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One of the first things to understand is that unrecorded liabilities are not necessarily something that develops because an individual or business has failed to practice due diligence in managing financial affairs. In fact, it is normal for any business to have some degree of these liabilities. Since an unrecorded liability is nothing more than a liability item that does not currently appear in a financial statement, it may be a factor that just has not become necessary to report up to that point.
As an example, many companies provide vacation time accrual to their employees. Often, employees have the ability to roll over unused vacation time from one year to the next. This can lead to a rather sizable amount of compensation being owed to the employee at the time the individual decides to retire. Unused vacation time does not routinely show up as a line item on many company financial statements. Since the vacation time has not been used, there is no real way to account for it, until payment for the time is actually issued. That unused accrued vacation time is an excellent example of unrecorded liabilities that may become recorded at some future point.
Another scenario would be changes in state and federal laws that might impact the relationship between a vendor and the company. For example, a change in laws governing telecommunications allows your long distance and conferencing vendors to retroactively charge a new service fee back to the first of the current fiscal year. Certainly, this was not a known factor before and could not be treated as a recorded liability. Instead it would be classified as an unrecorded liability that in time the company would have to pay.
The same is true with a home budget. The budget may allow for a certain fixed percentage on mortgages and credit card interest. When something happens to increase those interest rates, the result is unrecorded liabilities for the home operations. That is, something that was not anticipated in the home budget and does not have a place on the home balance sheet, will be treated as an unrecorded liability until the new expense is factored into household operations.
Competent financial auditing seeks to keep the amount of unrecorded liabilities within a reasonable limit, mainly line items that are either unforeseen or are not meant to be included in financial statements until they can be accounted for in an existing classification. They should never be seen as a catchall for issues that arise due to poor planning or management of resources.
Unrecorded liabilities pop up all the time in companies. The example of vacations is a good one as it is common for employees to bank sick and leave time that must be paid when that worker leaves the company.
There's not a good line item for that, nor is there a good line item for sudden changes in tax obligations and other things that show up in the normal course of business.
The term "unrecorded liabilities" sounds like something shady is going down, but that's rarely the case.
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