BCom 3rd Year Verification of Liabilities Notes Study Material

BCom 3rd Year Verification of Liabilities Notes Study Material

Bcom 3rd Year Verification of Liabilities Notes Study Material: We provide to all the students BCom 1st, 2nd, and 3rd Year notes Study material, question answers, sample papers, mock test papers, and pdf. At gurujistudy.com you can easily get all these study materials and notes for free. Here in this post, we are happy to provide you with BCom 3rd Year Verification of Liabilities Notes Study Material.

BCom 3rd Year Verification of Liabilities Notes Study Material
BCom 3rd Year Verification of Liabilities Notes Study Material

BCom 3rd Year Verification of Liabilities Notes Study Material

Verification of liabilities is equally important as the verification of assets. If liabilities are not properly verified and valued, the Balance Sheet will not reveal a true and fair view of the state of affairs of a business concern. Hence, it should be seen that the liabilities are true and duly authorized. It is necessary, therefore, for the auditor to examine that:

(1) all the liabilities have been clearly stated on the liabilities side of the Balance Sheet;

(2) all these liabilities relate to the business itself;

(3) they are all correct and authorized: and

(4) they are shown in the Balance Sheet as their actual figures.

It is to be realized that the liabilities are not valued like the assets. It is of special significance to show them in their proper figures.

The auditor should verify all the liabilities that are correct. He should obtain a certificate from some responsible officials of the business to the effect that all the liabilities for purchases or for expenses have been recorded in the books of accounts and all doubtful debts have either been provided for or have been shown by way of a footnote in the Balance Sheet.

In the case of Westminster Road Construction & Engineering Co. Ltd. (1932), it was held that the auditor is liable for the omission of liabilities from the Balance Sheet if such could be detected by the application of reasonable care and skill. The acceptance of a certificate without question in such a case is amounting to negligence.

Normally, the auditor should keep in mind the following important points while verifying the liabilities:

(a) Liabilities for Trade Creditors

(1) He should vouch for the Purchases Book and Purchases Returns Book with the help of invoices, credit notes, etc., and check the postings in the Ledger.

(2) He should obtain a schedule of creditors from the client and check it with reference to the balance of Ledger Accounts and Statement of Accounts received from the creditors.

(3) He should inspect the Goods Inward Book to ensure that the goods purchased have actually been received.

(4) He should check the outstanding bills payable in the Bills Payable Book at the date of the Balance Sheet.

(5) He should check the purchase invoices pertaining to a few weeks at the close of the financial period.

(6) The correctness of liabilities depends upon the correctness of purchases. Hence, he should compare the percentage of gross profit to purchases with that of the previous year to verify the correctness of purchases.

(b) Liabilities in respect of Loans

(1) The auditor should verify the existence of loans if any. He should examine the correspondence, contracts, and Directors’ Minute Book if the business is a company.

(2) It should be seen that the interest due on loans has been either paid to date or recorded as unpaid in the Books of Accounts.

(c) Liabilities of Expenses

(1) The auditor should see that all the outstanding expenses have been provided for. He should check receipts and other vouchers to ensure that the provision has been duly made. (BCom 3rd Year Verification of Liabilities Notes Study Material)

(2) He should check the entries, sales, and demand notes pertaining to a few weeks of the next financial year and ensure that they do not relate to the period under audit. (BCom 3rd Year Verification of Liabilities Notes Study Material)

(3) The expenses shown as unpaid during the current year should be compared with those of the last year and differences, if any, should be enquired into.

(4) He should obtain a certificate for outstanding expenses duly signed by some responsible official.

Capital

Capital is not the liability of a company but still, the auditor is required to verify it so that he can report the genuineness and correctness of the Balance Sheet. The duties of the auditor can be the following:

(a) If it is the First Year of the Existence of a Company:

(1) He should examine the Memorandum of Association and the Articles of Association.

(2) He should check the Cash Book, Pass Book, and Directors’ Minute Book to find out the number of shares, the various classes of shares, the amount received thereon, and the amount due from the shareholders.

(3) If some shares have been allotted to vendors, he should examine the contract between the vendors and the company.

(b) If it is not the First Year of a Company:

(1) The share capital would be the same as in the previous year unless there is some alteration or addition by fresh issue or otherwise.

(2) Similarly, for the reduction of share capital, he should see the provisions of the Act (Sec. 66).

(c) To Verify Capital in a Partnership Firm:

(1) The auditor should see the Partnership Deed; and

(2) He should also check the Cash Book and the Pass Book.

Reserves and Funds

It would not be out of place here to state that the auditor should examine the Profit & Loss Appropriation Account to verify reserves and funds. The volume and the propriety of reserves and funds created would, however, depend upon the circumstances of a business, and the nature and discretion of those who direct and manage it. It is to be remembered that such reserves and funds are appropriations out of profits and are determined under the decisions of the Directors of a company.

Creditors

The auditor should obtain a schedule of creditors from the client, and check the Purchases Ledger with its help. If necessary, he may check the Purchases Ledger with entries in the Purchases Book and also examine invoices, credit notes, Goods Inward Book, Goods Outward Book, Bills Payable Book, and Cash Book. (BCom 3rd Year Verification of Liabilities Notes Study Material)

He should ensure that goods purchased during the year have been entered into the books of accounts. He may call for the Statements of Accounts from the creditors and compare these with the schedule that he has received.

Debentures

The auditor should note the following points while verifying debentures:

(1) By examining the Memorandum of Association and the Articles of Association, he should acquire the knowledge of the powers of the company. Debentures should not be issued beyond these powers to borrow money.

(2) He should examine the Debenture Trust Deed and, with its help, the Debentures Account in the Ledger.

(3) If necessary, he can obtain a certificate from the Debenture holders.

(4) He should also see the arrangement made for the redemption of debentures. If a Debenture Redemption Fund has been created for the purpose, he should examine the Article of Association.

(5) If Debentures have been issued at a discount or at a premium, he should check the entries made in the books of accounts.

(6) He should also see the details as given in the Register of Mortgages and charges.

Bills Payable

A schedule of bills payable should be obtained and its totals should be compared with the Bills Payable Book and Bills Payable Account. The bills paid should be vouched with the entries passed in the Cash Book. He should especially see that bills paid during the date of the Balance Sheet and the date of his audit have been duly written in the books.

Amount Received in Advance

Sometimes, some money is received in advance for work not completed by the closing day. Hence, it is shown on the liability side of the Balance Sheet.

To verify it, the auditor should obtain a certified schedule thereof. It should be ensured that such an amount received in advance is not omitted from recording in the Balance Sheet. (BCom 3rd Year Verification of Liabilities Notes Study Material)

Forfeited Shares

The Auditor should examine the Articles of Association of the Company, the Directors’ Minute Book, and the relevant accounts kept in the financial books.

Employees Deposits

Normally, in commercial and industrial ventures, the employees who deal with cash or stores are required to deposit cash security as a safeguard against some possible misappropriation or pilferage. Sometimes, the employees in place of paying cash endorse trustee Securities in favor of the employers. It should be remembered in this connection that:

(1) Such security in cash or in Securities should be deposited separately in the bank.

(2) It should be shown distinctly on the liabilities side of the Balance Sheet.

(3) He should verify the amount of deposits by reference to the certified schedule received from the client.

Reserves for Bad and Doubtful Debts

The verification should be done as follows:

(1) The auditor should obtain a certificate from some responsible officers of the business and then check the amount received from bad and doubtful debts.

(2) The schedules of debtors should be compared with the balances of the ledger to account for the certain possible amount of bad and doubtful debts.

(3) The adequacy of such a reserve has specially to be checked. He should examine the nature, the circumstances of a particular business, and the necessary rules in practice in this connection. (BCom 3rd Year Verification of Liabilities Notes Study Material)

Taxation Liability

Taxation is an important liability these days and, hence, full provision should be made in the accounts in this regard. The auditor should see that the provision made therefore is sufficient to meet the estimated liability. Usually, auditors are required to advise on the adequacy of the liability, and in such a case, they work as a tax consultants. If this is the case, there is no difficulty in making the assessments.

Loans and Advances

The loans and advances may be for short and long periods. They may be of three types:

(1) Unsecured Loans and Advances. The duty of an auditor would be:

(i) to examine the correspondence and relevant documents, if any;

(ii) to study the conditions for interest payable, repayment of the loan, refund by installments, etc.:

(iii) to ensure that the loans are taken for use in the business; and

(iv) to get confirmation from the lenders concerned certifying the balances of principal and interest outstanding at the date of the Balance Sheet.

(2) Secured Loans and Advances. To verify the secured loans and advances, two important things should be noted:

(i) Actual amount which has been advanced, and

(ii) Security for the loan.

So far as the actual amount of loan or advance is concerned, if such an amount has been granted during the period under audit, it should be examined that this amount has been properly authorized and sanctioned by Directors in the case of a company and by Partners in case of a partnership firm. The auditor should examine the applications received and check the receipts which have been given in token of having received the loans. For the return of a part of the loan and interest thereon, it should be verified that the payment has been received from the borrower himself. (BCom 3rd Year Verification of Liabilities Notes Study Material)

The securities for loans can be of the following types:

(i) Investments, i.e., stock and shares;

(ii) Mortgage on Property;

(iii) Insurance Policies;

(iv) Guarantees by Third Parties; and

(v) Security of Goods.

(i) Investments i.e. stock and shares. Ordinarily, bearer Securities are said to be the best form of securities. The auditor should examine them and their valuation should be checked. Registered Securities can be deposited with the lender for loans. It would be in the interest of the lender if securities are transferred in his name.

(ii) Mortgage on Property. A mortgage on property can be used by depositing the Deed with the lender. The auditor in such cases should inspect the Title Deeds. If the mortgage has been exercised through conveyance in the name of the lender, the Mortgage Deed show be inspected. If there is a second charge of the mortgage on the property, a mention of these should be made in the Mortgage Deed. The auditor should also examine the certificate of the valuer for its valuation.

(iii) Insurance Policies. The auditor should inspect the insurance policies. It should be ensured that the interests of the lender have been duly recognized by the insurance company. It should be seen that loans are granted within the amount of the surrender value of the policy and the auditor should examine the certificate issued by the insurance company in this connection.

(iv) Guarantee by Third Parties. The value of a security depends upon the status of the guarantor. The auditor should ascertain whether his position continues to be as such throughout the term for which the loan is granted. Such a guarantee must be conveyed in mind and there should be nothing in it which might go against the interests of the lender.

The following points should especially be noted:

(i) Examine the Mortgage Deed to know the nature of the mortgage or the charge whether fixed or floating:

(ii) to see that the right of selling a property mortgaged has been exercised with the due approval of the mortgagee;

(iii) If it is sold, to ensure that there is nothing beyond the conditions laid down; and

(iv) to examine the Register of Mortgages and Charges if the borrower is a company.(BCom Verification of Liabilities Notes Study Material)

(v) Security of Goods. The loan may be advanced against the security of goods. Such goods may be kept in the godown with a godown keeper. The auditor should examine the godown keeper’s receipt. If the goods are at docks or in a bonded warehouse, the dock warrant or the warehouse receipt should be examined. In the absence of the dock warrant or the warehouse receipt (if not issued), he should examine the delivery note issued in favor of the client. He should ensure that the warehouse rent has been paid by the borrower. If not, the amount has to be added to the loan. (BCom 3rd Year Verification of Liabilities Notes Study Material)

The auditor should examine the Railway Receipt of the bills of Lading along with the Letter of Hypothecation, Invoices, and Insurance Policy as the case may be, which have been endorsed in the name of the client.

The value of the security may vary according to the market conditions. For this, he should examine the market quotations. To verify the number of goods, the Inspector’s Report should be inspected. He should see that the goods are not of perishable nature.

(3) Loans to Employees. Applications for loans are received by employers from their employees. Such applications are granted on some specific terms and conditions and they are considered to be an agreement in the absence of a separate loan agreement. Such agreements contain terms and conditions for repayment of loans and the interest payable thereon. Normally. such loans to employees are granted against the provident fund accounts as securities. (BCom 3rd Year Verification of Liabilities Notes Study Material)

Auditor’s Duty

(1) The auditor should examine the terms and conditions of the loan given in the loan agreements.

(2) He should see the conditions in respect of the repayment of loans and the interest payable. Such an interest may be payable at a low rate or there may be no interest at all. (BCom 3rd Year Verification of Liabilities Notes Study Material)

(3) He should ensure that installments of loans are being deducted out of the employee’s salary regularly in all cases.

(4) He should arrange to get confirmation from the employees in regard to their indebtedness at the end of each year.

(5) He should see that proper steps are taken by the organization if recovery of loans is doubtful in some cases.

Bank Overdraft

The verification of bank overdraft will be on the same lines as that of loans and advances. The difference is that it is the financial assistance obtained from a bank. The auditor should examine the Bank Pass Book and call for a Statement of Mortgaged Assets. It is to be remembered that the assets so mortgaged should be clearly stated as such in the Balance Sheet.

The auditor should take the following steps to verify the overdraft:

(1) He should examine the Memorandum and Articles of Association of the company or the Partnership Deed in the case of the partnership firm and ensure that the overdraft facility has been made use of with the powers given in these documents.

(2) He should see the authority for contracting the overdraft and it should be ascertained from the Board’s resolution or the resolution of the partners.

(3) The agreement for an overdraft with the bank should also be inspected. It is to be seen whether the overdraft is a clean one or it is against hypothecation or pledged assets of the company. (BCom 3rd Year Verification of Liabilities Notes Study Material)

(4) He should see the Register of charges to ascertain the assets given as security against the overdraft. Such a charge ought to have been registered by the company with the Registrar of Companies.

(5) He should verify the rate of interest and other terms of interest payment from the agreement.

(6) The amount of overdraft should be verified from the books of accounts and compared with the Pass Book.

(7) If the overdraft is against the hypothecation of assets like stock, a certificate from the bank should be obtained in this regard.

(8) It should be seen that the value of the security on the date of the Balance Sheet was neither lower nor higher than what was agreed with the bank. If there is some change that is possible in a hypothecation or pledge of stocks, the amount of the overdraft should be adjusted accordingly.

(9) Lastly, he should see that the overdraft is properly shown under ‘secured loans’, and the nature of security for overdraft has been properly disclosed in the Balance Sheet. (BCom 3rd Year Verification of Liabilities Notes Study Material)

Unexpired Discount

Discount is an income from a bank that discounts bills receivable by its customers. If the date of maturity of the bills discounted falls next year, the discount received therefore is not to be treated as the income of the current year. Hence, such a part of the discount not related to the current year is transferred to a separate account as a rebate on bills discounted. The auditor should examine carefully this account and also check the bills discounted. (BCom 3rd Year Verification of Liabilities Notes Study Material)

Outstanding Expenses

The auditor should obtain a certificate from a responsible officer to the effect that all the outstanding expenses have been included in the current year’s accounts. The amount paid on various accounts should be verified from the entries in the Cash Book. It should be ensured that the outstanding expenses include that part that is unpaid at the date of the Balance Sheet. The following points should be noted:

(1) He should carefully note all expenses, e.g., rent, rate, interest, wages, salary, audit fees, legal expenses, etc., have been accounted for in the books.

(2) He should check entries in the books passed on the basis of invoices and demand notes for some weeks after the close of the financial year to ensure that they are not re to the year under audit.

(3) He should compare all the paid and unpaid expenses of the current year with those of the previous year to see that there is not much difference.

(4) It should be ensured that all outstanding wages and salaries have subsequently been paid.

Contingent Liabilities

Contingent liabilities are those liabilities that may or may not arise in the future for payment. The auditor’s duty is to see that all known and unknown liabilities have been brought into the accounts at the date of the Balance Sheet and have been shown in the Balance Sheet separately as such:

(1) Liabilities on Bills Receivable Discounted and not Matured. If the bills receivable are discounted with a bank and the money so received from it is made use of the entire money will be refunded to the bank if the acceptor does not make payment on the date of its maturity. This is why such a contingent liability is distinctly shown in the Balance Sheet by way of a note at the foot.

(2) Liabilities for Calls on Partly Paid Shares. The amount called on shares held and paid should be verified from the Cash Book and the liability for the amount uncalled should be ascertained.

(3) Liability under a Guarantee. The auditor should ascertain the liability for a guarantee given by the client for a loan or overdraft to his friend, or partner. In case of non-payment of such a loan, the possible liability should be ascertained.

(4) Liability for Cases against the Company not Acknowledged as Debts. It is a liability in a disputed case where damages may have to be paid. A contingent liability should be ascertained and a note should be made at the foot of the Balance Sheet.

(5) Liability for Penalties under Forward Contracts. If losses are to arise in the case of purchases or sales made under forward contracts, a proper provision should be made for such losses. This is an example of contingent liabilities.

(6) Liability in respect of Arrears of Dividend on Cumulative Preference Shares. The auditor should examine the Articles of Association which should contain rules in this regard and due provision should be made for such a liability.

Auditor’s Duty. The auditor should very carefully check the various contingent liabilities named above. There may be some such liabilities for which no provision has been made in the books but merely a note has been made at the foot of the Balance Sheet, e.g., bills receivable which have been discounted and which have not matured at the date of the Balance Sheet, arrears of fixed accumulated dividends, etc.

For liabilities in respect of which provision has to be made on the Balance Sheet, e.g., liability which may arise in connection with a suit. etc., the auditor should examine such cases and ascertain the amount to be specifically reserved for the purpose.

The auditor should examine the Directors’ Minute Book, correspondence made with le legal advisers, and the information obtained from the officials of the business. He has to ensure that proper provision has been made for all such liabilities and if he is not satisfied, he should mention the fact in his report. It is to be remembered that the requirements of the Companies Act regarding contingent liability should be complied with in the Balance Sheet on the liabilities side. (BCom 3rd Year Verification of Liabilities Notes Study Material)

Contingent Assets

Some of examples of contingent assets may be the following:

(i) option to apply for shares in another company on favorable terms;

(ii) refund of octroi paid for goods sent out later on;

(iii) claim for money from a previous endorser of a bill receivable discounted but might be dishonored;

(iv) uncalled Share Capital;

(v) legal action for infringement of copyright, etc.

Unusually, contingent assets are not shown at the foot of the Balance Sheet on the assets side and the Companies Act does not require the contingent assets to be disclosed as such. (BCom 3rd Year Verification of Liabilities Notes Study Material)

BCom 3rd Year Verification of Liabilities Notes Study Material

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