Contingent liabilities are those liabilities which 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.
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ADVERTISEMENTS:
(2) Liability 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:
ADVERTISEMENTS:
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 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:
ADVERTISEMENTS:
If losses are to arise in 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 the 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 the contingent liability should be complied with in the Balance Sheet on the liabilities side.