Auditors plan the engagement so that each account in the balance sheet is audited, and auditors are concerned about overstatement of asset accounts and liability accounts that are understated. This auditing concept is based on the balance sheet formula:
Assets – liabilities = equity
If an asset account, such as accounts receivable, increases, the firm’s equity balance also increases. On the other hand, a decrease in accounts payable (a liability account) also increases equity. The auditor’s goal is to audit each balance sheet account, to ensure that each account is materially correct.
The search of unrecorded liabilities is a procedure that confirms accounts payable. The auditor scans large checks written shortly after the fiscal year end and reviews the accounts payable detail. An auditor wants to see if the check is paying a liability that was posted to accounts payable.
Assume, for example, that a company has a December 31st fiscal year end. A $5,000 check paid to a vendor on January 10th was not listed on the December 31st accounts payable detail. If the client was incurred the expense before year-end, the $5,000 should be added to accounts payable by posted an adjusting entry.
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