FinancialReporting
GET IT RIGHT
Common problems in financial statements
Steve Collings highlights areas of difficulty and how they can be addressed
Illustration: Jackie Parsons
Technical compliance is becoming more of a challenge for preparers of financial statements. It is expected that this challenge will become more widespread once the periodic review amendments of UK and Ireland accounting standards come into effect for accounting periods commencing on or after 1 January 2026. It is worth noting that early adoption of the periodic review amendments is permissible provided they are all adopted at the same time.
This article focuses on key problems within financial statements and explores ways in which preparers can overcome those challenges.
Knowledge of accounting standards
Deficiencies in financial statements often arise because of knowledge gaps in accounting standards. Undeniably, accounting standards such as FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland are vast and require a large amount of professional judgment in many areas. Interpreting the standards can also be a complex issue.
If there is a specific issue where the preparer is asking themselves “Am I doing the right thing?”, it is always advisable to either read around the subject (there will invariably be an article on the AAT Knowledge Hub or in AT that covers it). It might also be advisable to seek third-party technical advice to make sure you’re on the right track.
With significant changes coming into FRS 102 in the next couple of years, such as new lease accounting and revenue recognition principles, getting a sound understanding of the technical requirements is a must.
It might be advisable to seek third-party technical advice to make sure you’re on the right track.
Reliance on accounts production software systems
Modern accounts production software systems are very powerful tools and today’s accountancy practice cannot work without such software. However, an issue that frequently crops up during reviews of financial statements is the way in which narrative disclosures and accounting policies have been worded.
Often, accounts production software systems will generate disclosure requirements based on entries in the trial balance. These software-generated disclosures (or ‘software GAAP’ as they are frequently referred to) will usually be ‘boilerplate’ – i.e. the wording will simply be a regurgitation of an accounting standard.
Tailoring accounting policies to be entity specific is a fine art, but it is necessary to ensure that the policies are concise.
For example, take a typical accounting policy for revenue (turnover). It is not uncommon to see the following accounting policy: “Turnover is stated net of VAT and trade discounts.”
Turnover is often the biggest number in the financial statements and usually has the least devoted to it in terms of an accounting policy. An example of an entity-specific turnover policy is as follows:
“Turnover is measured at the fair value of the consideration received or receivable, net of VAT and trade discounts. Turnover is also measured net of the estimated value of customer returns and volume rebates.
“Turnover is recognised on dispatch of goods which is the point at which the company transfers the significant risks and rewards of ownership of the goods to the customer. The company retains legal title of the goods until the customer pays, but this does not constitute a retention of the significant risks and rewards of ownership.
“Amounts received in advance of shipping goods to customers are recognised as deferred income and presented within creditors: amounts falling due within one year.”
Where illustrative disclosures, such as the above, are provided, they are not to be taken as being conclusive or compliant. The key is making sure the accounting policy is as entity-specific and concise as possible.
> Measuring tools
Basic financial instruments, such as bank loans and finance leases, are dealt with in FRS 102, section 11, Basic Financial Instruments. This only permits the amortised cost method, which uses an effective interest rate, as a measurement basis for basic financial instruments.
Where the entity chooses to use a measurement basis other than amortised cost, such as ‘sum-of-the-digits’ or the ‘level-spread’ method, this will result in the accounting treatment being inconsistent with FRS 102. In some cases, this can present a misleading position in the financial statements.
> Deferred tax
The headline rate of corporation tax in England is 25%. Small companies generating taxable profit of £50,000 or less pay corporation tax at 19%; marginal rates apply to companies generating taxable profits between £50,001 and £250,000.
Deferred tax must be calculated using the tax rates and allowances that have been enacted or substantively enacted by the reporting date and which will apply to the reversal of the timing difference.
It is not uncommon to see deferred tax balances stated at the same value as the prior year. This is either coincidental, the movement is immaterial, or the preparer has forgotten to do anything with the deferred tax balance.
If the preparer ignores deferred tax, there is a risk that the financial statements will be misleading, especially given that the tax rates are higher in some cases. Simply saying “deferred tax is immaterial” without calculating it can be a risky strategy.
> Secured debt
The Small Companies and Groups (Accounts and Directors’ Report) Regulations 2008 (SI 2008/409), schedule 1, paragraph 55(2) and The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008/410), schedule 1, paragraph 61(4), require the total amount of debts included under ‘Creditors’ to be disclosed. In addition, the nature of any security that has been provided by the company must also be disclosed.
Often this disclosure is forgotten about. Where a client has, say, a bank loan, it is always worthwhile checking the information lodged at Companies House to see if the loan is secured. If it is, disclose it as a secured debt in the financial statements and provide particulars of the security pledged.
Incorrect treatment for property revaluations
FRS 102, section 16, Investment Property, deals with the recognition and measurement of investment property. Where a company has an investment property on its balance sheet (statement of financial position), and the investment property is not intra-group, FRS 102, section 16 requires the property to be measured at fair value through profit or loss.
It is not uncommon to see fair value gains and losses on investment property being taken to a revaluation reserve (i.e. it bypasses profit and loss). This is the incorrect treatment for investment property fair value gains and losses because FRS 102, section 16, applies the fair value accounting rules in company law and not the alternative accounting rules. The latter requires gains and losses to be posted into a revaluation reserve and reported as other comprehensive income.
Preparers must also remember to consider the deferred tax implications for fair value gains and losses on investment property. There may also be indexation allowance to bring into consideration as well, which might reduce, or even eradicate, any deferred tax consequences on the fair value gain.
For micro entities applying FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime, investment property must always be measured at cost less depreciation less applicable impairment losses. Fair value amounts cannot be used under FRS 105.
Intangible assets
Intangible assets (including goodwill) under UK and Ireland accounting standards cannot be assigned an indefinite useful life. This means that all intangible assets must be amortised on a systematic basis over those useful lives.
Keep in mind that when the directors are unable to determine the useful life of an intangible asset, the amortisation period is capped at 10 years. It can be shorter but not longer. Be careful with this cap though, as it will only apply in limited circumstances because often it will be possible to determine the useful economic life of an intangible asset.
Approval of the financial statements
When the financial statements of an entity are authorised for issue (approved), FRS 102, paragraph 32.9 requires the entity to disclose the date on which those financial statements were approved.
This is not necessarily the problem here. In some cases, it is who gave that authorisation that is not disclosed, which is also a requirement of FRS 102, paragraph 32.9. To put this issue into context, consider the following illustrations:
Illustration 1
The financial statements were authorised for issue on 1 November 2024 and were signed by...
Illustration 2
The financial statements were approved by the director and authorised for issue on 1 November 2024 and were signed by…
Illustration 1 does not comply with FRS 102, paragraph 32.9 because it does not explain who gave the authorisation for the financial statements to be approved, which illustration 2 does.
Conclusion
Where a client may have complex transactions or issues, it might be advisable to consider using an up-to-date checklist to ensure disclosures are as technically correct as possible.
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