Auditing and Assurance revision question and answer

Auditing and Assurance Revision Questions and Answers

Contingent liabilities Or
Forward Looking Co Ltd is dealing with various transactions that could be well termed as contingent liability. As an auditor, suggest some of the procedures for verifying contingent liabilities?


A contingent liability will be known or determined only on the occurrence or non-occurrence of one or more uncertain future events. The uncertainty as to whether there will be any legal obligation distinguishes a contingent liability from an actual liability. An obligation may be a contingent liability when the very basis of the obligation is contested. For example, when a claim is made against a company in respect of infringement of a patent and the suing company does not possess a legitimate title. Contingent liabilities should be disclosed as a foot note to the balance sheet. Some examples of contingent liabilities include claims against the company not acknowledge as debts, arrears of fixed cumulative dividends etc. In case there is a probability that a loss may be incurred and a reasonable estimate of the amount can be made, then such contingent liability must be adjusted in the financial statements. Otherwise, disclosure will have to be made describing nature of the event, uncertainties affecting the event and estimate of the financial effect or a statement that such an estimate cannot be made. In such circumstances, the auditor may take following steps.

i. Inspect the minute books of the company to ascertain all contingent liabilities known to the company.
ii. Examine the contracts entered into the company and the likelihood of contingent liabilities emanating there from.
iii. Scrutinize the lawyers’ bill to track unreported contingent liabilities.
iv. Examine bank letters in respect of bills discounted and not matured.
v. Examine bank letters to ascertain guarantees on behalf of other companies or individuals.
vi. Discuss with various functional officers of the company about the possibility of contingent liability existing in their respective field.
vii. Obtain a certificate from the management that all known contingent liabilities have been included in the accounts and they have been properly disclosed.
viii. Ensure that proper disclosure has been made as per the law.

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