One thing that can destroy the integrity of financial statements is hidden liabilities that are not recorded. The financial picture presented is rosier than it should be without these. Normally, it’s not anything fraudulent when we do an investigation on the financials and find these. Instead, it’s just that these have just been overlooked or undervalued.

So what might be some of these hidden liabilities that could be missing or understated:

1. Deferred revenues. The company may have been booking all the customer deposits right to revenues, but failing to recognize that some revenues may be earned over time. And so need to first be recorded as a liability on the balance sheet and then amortized over the life of the service. For example, a magazine subscription should be amortized over the month of the subscription or software licensing revenue over the same period that the license applies to.

2. Warranty expense. The company may have warrant that it offers customers on its products or services. Depending upon the history with the redemption rate and the materiality of the warranty, there should be a liability booked for the estimated warranty exposure.

3. Accrued expense. The company may have liabilities for expenses that have been incurred, but have bills that have not been received for yet. Sometimes this can be just a matter of timing. The service or supplier, for example, might bill midmonth, so an accrual is needed for two weeks worth or service in the previous month. Or, it might be that the supplier does weekly billings and the end of the month falls in the middle of the week. For example, if the end of the month is the 31^st which falls on a Wednesday and the service is generally tied to weekdays, you might need to accrue 60% of that first bill for the next month to reflect the estimated services received during those last three days of the month.

4. Missing accounts payable. If the company is buying inventory, it could be that there is merchandise received, but has not been billed for yet by the supplier. A test of this would be to look at the open receivers and see which ones do not have corresponding invoices. Any that pertain to that prior month should be booked as additional accounts payable.

5. Payroll liability. We don’t often see this, but sometimes it does come up that some payroll tax liabilities might have been missed.

6. Accrued bonuses. If a company has a history of paying out bonuses towards the end of the year and it hasn’t been accruing them during the year, it should consider doing so rather than having the entire bonuses get booked in the last month of the year.

7. Finance charges. There could be finance charges related to bank debt that gets paid in the following month, but needs to be accrued in the current month to get the full amount of interest expense booked for the month.

8. Other accruals. There might be other accruals that the company incurs, such as sales commission, that need to get booked into the financial.

9. Other continuing liabilities. There might be other liabilities that the company is liable for to a highly certain degree that need to get added into the liabilities on the financials to properly reflect the current financial exposure.

10. Professional fees. Some suppliers like attorneys, accountants and others are notoriously late with their invoices. You may need to be making some accrual for the invoices that you do not have yet for the month for such suppliers.

That gives a list of many liabilities that are sometimes missed in the financial statement. Take a look at your company and see if you have any exposure there.

It’s good to give it a test too. A couple tests that can be used include first looking to see if there is significant fluctuation between months on expenses that might not make sense compared to the revenues. This could be a sign that perhaps some accruals or other expenses were missing.

So give yourself a good test on the hidden liabilities. Think about the activities going on in your business, what you incur expenses for and what might not be showing up on the financials right now.

Jon Paul, MBA, CPA, CMC, CM&AA

President, Value Added Finance Resources
Bringing new insights on results and maximizing company value