Audit and Assurance Practice Exam

Which inherent risk is commonly associated with accounts payable?

1. Accurate understatement of assets

2. Timing differences in revenue recognition

3. Management's desire to understate accounts payable due to debt covenants

4. Overstatement of inventory values

The correct answer is: Management's desire to understate accounts payable due to debt covenants

Management's desire to understate accounts payable due to debt covenants is a commonly recognized inherent risk associated with accounts payable. This risk arises because organizations often have financial agreements that include covenants, which may set limits on certain financial ratios such as the debt-to-equity ratio or current ratio. To maintain compliance with these covenants, management may be incentivized to manipulate financial reporting metrics by understating liabilities, including accounts payable. By doing so, management can present a healthier financial position, which can impact the company’s ability to secure financing or maintain existing loans. Considering the context of the other options, the accurate understatement of assets primarily relates to balance sheet manipulation for overall asset reporting rather than the specific context of accounts payable. Timing differences in revenue recognition pertain more to the recognition of revenues rather than liabilities and are generally not a primary concern for accounts payable. Overstatement of inventory values does involve asset misrepresentation but doesn’t directly connect with accounts payable, which relates specifically to liabilities. The focus of the question is on inherent risks tied to accounts payable, making the choice concerning management’s motivations aligned with debt covenants a relevant and accurate reflection of the specific risks present in financial reporting related to liabilities.