During the course of your audit work, you discover the following fact pattern:

- The client accrued a liability for accrued vacation balances using old pay rates for employees. - The client laid employees off after the balance sheet date but booked an accrued liability for severance costs at the balance sheet date. The plans had not been formulated at that point in time and had not been announced. Under GAAP, the client does not meet the threshold to record a liability. - The client booked a bonus payable amount, but the amount does not appear to be supportable by the bonus plan offered by the Company, and in fact is higher than what the actual payouts were 30 days past the balance sheet date. - The Controller indicated the liabilities are simply estimates, and everything is good enough for government work and therefore you shouldnt be worried about it. - Based on your audit work, you believe the accrued liabilities balance is overstated on a net basis by 18% - The client exceeded their net income target for the year; all in all, the financials look very strong, even with an overstatement of the accrued liabilities balance.

Questions: (2 pages)

1. What reasons might a client have to overstate liabilities with the given fact pattern above?

2. As an auditor, how would you approach a conversation with the client when you observe/ determine the fact pattern above?

3. Under what circumstances might a client understate these same liability balances?