Rights and obligations definition
/What are Rights and Obligations?
Rights and obligations are an underlying assertion used in the construction of financial statements, stating that the organization has title to its stated assets and has an obligation to pay its stated liabilities. For example, management is asserting that an entity has title to the fixed assets that are summarized into a line item on the organization's balance sheet.
Auditors create audit procedures specifically to determine whether the assets and obligations reported by a client are actually associated with it. An auditor’s main concerns are whether the client is reporting all of the obligations for which it is liable, and whether it is reporting assets that it does not actually own.
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Example of Rights and Obligations
An example of the rights and obligations assertion in financial statements can be seen in the case of leased equipment and loan obligations. Suppose a company includes a fleet of delivery trucks on its balance sheet, with a total net book value of $500,000. To support the rights aspect of the assertion, the company must demonstrate that it holds legal ownership or control over these assets. In this case, if the trucks are owned outright, the company should have titles or purchase agreements. However, if the trucks are under a finance lease, the lease terms must transfer substantially all the risks and rewards of ownership to the company. The presence of these contracts validates that the company has the right to use and control the trucks, justifying their inclusion as assets.
On the obligations side, consider a $2 million loan listed as a liability on the balance sheet. To meet the obligations assertion, the company must confirm that it is legally responsible for repaying this loan. Supporting documents such as signed loan agreements and amortization schedules provide evidence of this responsibility. Including this liability ensures that the financial statements reflect the organization's actual debt obligations, in accordance with accounting standards.