/ease) the risk of losses in the payables
function. Payables controls are aggregated into three general categories, which are verifying the
obligation of the business to pay, entering the payables data into the computer system and
paying suppliers.
1. Obligation to pay control:
The verification of obligation to pay can be accomplished through one of several possible
controls. They are:
a. Invoice approval: The person in a position to authorize payment signifies his or her approval
of a supplier invoice. However, this is actually a relatively weak control if the approver only sees
the supplier invoice, since there is no way to tell if the goods or services were received. The
approver may also want to know which general ledger account will be charged. Consequently, it
is better to have the payables staff first assemble the supplier invoice, authorizing purchase
order, and receiving documentation into a packet, and then stamp the invoice with a signature
block that includes the account number to be charged, and then have the approver review it. This
approach gives reviewers a very complete set of information to work with.
b. Purchase order approval: The purchasing department issues a purchase order for every
purchase made. By doing so, the purchasing staff is, in essence, approving all expenditures
before they have been made, which may prevent some expenditures from ever occurring. Since
this control entails a considerable amount of work by the purchasing staff, they will likely ask
employees to request items on a formal purchase requisition form.
c. Complete a three-way match: The payables staff matches the supplier invoice to the related
purchase order and proof of receipt before authorizing payment. This approach supersedes the
need for individual invoice approval, since approval is based on the purchase order instead. It is
also better than approving only based on the purchase order, since it also verifies receipt of the
goods. However, it is also painfully slow and can break down if there is missing paperwork.
d.Manual duplicate payment search: A computerized payables system conducts an automatic
search for duplicate invoice numbers. This is a much more difficult endeavor in an entirely
manual accounting system. In this case, the payables clerk can search through the vendor file
and unpaid invoices file to see if an invoice just received from a supplier has already been paid.
2. Data Entry Control:
a. Record after approval: This control forces the accounts payable staff to verify the approval of
every invoice before entering it into the system.
b. Record prior to approval: This control places greater priority on paying suppliers than it does
on obtaining authorizations to pay, since every invoice received is recorded in the payables
system at once. This control works best where purchase orders have already been used to
authorize a purchase.
c. Adopt an invoice numbering guideline: Perhaps the largest problem in the area of payables
data entry is duplicate payments. This would not appear to be a problem, since most companies
use accounting software that automatically detects duplicate invoices and prevents duplicate
payments. However, there can be inconsistency (contradictory) in how invoice numbers are
recorded.
d. Match to budget in financial statements. If a supplier invoice was incorrectly charged to the
wrong department, it is possible that a department manager perusing the financial statements
would detect a disparity between the amount charged and the budget, and so would bring the
issue to the attention of the accounting department.
3. Payment Control:
a. Split cheque printing and signing: One person should prepare cheque, and a different person
should sign them. By doing so, there is a cross-check on the issuance of cash.
b. Store all cheques in a locked location: Unused cheque stock should always be stored in a
locked location. Otherwise, cheques can be stolen and fraudulently filled out and cashed. This
means that any signature plates or stamps should also be stored in a locked location.
c. Track the sequence of cheque numbers used. Maintain a log in which are listed the range of
cheque numbers used during a cheque run. This is useful for determining if any cheques in
storage might be missing. This log should not be kept with the stored cheques, since someone
could steal (theft/robbery) the log at the same time they steal cheques.
d. Require manual cheque signing: A company can require that all cheques be signed. This is
actually a relatively weak control, since few cheque signers investigate into why cheques are
being issued, and rarely question the amounts paid. If a company chooses to use a signature
plate or stamp instead, then it is much more important to have a strong purchase order system.
e. Require an additional check signer: If the amount of a cheque exceeds a certain amount,
require a second cheque signer. This control supposedly gives multiple senior-level people the
chance to stop making a payment. In reality, it is more likely to only introduce another step into
the payment process without really strengthening the control environment.
Audit Program for Liabilities - CAVEBOP
1. Completeness

 Check balances extracted from purchase ledger balances to list of creditors: check a
sample of balances from purchase ledger to schedule/list of creditors.
 Last year brought forward is correct: check whether last year’s closing balances have
been properly brought forward.
 Last year significant suppliers that are not in current year list: investigate any supplier
names that were shown on last year’s payables listing but do not have a balance showing
in this year’s list of balances.
 Cut off before and after year end: select a sample of goods received note just before and
after the year end, trace to invoices and purchases ledger.
 Post balance sheet payments and invoices accounted: review after date invoices and
payments and ensure they have been provided for at the yearend as appropriate.
2. Accuracy
 • Check balances extracted from purchase ledger balances to list of creditors: Check a
sample of balances from the schedule to the purchase ledger.
• Tally creditors list to creditors control account: Check the total of the list to the
purchases control account.
• Vouch a sample of recorded creditor’s transactions to supporting documents: To agree
the amount.
• Perform cut off tests both before and after the year end: To ensure posting made in the
correct period.
• Reconcile creditors with monthly supplier’s statements.
• Perform analytical procedures
3. Valuation

 Confirm with creditors through circularization: where balances are material, no

suppliers statement and internal control systems weakness.
 Ensure adequacy of provision for accrual: invoices not yet received.
 Letter of representation from management confirming all trade payables: have been
included in financial statement.
 Ageing list of creditors.
 Checks if there are set off: between receivable ledger and payable ledger.
 Perform analytical procedures: on payables, comparing age analysis with previous
periods and payables days.
4. Existence

 Carry out creditor’s circularization: where balances are material, no supplier’s

statement and internal control weakness.
 Vouch a sample of recorded creditor’s transaction to supporting documents. ( invoices,
goods received etc)
 Check whether last year closing balance has been brought forward: e.g this year’s
opening balance exist in balance sheet.
 Review payments to suppliers just after year end.
5. Beneficial ownership
 Confirm with creditors- circularization.
 Vouch to supporting documentation.
6. Occurrence

 Select a sample of transactions from purchase ledger, trace to invoices, GRN, PO and
ensure the goods/services have been received
7. Presentation and disclosure
 Compliance with accounting standards and companies act.
 Creditors are properly classified as to type and expected date of realization.
 Debit balances disclosed under current assets.
 Related party transaction properly disclosed.