With the coming end of the calendar year, there will once again be a period of hard work for accounting departments. In many companies, preliminary audits of the financial statements will begin in the coming months, the final result of which will be an opinion by auditors on the reliability of the accounts and the financial statements drawn up on their basis.
In response to these challenges, using audit experience, we remind ourselves of typical irregularities in books and financial statements. We hope that this will help to better prepare for the closure of the coming financial year.
Intentional and unintended errors
The errors and irregularities found in the books and in the accounts can be broken down into:
- • errors of intent resulting from informed actions of employees or the management of the undertaking;
- • errors caused, inter alia, by ignorance of the law, lack of competence, negligence or other mistakes;
The intended actions are generally fraud and embezzlement involving often property acquisitions or falsification of financial statements in order to obtain personal benefits from management, employees or the company as a whole. In practice, they take forms such as: (1) manipulation, (2) falsification of documents, (3) omitting transactions, (4) recording of apparent transactions or (5) adopting incorrect assumptions in the methodology for calculating estimates.
Any of the errors, including those referred to in the Article, may, depending on the recital, be intentional or unintended. It is worth remembering that intentional errors are usually characterised by increased difficulty of detection.
Typical irregularities.
The most common irregularities reported are:
- • incompleteness of information and disclosures in periodic financial statements
- • distortions of the financial result by inflating revenue or lowering costs
- • poor way of establishing accounting estimates
- • settlement inventory errors
The incompleteness of information in the periodic financial statements is most common:
- lack of description of important, significant but unusual transactions, i.e. acquisition of an entity, underlying error, change in accounting policy, acquisition of shares or shares changing the nature of the relationship with the associate company to a subsidiary, or vice versa partial sale of shares
- failure to adapt accounting policies that would take into account specific situations arising from the nature of an entity or industry, including specific settlement of revenues, accruals of costs or a methodology for clearing stocks of products, long-term contracts
- lack of adequate disclosures in terms of business continuity; in recent years incompleteness is most often linked to insufficient reporting in financial statements of forecasts and plans that respond to existing risks and uncertainties of the economic environment
- no description of the risk elements associated with the monitoring of claims (credit policy) and foreign exchange risk and the management system of those risks
- insufficiently detailed tables for material items covering m.i.n.: accruals of costs, reserves, current and deferred tax calculations;
The distortion of the financial result is linked to the presentation of a better financial condition than actually existing in the company. The motive for such actions is to obtain personal benefits (employees, managers) or benefits for the company itself (the Board, owners).
This is most often done by shifting costs and revenues between years. It may happen that the disadvantage for the company manipulating the results due to macro- or micro-economic factors is worsening.
At that time, further, increasing transfers are made in subsequent years, in order not only to compensate for the current adverse situation for the entity but also the effect of the previous year's targeted errors which reduced the financial result of the current period.
In time, the unit ceases to control the height of the shifts and this is when they occurred. The question of "hidden errors" then returns with double force most often after external audit or tax audit.
This is when the actual costs of such an operation are revealed, not only in connection with the need to correct the tax settlements of previous years, but also with fines, penalty interest and in extreme situations even the liquidation of the company or criminal-tax and criminal proceedings for those responsible for the existence of a proceeding.
The result may also be distorted by introducing a cost balance sheet into the assets. This is often the case in real estate or construction companies that invest heavily or in dynamically developing companies.
With a large scale of investment in such entities, it is relatively easy to hide the costs of the period associated with the administration and operation of the company in the production costs of the fixed assets, i.e. real estate (in particular buildings and buildings), or stocks or operating systems created within the IT unit.
Accounting estimates appear in a number of balance sheet items, both on the asset side (stocks, receivables, asset depreciation, deferred income tax assets) and liabilities (reserves, accruals).
Practice indicates that many individuals, if they make estimates, do it too intuitive, without a developed uniform system of using rational premises. They shall not have adequate documentation of the estimates, including:
- • accepted for calculation of assumptions,
- • description of the calculation methodology used,
- • the final result of the calculation agreed with the historical data or information after the balance sheet date.
It is also common to note that financial and accounting departments do not cooperate enough in this respect with other departments of the entity, such as sales, recovery or purchasing and production. It is worth remembering that the employees of the operational departments have significantly better knowledge and understanding of the company and can provide more reliable information in this respect, which will significantly increase the reasonableness of respect and thus contribute to improving the quality of the financial statements.
Commonly occurring irregularities in accounting estimates are also associated with unjustified changes in the methodology of their calculation, or even the failure to create some of the reserves and write-downs. Such a situation may have a significant impact on the understatement or overshoot of the net financial result and consequently distort the entity's financial and property position.
Classical examples of misstatements on estimates include underwrites in stock, receivables or underwrites in guarantee costs and other costs/services incurred but not invoiced before the end of the period. Frequent manipulations can also be noted in construction and service companies using long-term contracts.
The manipulation of estimates in these entities is usually made through incorrect forecasts that affect the determination of the level of progress of the contract and consequently the result shown on it during the period.