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¢100million in respect of pending legal suit against the company. The CEO quizzed the chief Accountant to explain how the amount of GH¢100million was arrived at.
Required:
i) Describe briefly what a contingent liability is giving example where appropriate. (2 marks)
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A Contingent liability is a potential liability that may occur, depending on the outcome of an uncertain future event. A contingent liability is recorded in the accounting records if the contingency is probable and the amount of the liability can be reasonably estimated. Contingent liability refers to a liability which will crystallized or occurs on the happening of a particular events. For e.g. pending legal cost.
ii) Explain in detail the audit procedures for the verification of contingent liability. (5 marks)
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- Review the client’s system for recording claims and disputes and the procedures for bringing these to the attention of the Board.
- Review the arrangements for instructing solicitors.
- Examine the minutes of the Board on this issues
- Examine bills rendered by solicitors
- Obtain a list of matters referred to solicitors from a director.
- Obtain a written assurance from the appropriate directors that they are not aware of any matter referred to solicitors other than those disclosed.
- If the auditor is at all in doubt he should obtain a direct confirmation from the company’s legal adviser.