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- 7 Marks
Question
At a meeting to discuss the draft accounts with senior management of Good Old Days Ltd, the external auditors, Gelian Chartered Accountants, asked management to confirm the amount of contingent liability of GH¢100 million in respect of a pending legal suit against the company. The CEO quizzed the chief accountant to explain how the amount of GH¢100 million was arrived at.
Required:
i) Describe briefly what a contingent liability is, giving examples where appropriate. (2 marks)
ii) Explain in detail the audit procedures for the verification of contingent liabilities. (5 marks)
Answer
i) Contingent liability: A contingent liability is a potential liability that may occur depending on the outcome of an uncertain future event. It is recognized only if the probability of the event occurring is more than likely and the amount can be reasonably estimated. An example would be pending legal claims or guarantees issued on behalf of another entity.
(2 marks)
ii) Audit procedures for verification of contingent liabilities:
- Review management’s procedures for identifying and recording contingent liabilities.
- Examine board minutes for discussions relating to any legal claims or potential liabilities.
- Inquire with legal advisors: Obtain a direct confirmation from the company’s legal advisors about the likelihood and potential amount of the liability.
- Review correspondence with external legal counsel and other relevant parties to assess the status of the case.
- Review subsequent events: Check for any developments after the reporting date that might impact the outcome of the contingent liability.
- Tags: Audit Procedures, Contingent Liability, Legal claims, Verification
- Level: Level 2
- Topic: Audit and Assurance Evidence
- Series: MAY 2017
- Uploader: Theophilus