Verification of liabilities: creditors, bills payable, loans, outstanding expenses and contingent liabilities

1. Why liabilities need verification

With assets the risk is over-statement; with liabilities it is under-statement or omission. Leaving out a creditor or an outstanding expense increases the profit and makes the business look stronger than it is. The auditor must therefore see that:

• all liabilities existing at the balance sheet date are included;
• they are stated at the correct amounts;
• they are properly classified (current and non-current, secured and unsecured) and disclosed as Schedule III to the Companies Act 2013 requires;
• any security given for them (charge on assets) is disclosed;
• no fictitious liability is shown (to reduce profit, or to cover a fraud by a dummy creditor).

2. General procedure

1. Obtain schedules of each liability and agree them with the ledger.
2. Obtain direct confirmations from lenders, banks and major creditors (SA 505).
3. Examine agreements, debenture trust deeds, loan sanction letters and the register of charges.
4. Read the minutes of the Board and general meetings for borrowings, guarantees and commitments.
5. Examine payments made soon after the year end, and invoices received after it, to detect unrecorded liabilities (search for unrecorded liabilities).
6. Obtain a certificate from management that all known liabilities have been included (SA 580).
7. Consider events after the balance sheet date (SA 560) such as an adverse court decision.

3. Specific liabilities

Share capital (companies): verify with the memorandum (authorised capital), the register of members, the allotment minutes and return of allotment filed with the Registrar; see calls in arrears and forfeited shares correctly shown; for shares issued for consideration other than cash, see the contract. Under section 143(1)(f) the auditor must inquire whether shares allotted for cash were actually paid for in cash.

Reserves and surplus: trace movements to resolutions; see that capital reserves (securities premium, revaluation reserve) are used only as the law allows (for example section 52 for securities premium).

Debentures and secured loans: examine the debenture trust deed or loan agreement; check the borrowing limits under the articles and section 180(1)(c); see that the charge is registered with the Registrar (section 77) and disclosed; obtain confirmations from the trustee or bank; check interest accrued and paid, and redemption terms.

Unsecured loans and deposits: confirm with lenders; for a company, check compliance with the deposit rules under sections 73 to 76; loans from directors must be disclosed.

Trade creditors (sundry creditors)

• Obtain a schedule; agree it with the purchase ledger.
• Compare balances with suppliers’ statements and send confirmations to large and unusual accounts.
• Check purchases near the year end and goods received notes for cut-off: goods received but invoices not entered must be included.
• Look for debit balances in the creditors’ ledger; they should be shown as assets, not set off.
• Watch for fictitious creditors (a dummy account through which payments are diverted): check that each creditor is a real supplier with whom there were purchases.
• Disclose dues to micro and small enterprises separately as Schedule III requires.

Bills payable

• Obtain a schedule of bills accepted and outstanding at the year end, and agree it with the bills payable book and ledger.
• Check bills paid after the year end with the bank statement; see that they were included.
• Obtain confirmation from the holders where possible.
• Check that bills paid during the year are cancelled and returned by the payee.
• See that dishonoured or renewed bills are properly accounted.

Outstanding expenses: check that expenses accrued but unpaid (salaries, rent, electricity, audit fees, interest) are provided, by comparing with the previous year and with payments made after the year end.

Provisions (for taxation, gratuity, warranties): see that they are based on a reasonable estimate; check the tax computation, actuarial valuation for employee benefits (AS 15 / Ind AS 19), and the basis for warranties.

4. Contingent liabilities

A contingent liability is a possible obligation that arises from past events and whose existence will be confirmed only by uncertain future events not wholly within the control of the business, or a present obligation that is not recognised because an outflow is not probable or the amount cannot be measured reliably (AS 29 / Ind AS 37). Examples: claims against the company not acknowledged as debts, guarantees given for others, bills discounted not yet matured, disputed tax demands under appeal, uncalled liability on partly paid shares held.

Verification and the auditor’s position

1. Contingent liabilities are not shown in the balance sheet total but disclosed in the notes; the auditor must see that all are disclosed with their nature and estimated amount.
2. Enquire of management, examine minutes, contracts, correspondence with lawyers, and legal expense accounts to find pending litigation (SA 501 requires procedures on litigation and claims, including where necessary direct communication with the client’s lawyer).
3. Examine bank confirmations for guarantees and bills discounted.
4. Examine tax assessment orders and appeals.
5. Obtain a written representation from management that all contingent liabilities are disclosed.
6. If the liability has become probable and measurable, it must be provided for, not merely disclosed; failing that, the auditor must qualify his report.
7. The Companies (Audit and Auditors) Rules 2014 also require the auditor to report whether the company has disclosed the impact of pending litigations on its financial position.

How this is examined

Ten-mark: “Explain the ways to verify the liabilities of the balance sheet” (April 2021); “explain verification and valuation of assets and liabilities for a balance sheet” (2022, with the previous two notes). Short notes: verifying the liability side (2022, April 2023); auditor’s position regarding valuation of contingent liabilities (June 2025). Items: contingent liability (2019, October 2023), bills payable (November 2021, June 2025), creditors (August 2024).