Introduction
Other long-term liabilities encompass various obligations that are not due within the next 12 months but do not fall under specific categories like borrowings or provisions. These liabilities can include deferred tax liabilities, long-term provisions, and other non-current obligations. Conducting a statutory audit of these liabilities ensures they are accurately recorded, classified, and disclosed in compliance with Indian laws and accounting standards. This guide provides detailed directions on how to audit other long-term liabilities, addressing common queries and confusions with practical examples.
Key Regulations and Compliance
- Companies Act, 2013:
- Section 129: Mandates the preparation of financial statements in compliance with accounting standards.
- Schedule III: Provides the format and requirements for presenting financial statements, including long-term liabilities.
- Sections 128 and 133: Govern the maintenance of books of accounts and compliance with accounting standards notified by the Ministry of Corporate Affairs (MCA).
- Indian Accounting Standards (Ind AS):
- Ind AS 1: Presentation of Financial Statements requires clear distinction and disclosure of non-current liabilities.
- Ind AS 12: Income Taxes deals with accounting for deferred tax liabilities.
- Ind AS 19: Employee Benefits covers long-term employee benefit obligations.
- Ind AS 37: Provisions, Contingent Liabilities, and Contingent Assets provide guidelines on recognizing and measuring provisions.
- Income Tax Act, 1961:
- Governs the treatment of deferred tax liabilities and related disclosures.
- SEBI Regulations:
- SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 mandate specific disclosures for listed companies.
Detailed Audit Procedures
1. Verification of Nature and Existence
Objective: To ensure the liabilities are genuine and accurately classified.
- Document Review: Obtain and review agreements, contracts, and other supporting documents related to the long-term liabilities.
- Example: A company has a long-term contractual obligation to pay for services over the next five years. Review the contract to ensure it specifies the payment terms and duration.
- Existence Verification: Confirm the existence of these liabilities by checking contractual obligations, correspondence with counterparties, and other relevant documents.
- Example: Confirm the existence of a deferred tax liability by reviewing tax assessments and correspondence with tax authorities.
- Classification: Ensure liabilities are classified as non-current if they are not due within the next 12 months. Verify consistency with the terms of agreements and contracts.
- Example: A provision for legal claims that are expected to be settled beyond one year should be classified as a non-current liability.
2. Compliance with Regulatory Requirements
Objective: To ensure compliance with statutory and regulatory provisions.
- Companies Act, 2013: Verify compliance with Sections 128, 129, and 133 regarding the preparation and presentation of financial statements.
- Deferred Tax Liabilities: Ensure compliance with Ind AS 12 for recognition, measurement, and disclosure of deferred tax liabilities.
- Example: Review the company’s deferred tax liability calculations to ensure they consider all temporary differences and apply the correct tax rates.
- Provisions and Contingent Liabilities: Verify compliance with Ind AS 37 for long-term provisions and contingent liabilities.
- Example: A company has recognized a provision for an environmental cleanup that will take several years. Review the provision’s calculation and ensure it complies with Ind AS 37.
3. Examination of Deferred Tax Liabilities
Objective: To ensure accurate recognition and measurement.
- Deferred Tax Calculation: Verify the accuracy of deferred tax calculations by reviewing the temporary differences between accounting and tax treatments.
- Example: A company has different depreciation methods for tax and accounting purposes, leading to a deferred tax liability. Verify the calculation of the temporary difference.
- Tax Rates: Ensure the use of appropriate tax rates in calculating deferred tax liabilities.
- Disclosure: Verify proper disclosure of deferred tax liabilities in the financial statements as per Ind AS 12.
4. Verification of Long-Term Provisions
Objective: To ensure provisions are recognized and measured correctly.
- Provision Documentation: Obtain documentation supporting the recognition of long-term provisions, such as legal obligations, restructuring plans, and warranty obligations.
- Example: A company has a long-term provision for warranties on products sold. Review past warranty claims to assess the reasonableness of the provision.
- Measurement: Verify the basis for measuring provisions, ensuring compliance with Ind AS 37. Check for consistency with historical data and management estimates.
- Reversal and Adjustments: Review any adjustments or reversals of provisions during the audit period. Ensure appropriate disclosure of such changes.
5. Review of Other Non-Current Obligations
Objective: To ensure all other long-term liabilities are accurately recorded.
- Lease Liabilities: For long-term lease obligations, verify compliance with Ind AS 116 (Leases). Check lease agreements, payment schedules, and discount rates used in calculations.
- Example: A company has a long-term lease for office space. Verify the lease liability calculation, including the present value of future lease payments.
- Employee Benefit Obligations: Verify long-term employee benefit obligations, such as gratuity and pension liabilities, ensuring compliance with Ind AS 19 (Employee Benefits).
- Example: Review the actuarial valuation report for a company’s long-term employee benefit obligations to ensure accuracy and compliance with Ind AS 19.
- Contractual Obligations: Review other long-term contractual obligations and ensure proper recognition and disclosure.
- Example: A company has a long-term obligation to purchase raw materials at a fixed price. Verify the contract and ensure the liability is correctly recorded.
6. Reconciliation of Balances
Objective: To ensure the accuracy of recorded amounts.
- Balance Confirmation: Obtain confirmations for long-term liabilities from counterparties where applicable.
- Reconciliation: Reconcile the confirmed balances with the company’s records and investigate any discrepancies.
- Example: Obtain a confirmation from a lender for a deferred payment arrangement and reconcile it with the company’s liability records.
7. Compliance with Disclosure Requirements
Objective: To ensure adequate disclosure in financial statements.
- Notes to Financial Statements: Verify that the financial statements include detailed notes explaining the nature, terms, and amounts of long-term liabilities.
- SEBI Requirements: For listed companies, ensure compliance with SEBI disclosure requirements for long-term liabilities.
8. Practical Examples and Case Studies
Example 1: Deferred Tax Liability
- Scenario: A company has a deferred tax liability arising from accelerated depreciation for tax purposes.
- Audit Approach: Verify the temporary difference between book depreciation and tax depreciation. Ensure the deferred tax liability is calculated using the appropriate tax rate and is disclosed as per Ind AS 12.
- Practical Insight: Confirm the tax rate used in the calculation aligns with the latest enacted or substantively enacted tax rates.
Example 2: Long-Term Provision for Warranty
- Scenario: A manufacturing company provides a three-year warranty on its products and recognizes a provision for future warranty claims.
- Audit Approach: Review historical data on warranty claims, assess the reasonableness of management’s estimate, and verify the provision calculation. Ensure compliance with Ind AS 37 and appropriate disclosure in the financial statements.
- Practical Insight: Compare the provision against actual claims over previous periods to assess the adequacy of the provision.
Example 3: Lease Liability
- Scenario: A company has a long-term lease for its office building.
- Audit Approach: Review the lease agreement, verify the lease term and discount rate used, and ensure the lease liability is calculated as per Ind AS 116. Check for accurate classification and disclosure of the lease liability in the financial statements.
- Practical Insight: Ensure the discount rate used reflects the company’s incremental borrowing rate if the interest rate implicit in the lease is not readily determinable.
Common Queries and Areas of Confusion
1.Classification between Current and Non-Current:
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- Confusion: Correct classification of liabilities due within the next 12 months as current liabilities.
- Resolution: Verify repayment schedules and ensure consistent classification as per agreements.
2. Measurement of Provisions:
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- Confusion: Determining the appropriate basis for measuring long-term provisions.
- Resolution: Ensure compliance with Ind AS 37 and review historical data and management estimates.
3. Deferred Tax Calculation:
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- Confusion: Accurate calculation of deferred tax liabilities.
- Resolution: Verify temporary differences and tax rates used in calculations. Ensure compliance with Ind AS 12.
4. Lease Liabilities:
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- Confusion: Correct calculation and classification of long-term lease liabilities.
- Resolution: Review lease agreements and payment schedules. Ensure compliance with Ind AS 116.
5. Disclosure Requirements:
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- Confusion: Adequate disclosure of long-term liabilities in financial statements.
- Resolution: Verify detailed notes to financial statements and ensure compliance with SEBI and other regulatory requirements.
Conclusion
Auditing other long-term liabilities requires a thorough understanding of regulatory requirements, detailed examination of supporting documents, and verification of compliance with accounting standards. By following the detailed procedures outlined above, auditors can ensure that long-term liabilities are accurately recorded, classified, and disclosed in the financial statements, providing stakeholders with a clear and accurate picture of the company’s financial obligations.
Author
CA Sourabh Kothari (C.A., B.Com)
He is currently working as Partner – Risk and Transaction advisory with a renowned firm in Jaipur having experience in Internal Audit, IFC Audit, Business consultancy, Due Diligence and Management consultancy.
E-mail: Sourabh.kothari@jainshrimal.in | LinkedIn: Sourabh Kothari
