VERIFICATION OF LIABILITIES 1. Liabilities to be verified.—In the matter of veri fying the liabilities the auditor's duty consists in ascer taining whether or not all liabilities are stated, and whether or not those that are shown are properly lia bilities of the undertaking.
Some business undertakings make large purchases of raw materials in the current period which are to be manufactured into finished goods in the following period. Inasmuch as the raw material is purchased for the next business period, many business men con tend that the amount of such purchases if unpaid for should be eliminated both from the inventory on hand at the close of the current period and from the current payables. This contention is advanced especially if the goods have been purchased at advantageous prices and if the payment will not be due until some time in the future.
An auditor cannot accept this view, because if the title to the mercandise vests in the undertaking whose accounts he is auditing, the amount due to the vendors is a valid liability and must be so stated in the balance sheet which he prepares. While the inclusion of these items in the balance sheet may disturb that favorable relation between current assets and current liabilities which a banker or a lender of funds expects to find, it is possible to explain to the banker the reason for the apparently unfavorable showing. If the mer chandise has been purchased on advantageous terms and if the quantity on band is reasonable, an intelli gent banker will make allowances therefor.
2. Procedure in verifying outstanding accounts payable.—The only sure method which the auditor may employ in determining whether or not the amount of the liabilities outstanding at the date of the audit is correct, is to secure confirmation of the amount from the creditors themselves. The auditor may also make an examination of the correspondence files from which he may extract information to aid him in determining whether or not all of the outstanding obligations have been taken up in the accounts.
Very often, either by design or by accident, the total amount of liabilities due at the end of a period is not stated. An auditor was recently requested to make an audit of a retail grocery store for bank "A," to which an application had been made for a loan. The grocer was doing business with another bank "B," but had succeeded in borrowing money on one note from bank "A," altho he had no account at the latter bank. The records of the grocer were kept by single entry and after making a thoro analysis of the records and such other data as he could obtain, the auditor made up a statement of the assets and lia bilities of the grocer which he presented to the officers of bank "A." The latter bank, however, had not in formed the auditor of the outstanding note held by it, and when the balance sheet was presented to the cashier, it did not disclose as a liability the note held by bank "A." When the auditor was informed of this, he made a further investigation to determine why the records of the grocer did not disclose this note. The auditor found that the loan was originally made at a date con siderably prior to the audit period, and that it had been renewed several times. When the proprietor re newed the note, he paid the discount on each occasion to the bank in cash, and the amounts withdrawn from the business in cash appeared in his cash book as tho they were ordinary drawings of the proprietor and were so considered by the auditor in making his investigation.
In this case, the auditor had used what might fairly be considered reasonable care and prudence in ascer taining from the records the existence of all liabilities. Furthermore, there was nothing in the records which he examined that would cause him to suspect that an other note was outstanding. The grocer was also free from blame because he did not handle the transac tions in this way with the intention of deceiving.