26

GUIDANCE NOTE ON AUDIT OF LIABILITIES*

Contents
Paragraph(s)
Introduction ..........................................................................................3-8
Internal Control Evaluation ...............................................................9-10
Verification........................................................................................11-60
Examination of records ..................................................................12-40
Loans and borrowings................................................................12-21
Trade Creditors and Other Current Liabilities .............................22-28
Provisions....................................................................................29-37
Contingent Liabilities ...................................................................38-40
Direct Confirmation Procedure........................................................41-53
Examination of Disclosure ..............................................................54-57
Analytical Review Procedures ............................................................. 58
Special considerations in the case of a company............................ 59
Management Representations............................................................. 60
Documentation ...................................................................................... 61
Appendices

* Published in December, 1995 issue of ‘The Chartered Accountant’.

Handbook of Auditing Pronouncements-II

The following is the text of the Guidance Note on Audit of Liabilities issued
by the Auditing Practices Committee (APC) ** of the Council of the Institute
of Chartered Accountants of India. This Guidance Note should be read in
conjunction with the Statements on Standard Auditing Practices (SAPs)+
issued by the Institute.
1. Para 2.1 of the Preface to the Statements on Standard Auditing
Practices issued by the Institute of Chartered Accountants of India states
that the “main function of the APC is to review the existing auditing
practices in India and to develop Statements on Standard Auditing
Practices (SAPs) so that these may be issued by the Council of the
Institute.” Para 2.4 of the Preface states that the “APC will issue Guidance
Notes on the issues arising from the SAPs wherever necessary.”
2. The Auditing Practices Committee has also taken up the task of
reviewing the Statements on auditing matters issued prior to the formation
of the Committee. It is intended to issue, in due course of time, SAPs or
Guidance Notes as appropriate, on the matters covered by such
Statements which would then stand withdrawn. With the issuance of this
Guidance Note on Audit of Liabilities, Chapter 9 of the Statement on
Auditing Practices, titled ‘Liabilities’, shall stand withdrawn. In due course
of time, the entire Statement on Auditing Practices shall be withdrawn.

Introduction
3. Liabilities are the financial obligations of an enterprise other than
owners’ funds.
4. Liabilities include loans and borrowings, trade creditors and other current
liabilities, deferred payment credits, instalments payable under hire purchase
agreements, and provisions. Besides liabilities, this Guidance Note also
deals with contingent liabilities, i.e., obligations relating to past transactions
or other events or conditions that may arise in consequence of one or more
future events which are presently deemed possible but not probable.
5. Special considerations may apply in the case of audit of liabilities of
specialised entities like banks, financial institutions and venture capital funds.

**
Now known as the Auditing and Assurance Standards Board (AASB).
+
Now known as the Auditing and Assurance Standards (AASs).

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6. Liabilities generally constitute a significant proportion of the total sources

of funds of an entity. The audit of liabilities is primarily directed at ensuring
that all known liabilities have been properly accounted for, since material
omission or misstatement of liabilities vitiates the true and fair view of the
financial statements.
7. An important feature of liabilities which has a significant effect on the
related audit procedures is that these are represented only by documentary
evidence which originates mostly from third parties in their dealings with
the entity.
8. In any auditing situation, the auditor employs appropriate procedures to
obtain reasonable assurance about various assertions [see Statement on
Standard Auditing Practices (SAP) 5, Audit Evidence]. In carrying out an
audit of liabilities, the auditor is particularly concerned with obtaining
sufficient appropriate audit evidence to satisfy himself that all known
liabilities are recorded and stated at fair and reasonable amounts.

Internal Control Evaluation

9. The auditor should study and evaluate the system of internal control
relating to liabilities to determine the nature, timing and extent of his other
audit procedures. He should particularly review the following aspects of
internal control relating to liabilities.1
(a) In respect of loans and borrowings (including advances and deposits)
(i) As far as possible, the following should be clearly specified:
the borrowing powers and limits;
persons authorised and competent to borrow;
terms of borrowings;
procedure for ensuring compliance with relevant legal
requirements/internal regulations.
(ii) Any variations in the terms of loans and borrowings should be
truly approved/ratified in writing by competent authority.

1 The extent of review of controls would depend upon the facts and circumstances of each case.
Reference may be made in this regard to the Internal Control Questionnaire, issued by the Institute
of Chartered Accountants of India, which contains, inter alia, an illustrative list of internal controls in
relation to creditors and borrowings.

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(iii) Security offered against loans and borrowings should be properly

recorded and periodically reviewed.
(iv) The records and documents should be kept in proper custody
and reviewed periodically.
(v) The system should bring out all cases of non-compliance with
terms and conditions including amounts of principal and/or
interest which have become overdue.
(vi) Confirmation of balances should be obtained at periodic intervals
and the discrepancies, if any, should be duly investigated and
reconciled.
(vii) There should be a proper procedure for year-end valuation of
loans and borrowings, especially for those designated in foreign
currencies.2
(b) In respect of Trade Creditors
(i) The procedure should ensure proper recording of transactions
and facilitate the linking of payments with outstandings.
(ii) The payments made to creditors should be in line with the
approved policies of the entity.
(iii) There should be specific procedures for payments against
duplicate invoices or other duplicate records as well as for
payments against accounts which have remained unclaimed for
quite some time.
(iv) There should be a procedures for preparation of schedules of
trade creditors at periodic intervals; this should be reviewed by a
responsible person and necessary action initiated on overdue
accounts.
(v) Statements of account should be called for creditors at periodic
intervals and the discrepancies, if any, should be duly
investigated and reconciled.
(vi) All adjustments in the creditors’ accounts such as those relating
to claims for returns, defectives, short receipts of goods, rebates,

2Reference may be made in this regard to Accounting Standard 11 (revised 2003), Effects of
Changes in Foreign Exchange Rates, issued by the Institute of Chartered Accountants of India.

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allowances and commissions etc., should require approval of

competent authority. Similarly, any write-back of creditors’
balances and escalation claims should be approved by
competent authority.
(vii) There should be appropriate cut-off procedures in relation to
transactions affecting the creditor accounts.
(c) In respect of other current liabilities, trade deposits and provisions
The internal control procedures as spelt out above for loans and
borrowings and creditors broadly apply in relation to these items.
10. In respect of contingent liabilities, the auditor should examine whether
the internal control system of the entity provides for a procedure for
identifying and estimating such liabilities and for periodic review of the
same.

Verification
11. Verification of liabilities may be carried out by employing the following
procedures:
(a) examination of records;
(b) direct confirmation procedure;
(c) examination of disclosure;
(d) analytical review procedures,
(e) obtaining management representations.
The nature, timing and extent of substantive procedures to be performed is,
however, a matter of professional judgement of the auditor which is based,
inter alia, on the auditor’s evaluation of the effectiveness of the related
internal controls.

Examination of records
Loans and Borrowings
12. The auditor should satisfy himself that the loans obtained are within the
borrowing powers of the entity.

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13. The auditor should carry out an examination of the relevant records to
judge the validity and accuracy of the loans.
14. In respect of loans and advances from banks, financial institutions and
others, the auditor should examine that the book balances agree with the
statements of the lenders. He should also examine the reconciliation
statements, if any, prepared by the entity in this regard.
15. The auditor should examine the important terms in the loan agreements
and the documents, if any, evidencing charge in respect of such loans and
advances. He should particularly examine whether the requirements of the
applicable statute regarding creation and registration of charges have been
complied with.
16. Where the entity has accepted deposits, the auditor should examine
whether the directives issued by the Reserve Bank of India or other
appropriate authority are complied with.
17. In case the value of the security falls below the amount of the loan
outstanding, the auditor should examine whether the loan is classified as
secured only to the extent of the market value of the security.
18. Where short-term secured loans have been disclosed separately from
other secured loans, the auditor should verify the correctness of the
amount of such short-term loans.
19. Where instalments of long-term loans falling due within the next twelve
months have been disclosed in the financial statements (e.g., in
parentheses or by way of a footnote), the auditor should verify the
correctness of the amount of such instalments.
20. The auditor should examine the hire purchase agreements for the
purchase of assets by the entity and ensure the correctness of the amounts
shown as outstanding in the accounts and also examine the security
aspect. Future instalments under hire purchase agreements for the
purchase of assets may be shown as secured loans.
21. The deferred payment credits should be verified with reference to the
important terms in the agreement, including due dates of payments and
guarantees furnished by banks. The auditor should also verify the copies of
hundies/bills accepted separately.

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Trade Creditors and Other Current Liabilities

22. The auditor should check the adequacy of cut-off procedures adopted
by the entity in relation to transactions affecting the creditor accounts. For
example, the auditor may examine the documents relating to receipt of
goods from suppliers during a few days immediately before the year-end
and verify that the related invoices have been recorded as purchases of the
current year.
23. The auditor should check that the total of the creditors' balances agrees
with the related control account, if any; the difference, if any, should be
examined.
24. The auditor should examine the correspondence and other relevant
documentary evidence to satisfy himself about the validity, accuracy and
completeness of creditors/acceptances.
25 The auditor should verify that in cases where income is collected in
advance for services to be rendered in future, the unearned portion, not
applicable to the period under audit, is not recognised as income of the
period under audit but is shown in the balance sheet as a part of current
liabilities.
26. While examining schedule of creditors and other schedules such as
those relating to advance payments, unclaimed dividends and other
liabilities, the auditor should pay special attention to the following aspects:
(a) long outstanding items;
(b) unadjusted claims for short supplies, poor quality, discount,
commission, etc.;
(c) liabilities not correlated/adjusted against related advances;
(d) authorisation and correctness of transfers from one account to
another.
Based on his examination as aforesaid, the auditor should determine
whether any adjustments in accounts are required.
27. In case there are any unusual payments around the year-end, the
auditor should examine them thoroughly. In particular, the auditor should
examine if the entries relating to any such payments have been reversed in
the subsequent period.

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28. The auditor should review subsequent transactions to identify/confirm

material liabilities outstanding at the balance sheet date.

Provisions
29. The term ‘provision’ means amounts retained by way of providing for
depreciation or diminution in value of assets or retained by way of providing
for any known liability the amount of which cannot be determined with
substantial accuracy. Provisions include those in respect of depreciation or
diminution in the value of assets, product warranties, service contracts and
guarantees, taxes and levies, gratuity, proposed dividend etc. This
Guidance Note, however, does not deal with provisions for depreciation or
diminution in the value of assets.
30. The audit of provisions primarily involves examining the
reasonableness and adequacy of the amounts provided for. The auditor
should also examine that the provisions made are not in excess of what is
reasonably required.
31. Provisions for Taxes and Duties: The adequacy of the provision for
taxation for the year should be examined. The position regarding the
overall outstanding liability of the entity as at the date of balance sheet
should be reviewed. In respect of assessments completed, revised or
rectified during the year, the auditor should examine whether suitable
adjustments have been made in respect of additional demands or refunds,
as the case may be. Similarly, he should examine whether excess
provisions or refunds have been properly adjusted. The relevant orders
received up to the time of audit should be considered and, on this basis, it
should be examined whether any short provisions have been made good. If
there is a material tax liability for which no provision is made in the
accounts, the auditor should qualify his report in this respect even if the
reserves are adequate to cover the liability.
32. If the entity disputes its liability in regard to demands raised, the auditor
should examine whether there is a positive evidence or action on the part
of the entity to show that it has not accepted the demand for payment of tax
or duty, e.g., where it has gone into appeal under section 246 of the
Income-tax Act, 1961. Where an application for rectification of mistake
(e.g., under section 154 of the Income tax Act, 1961) has been made by
the entity, the amount should be regarded as disputed. Where the demand

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notice/intimation for the payment of tax is for a certain amount and the
dispute relates to only a part and not the whole of the amount, only such
amount should be treated as disputed. A disputed tax liability may require a
provision or suitable disclosure (see Accounting Standard (AS) 4,
Contingencies and Events Occurring After the Balance Sheet Date issued
by the Institute of Chartered Accountants of India). In determining whether
a provision is required, the auditor should, among other procedures, make
appropriate inquiries of management, review minutes of the meetings of the
board of directors and correspondence with the entity's lawyers, and obtain
appropriate management representations.
33. In case the entity has made the provision for taxation on the basis of
the tax-effect accounting method, the auditor should examine whether the
method has been applied properly.3
34. Provision for Gratuity: The auditor should examine whether the entity is
required to pay gratuity to its employees by virtue of the provisions of the
Payment of Gratuity Act, 1972 and/or· in terms of agreement with
employees and, if so, whether provision for accruing gratuity liability has
been made by the entity.4 The auditor should examine the adequacy of the
gratuity provision with reference to the actuarial certificate obtained by the
entity. In case the entity has not obtained such an actuarial certificate, the
auditor should examine whether the method followed by it for calculating
the accruing liability for gratuity is rational.
35. Provision for Bonus: In the case of provision for bonus, the auditor
should examine whether the liability is provided for in accordance with the
Payment of Bonus Act, 1965 and/or agreement with the employees or
award of competent authority. Where the bonus actually paid is in excess
of the amount required to be paid as per the provisions of the applicable
law/agreement/award, the auditor should specifically examine the authority
for the same (e.g., resolution of the board of directors in the case of a
company).
36. Provision for Dividends: The auditor should examine that dividends are

3 Reference may be made in this regard to the Accounting Standard (AS) 22, Accounting for Taxes

on Income issued by the Institute of Chartered Accountants of India.

4 Reference may be made in this regard to Accounting Standard (AS) 15, Accounting for

Retirement Benefits in the Financial Statements of Employers, issued by the Institute of Chartered
Accountants of India.

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provided for as per applicable provisions of the relevant laws and rules
framed thereunder, relevant agreements and resolutions.
37. Other Provisions: Where provisions are made for liabilities that may
arise on account of product warranties, service contracts, performance
warranties etc., the auditor should examine whether the provisions made
are in accordance with Accounting Standard (AS) 4, Contingencies and
Events Occurring After the Balance Sheet Date, issued by the Institute of
Chartered Accountants of India. The auditor should also examine the
reasonableness of the basis adopted for quantifying the provision with
reference to the relevant agreements.

Contingent Liabilities
38. The term ‘contingent liabilities’ refers to obligations relating to past
transactions or other events or conditions that may arise in consequence of
one or more future events which are presently deemed possible but not
probable. Contingent liabilities may or may not crystallize into actual
liabilities. If they do become actual liabilities, they give rise to a loss or an
expense. The uncertainty as to whether there will be any legal obligation
differentiates a contingent liability from a liability that has crystallized.
Contingent liabilities should also be distinguished from those contingencies
which are likely to result in a loss (i.e., a loss is not merely possible but
probable) and which, therefore, require an adjustment of relevant assets or
liabilities.5 Some of the instances giving rise to contingent liabilities are:
(a) law suits, disputes and claims against the entity not acknowledged as
debts:
(b) membership of a company limited by guarantee.
39. The following general procedures may be useful in verifying
contingent liabilities.
(a) Review of minutes of the meetings of board of directors, committees
of board of directors/other similar body.
(b) Review of contracts, agreements and arrangements.

5 Reference may be made in this regard to the Accounting Standard (AS) 4, Contingencies and
Events Occurring After the Balance Sheet Date, issued by the Institute of Chartered Accountants of
India.

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(c) Review of list of pending legal cases, correspondence relating to

taxes, duties, etc.
(d) Review of terms and conditions of grants and subsidies availed under
various schemes.
(e) Review of records relating to contingent liabilities maintained by the
entity.
(f) Enquiry of, and discussions with, the management and senior officials
of the entity.
(g) Representations from the management.
40. The auditor should verify that contingent liabilities do not include any
items which require an adjustment of relevant assets or liabilities.

Direct Confirmation Procedure

41. The verification of balances by direct communication with creditors is
theoretically the best method of ascertaining whether the balances are
genuine, accurately stated and undisputed, particularly where the internal
control system is weak. However, the utility of this procedure depends to a
large extent on receiving adequate response to confirmation requests.
Therefore, in situations where the auditor has reasons to believe, based on
his past experience or other factors, that it is unlikely that adequate
response would be received from the creditors, he may limit his reliance on
direct confirmation procedure and place greater reliance on the other
auditing procedures.
42. The auditor employs direct confirmation procedure with the consent of
the entity under audit. There may be situations where the management of
the entity requests the auditor not to seek confirmation from certain
creditors. In such cases, the auditor should consider whether there are
valid grounds for such a request. For example, the management may
explain the reason as being the fact that there is a dispute with the
particular creditor and the request for confirmation may aggravate sensitive
negotiations between the entity and the creditor. Before accepting a refusal
as justified, the auditor should examine any available evidence to support
the management's explanations, e.g., correspondence between the entity
and the creditor. In such a case, alternative procedures should be applied
to creditors not subjected to confirmation. In appropriate cases, the auditor

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may also need to re-consider the nature, timing and extent of his audit
procedures including the degree of planned reliance on management's
representations,
43. The confirmation date, the method of requesting confirmations, and the
particular creditors from whom confirmation of balances is to be obtained
are to be determined by the auditor. While determining the information to
be obtained, the form of confirmation, as well as the extent and timing of
application of the confirmation procedure, the auditor should consider all
relevant factors such as the effectiveness of internal control, the apparent
possibility of disputes, inaccuracies or irregularities in the accounts, the
probability that requests will receive consideration, and the materiality of
the amounts involved.
44. The creditors may be requested to confirm the balances either (a) as at
the date of the balance sheet, or (b) as at any other selected date which is
reasonably close to the date of the balance sheet. The date should be
settled by the auditor in consultation with the entity. Where the auditor
decides to seek confirmation from the creditors at a date other than the
balance sheet date, he should examine the movements in creditor balances
which occur between the confirmation date and the balance sheet date and
obtain sufficient evidence to satisfy himself that creditor balances stated in
the balance sheet are not materially misstated.
45. The form of requesting confirmation from the creditors may be either (a)
the 'positive' form of request, wherein the creditor is requested to respond
whether or not he is in agreement with the balance shown, or(b) the
‘negative’ form of request, wherein the creditor is requested to respond
only if he disagrees with the balance shown.
46. The use of the positive form is preferable when individual account
balances are relatively large, or where the internal controls are weak, or
where the auditor has reason to believe that there may be a substantial
number of accounts in dispute or with inaccuracies or irregularities. An
illustrative positive form of request letter is given in Appendix I to this
Guidance Note.
47. The negative form is useful when internal controls are considered to be
effective, or when a large number of small balances are involved, or when
the auditor has no reason to believe that the creditors are unlikely to
respond. If the negative rather than the positive form of confirmation is

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used, the number of requests sent and the extent of the other auditing
procedures to be performed should normally be greater so as to enable the
auditor to obtain the same: degree of assurance with respect to the creditor
balances. An illustrative negative form of request letter is given in Appendix
II to this Guidance Note.
48. In many situations, it may be appropriate to use the positive form for
creditors with large balances and the negative form for creditors with small
balances.
49. Where the number of creditors is small, all of them may be circularised,
but if the creditors are numerous, this may be done on a sample basis. The
sample list of creditors to be circularised, in order to be meaningful, should
be based on a complete list of all creditor accounts. While selecting the
creditors to be circularised, special attention should be paid to accounts
with large balances, accounts with old outstanding balances, and supplier
accounts with debit balances. In addition, the auditor should select
accounts in respect of which balances have been written back to the profit
and loss account. In such cases, the auditor may decide that the balance
as per the books of the entity may not be stated in the request letter sent to
the creditors concerned; instead, the creditors may be asked to intimate the
balance as per their records. The auditor may also consider including in his
sample some of the accounts which have been fully squared up. The
nature of the entity's business and the type of third parties with whom the
entity deals, should also be considered in selecting the sample, so that the
auditor can reach appropriate conclusions about the creditors as a whole.
50. In appropriate cases, the creditor may be sent a copy of his complete
ledger account for a specific period as shown in the entity’s books. This
procedure is more likely to reveal errors and fraud and may be particularly
useful in the case of large accounts involving many entries, or where there
is evidence that accounts are in dispute or are not being settled in
accordance with the usual trade terms.
51. The method of selection of the creditors to he circularised should not
be revealed to the entity until the trial balance of the creditors’ ledger is
handed over to the auditor. A list of creditors selected for confirmation
should be given to the entity for preparing requests for confirmation which
should be properly addressed and duly stamped. The auditor should
maintain strict control to ensure the correctness and proper dispatch of

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request letters. In the alternative, the auditor may request the client to
furnish duly authorised confirmation letters and the auditor may fill in the
names, addresses and the amounts relating to creditors selected by him
and mail the letters directly. It should be ensured that confirmations as well
as any undelivered letters are returned to the auditor and not to the client.
52. Where positive form of request is used, the auditor may, in appropriate
cases, request the entity to follow up with a reminder to those creditors
from whom he receives no replies. In exceptional circumstances, the
auditor may also correspond directly with those significant creditors from
whom he receives no replies despite reminders, with intimation to the
entity. In the event of inadequacy of responses received, the auditor will
have to increase the extent of examination of records and analytical review
procedures beyond that planned originally.
53. Any discrepancies revealed by the confirmations received or by the
additional tests carried out by the auditor may have a bearing on other
accounts not included in the original sample. The entity should be asked to
investigate reconcile the discrepancies. In addition, the auditor should also
consider what further tests he can carry out in order to satisfy himself as to
the correctness of the amount of creditors taken as a whole.

Examination of Disclosure
54. The auditor should satisfy himself that the liabilities have been
disclosed properly in the financial statements. Where the relevant statute
lays down any disclosure requirements in this behalf, the auditor should
examine whether the same have been complied with.
55. In some cases loans are guaranteed by third parties in whose favour
the assets of the entity are charged. The auditor should examine whether
the disclosures concerning such loans are appropriate, e.g., they may be
classified as secured with disclosure of the fact that the assets of the entity
have been charged in favour of third parties which, in turn, have given
guarantees to parties from whom loans have been obtained.
56. The auditor should recommend to the entity to disclose, in parentheses
or in footnotes, the installments of term loans, if any, falling due for
repayment within the next twelve months.
57. The auditor should examine that the following have been disclosed in

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respect of contingent liabilities:

(a) nature of each contingent liability;
(b) the uncertainties which may affect the future outcome;
(c) an estimate of the financial effect or a statement that such estimate
cannot be made.

Analytical Review Procedures

58. In addition to the audit procedures discussed above, the following
analytical review procedures may often be helpful as a means of obtaining
audit evidence regarding the various assertions:
(a) comparison of closing balances of loans and borrowings, creditors,
etc., with the corresponding figures for the previous year;
(b) comparison of the relationship between current year creditor balances
and the current year purchases with the corresponding figures for the
previous year;
(c) comparison of actual closing balances of loans and borrowings,
creditors, etc., with the corresponding budgeted figures, if available;
(d) comparison of current year’s aging schedule of creditors with the
corresponding figures for the previous year;
(e) comparison of significant ratios relating to loans and borrowings,
creditors, etc., with the similar ratios for other firms in the same
industry, if available;
(f) comparison of significant ratios relating to loans and borrowings,
creditors, etc. with the industry norms, if available.
It may be clarified that the foregoing is only an illustrative list of analytical
review procedures which an auditor may employ in carrying out an audit of
liabilities. The exact nature of analytical review procedures to be applied in
a specific situation is a matter of professional judgement of the auditor

Special Considerations in the Case of a Company

59. In addition to the procedures described above, the auditor· should also
employ the following procedures in the case of audit of a company.

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(a) In determining whether the loans obtained by the company are within
its powers, the auditor should scrutinise its memorandum and articles
of association and also examine whether the provisions of sections
292 and 293(1(d) of the Companies Act, 1956 are complied with.
(b) The auditor should examine the register of charges to ensure that
charges created have been duly registered. He should also ensure
that the description of such charges disclosed in the balance sheet
agrees in substance with that stated in the documents creating the
charges.
(c) The auditor should examine all loans taken from bodies corporate
under the same management or from a company, firm or other party in
which any director is interested and determine whether, in his opinion,
the rate of interest and other terms and conditions of the loans are
prime facie prejudicial to the interest of the company.6
(d) Where the company has accepted deposits, the auditor should
examine compliance with the relevant legal provisions, e.g., section
58A of the Companies Act, 1956 and the rules framed
thereunder/directions issued by the Reserve Bank of India.
(e) In respect of unclaimed dividends, the auditor should examine
whether the company has complied with the provisions of section
205A of the Companies Act, 1956 and the rules framed thereunder
regarding transfer of certain unpaid or unclaimed dividends to a
special bank account/general revenue account of the Central
Government.
(f) The auditor should examine whether any undisputed amounts payable
in respect of income-tax, wealth tax. sales tax, customs duty and
excise duty are outstanding as at the balance sheet date for a period
of more than six months from the date they became payable. If so, the
auditor should report the amounts of such outstanding dues.7
(g) The verification procedure to be adopted by the auditor for audit of

6 Reference may also be made in this regard to the Statement on the Manufacturing and Other
Companies (Auditor’s Report) Order, 1988 issued by the Institute of Chartered Accountants of
India.
7 Reference may also be made in this regard to the Statement on the Manufacturing and Other
Companies (Auditor’s Report) Order, 1988 issued by the Institute of Chartered Accountants of
India.

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debentures would vary from year to year, depending upon whether

fresh debentures are issued and/or they are redeemed or converted
into shares during the year. In case of fresh issue of debentures, the
auditor should examine the memorandum and articles of association
of the company and resolutions authorising the issue. He should also
examine compliance with the requirements of the terms of issue and
any variations thereof and necessary approvals/clearances for· the
issue from authorities concerned such as SEBI, RBI etc. The auditor
should also examine that proper accounts are maintained with regard
to amounts received towards application, allotment and calls and that
the Payments by way of refunds/interest and all other relevant
accounts are duly reconciled. Where debentures are issued at a
premium/discount, the auditor should ensure that such sums are
accounted for distinctly. In case of buy-back, conversion, re-issue or
redemption of debentures, the auditor should examine that these are
in accordance with the terms of the issue. The auditor should examine
that the requirements relating to creation of debenture redemption
reserve and, where applicable, sinking fund and its Investment; and
other related requirements are complied with.

Management Representations
60. The auditor should obtain from the management of the entity a written
statement that all known liabilities have been recorded in the books and
that all contingent liabilities have been properly disclosed. While such a
representation letter serves as a formal acknowledgment of the
management's responsibilities for proper accounting and disclosure of the
relevant items, it does not relieve the auditor of his responsibility for
performing audit procedures to obtain sufficient appropriate audit evidence
to form the basis for the expression of his opinion on the financial
statement. A sample management representation letter regarding liabilities
and contingent liabilities is given in Appendix III to this Guidance Note. It
may be mentioned that the representations made in the letter can
alternatively be included in the composite representation letter usually
issued by the management to the auditor.

Documentation
61. The auditor should maintain adequate working papers regarding audit

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of liabilities and contingent liabilities. Among others, he should maintain on

his audit file, confirmations received as well as any undelivered letters of
request for confirmation. The management representation letter contingent
liabilities and contingent liabilities should also be maintained on the audit
file.

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Appendix I
Illustrative Letter of Confirmation to be Sent to
Creditors - Positive Form

[Ref. paragraph 46]

[Letterhead of Entity]

[Name and Address of Creditor] [Date]

Dear Sir,
For audit purposes, kindly confirm directly to our auditors (name and address of
the auditors) that the balance of Rs. due by us to you as on _______ as
shown by our books, is correct. The details of the balance are as under:8
Invoice No. Date Order Reference Amount

Total _________
Less: Payments made/other debits _________
Net amount due to us (Rs.) _________

A stamped envelope addressed to our auditors is enclosed for your

convenience.
If the amount shown is in agreement with your books, kindly strike-out the
paragraph marked (B) below. If the amount shown is not in agreement with
your books, kindly furnish the details in the proforma given in the paragraph
marked (B) below and strike-out paragraph (A). In either case, kindly sign at
the place provided below and return this entire letter directly to our auditors
in the enclosed envelope. Your prompt compliance with this request will be
appreciated.

8 In case the list of invoices forming the balance is too large, these details may not be given.

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Kindly return this form in its entirety.

Yours faithfully,

(Signature of responsible official of the entity)

(Do not perforate the form at this point)

[Name and Address of Entity]

(A) We confirm that the above stated amount is correct as at ______
OR
(B) We state that the above-stated amount is not correct as per our records.
The details of the balance as at _____ as per our records are as below:
Invoice No. Date Order Reference Amount

Total _________
Less: Payments made/other debits _________
Net amount due to us (Rs.) _________

Date

(Signature of creditor/responsible official)

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Appendix II
Illustrative Letter of Confirmation to be Sent to
Creditors - Negative Form

[Ref. paragraph 47]

[Letterhead of Entity]
[Date]
[Name and Address of Creditor]
Dear Sir,
For audit purposes, kindly write directly to our auditors (name and address of
the auditors) if the balance of Rs. ________ due by us to you as on
________ as shown by our books, is not correct, giving details of the
differences. The details of the balance are as under:9
Invoice No. Date Order Reference Amount

Total _________
Less: Payments made/other debits _________
Net amount due y us (Rs.) _________

If you do not notify our auditors of any difference within ten days of the date of
this letter, it will be presumed that the balance stated above is correct.
A stamped envelope addressed to our auditors is enclosed for your
convenience.
Yours faithfully,

(Signature of responsible official of the entity)

9 In case the list of invoices forming the balance is too large, these details may not be given

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Appendix III
Illustrative Representation Letter for
Liabilities and Contingent Liabilities

[Ref. paragraph 60]

The following is a sample representation letter for liabilities and contingent
liabilities. It might be used to supplement the general letter of representation
or included therein. The letter should be modified where appropriate.
[Letterhead of Entity]
[Date]
[Name and Address of the Auditor]
Dear Sir,
In connection with your audit of the financial statements of X Ltd. as of …....,
19….., and for the year then ended, we confirm, to the best of our knowledge
and belief, the following representations:
1. We have recorded all known liabilities in the financial statements.
2. We have disclosed in notes to the financial statements all guarantees
that we have given to third parties and all other contingent liabilities.
3. Contingent liabilities disclosed in the notes to the financial statements
do not include any contingencies which are likely to result in a loss and
which, therefore, require adjustment of assets or liabilities.
4. Provisions have been made in the accounts for all known losses and
claims of material amounts.
Yours faithfully,

(Signature of responsible official of the entity)

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