by Dinesh Bhola (Managing Director, DSB Financial Solutions Ltd)
Your financial reporting team has provided you with your year-end Management Accounts Package (MAP) for your review. One of the first things on your checklist is to compute the year end Employee Bonus (which is based on reported profits). Thereafter, next on your list is to review your final tax computation.
The MAP appears to be in good order and there are several charts, graphs and narratives which explain the numbers in a fair level of detail.
However, you have a gut feeling, something just doesn’t look right. You check with your trusted business advisor and ask him to go through the numbers. He notes the following:
- A bank account was opened early in the financial year and was not reflected in the MAP. Accordingly, all payments and deposits from this bank account were not recorded.
- An item of equipment and the corresponding loan to purchase the said equipment was not recorded in the MAP
- A series of cheques written in the last month of the financial year were not recorded in the MAP
- A batch of invoices is sitting in the Administrative Assistant’s desk drawer and therefore has not been entered
- No provisions were made for additional liabilities arising out of a recently concluded court matter.
- There were five duplicate entries in the accounts payable ledger.
The above shows that even though a completed MAP may be made available to you, there may be material omissions which can result in inappropriate decisions taken.
A key assertion in preparing a set of financial statements is “Completeness”. This essentially means that All transactions that occur are entered and accepted for processing once and only once in the financial reporting system. So all must be included and there must be no duplicates.
These issues tend to arise in the following situations:
- Lack of awareness of requirements. Accountants prepare financial statements based on information submitted to them. Therefore, it is important that business owners and Line Managers are aware of their role in the process and what inputs is required from them. Owners, as the persons ultimately responsible for the financial statements should ensure there is proper communication lines between the front office and the back office. How involved is your accountant in the business? Do you all him/her unrestricted access to accounting information?
- Failure to execute proper accounting close-out procedures at year-end (in particular those to ensure “completeness” of transactions).
Accounting close-out procedures to ensure completeness include:
- Discussions with the business owner and line managers on business activity, status of business projects and developments. A review of minutes of meetings and project site visits may also assist (if practical).
- Understand and evaluate what controls (if any) exists to ensure all transactions are reflected in the MAP. Also consider automated controls in accounting software to reject posting of duplicate entries.
- Sending out a formal communication to all staff informing them of the monthly close off deadline and the need for all invoices and other information to be submitted on or before an agreed date. Consider having penalties for non-compliance (e.g. a salary deduction for late submission of expense reports tend to be effective).
- Performing analytical review procedures. Compute financial statement ratios and compare to benchmark. Compare actual performance against budgets. Trend out financial information by month and review for unusual fluctuations. Review Aged Receivables and Aged Payables report and investigate long outstanding items as these may be indicative of duplicate or invalid entries. Do the numbers make sense?
- Ensuring all reconciliations are completed and up to date. In particular, items on the bank statement and not in the system can be indicative of unrecorded activity. Perform vendor reconciliations to supplier statements.
- Sending out bank confirmation letters to bankers asking for pertinent information on bank accounts, loan accounts and contingent liabilities
- Reviewing contracts, legal and tax correspondence files for information/updates on matters
- Performing a sequence review on invoices and cheques for the year. Investigate sequence breaks.
- Comparing non-financial information (e.g. project management worksheets, sales volume reports, production reports) to the accounting records.
The above are just some of the key procedures to consider to gain assurance over completeness of information.
Thus far in this article, we touched on Completeness. In previous articles, we touched on Valuation and Accuracy. In financial reporting, there are other areas which can go wrong, whether through error or fraud
- Cut off – Transactions recorded in the wrong period. A Sales Manager may try to push out a lot of stock/sales on credit at the end of the year to secure a bonus. After year end, the debtors may fail to pay or may return the goods. This is an example of “Trade Loading”.
- Classification – Expenses may be inappropriately classified within other items. For example, Entertainment or Personal Expenses, may be purposely hidden within “Cost of Sales” to escape the tax restriction. Alternatively, if the budget for an item of expense has been exhausted, management may decide to classify within another item.
- Presentation/Disclosure – An entity may choose to present a current liability as non-current to improve their current ratio. An entity may also omit an important disclosure relating to a contingent court settlement in an effort to conceal the exposure. There are several other “window dressing” strategies that entities can use.
- Occurrence/existence – Fictitious transactions and balances may be recorded through the use of journal entries and related party transactions. We would have touched on this in our article on fraud.
- Rights/Obligations/Ownership – The company may have assets on their balance sheet which they do not own or control. Lenders may unknowingly grant credit on the assumption that these assets exist.
So all in all, even with the most sophisticated systems, human error or override can lead to significant misstatements to your financial reports. Having access to a qualified accounting resource (internal or external) can go a long way in ensuring that financial reports are fairly stated.
Dinesh Bhola is the Managing Director at DSB Financial Solutions Ltd, a company providing accounting, audits, taxation and business advisory services. The above is for general informational purposes only and is not meant to serve as a substitute for formal advice. We urge you to consult with your service provider or us if you require further advice or recommendations.
