Concealed liabilities and expenses (including improper capitalization)

Liabilities and expenses are omitted or understated: invoices not recorded, accruals reduced or reversed without basis, warranty and return obligations ignored, or operating expenses capitalized as assets.

Partly covered. The remaining analysis needs receivables data, which is planned.

Starter pack: Journal entry testing

Red flags

In the data

• Manual entries to accruals, reserves, or fixed asset accounts
• Expense-type items capitalized
• Operating cash flow consistently below net income; high accruals ratio

Behavioral

• Management pressure to meet earnings or covenant targets

Internal controls

• No search for unrecorded liabilities at period end
• No capitalization policy or no review of capitalized items