Common errors in financial statements.

COMMON ERRORS IN FINANCIAL STATEMENTS

As the demand for better and fuller financial statement disclosure grows, CPAs must be aware of proper presentations. This article examines common financial statement errors found by the Montana Society of CPAs financial statement review committee and explains how practitioners can correct or improve presentations.

FIVE PROBLEM AREAS

Some of the most frequently seen errors relate to long-term debt, related-party disclosures, accompanying information, goodwill and references to accountants' reports.

Long-term debt disclosures. The most common error was inappropriate disclosure of long-term debt under Financial Accounting Standards Board Statement no. 47, Disclosure of Long-Term Obligations. The combined aggregate amount of maturities and sinking-fund requirements for all long-term borrowings must be disclosed for each of the five years following the date of the latest balance sheet presented. In some of the financial statements, the disclosures were simply omitted. In others, disclosure was insufficient.

While Statement no. 47 doesn't specify the exact disclosure format, here's an example of an acceptable presentation:

D Company has two long-term borrowings outstanding. The first is a $100,000 sinking-fund debenture with annual sinking-fund payments of $10,000 in 19X2, 19X3 and 19X4; $15,000 in 19X5 and 19X6; and $20,000 in 19X7 and 19X8. The second borrowing is a $50,000 note due in 19X5. D's disclosure might be the following:

Maturities and sinking fund requirements on long-term debt are as follows:

  19X2          $10,000
  19X3           10,000
  19X4           10,000
  19X5           65,000
  19X6           15,000
  19X7-19X8      40,000
               $150,000

Related-party disclosures. Notes receivable and notes payable between shareholders and closely held corporations were common related-party transactions, but in some financial statements the related-party notes were not disclosed adequately. In some of the footnotes, the descriptions, amounts or terms of the related-party notes were not disclosed as required by FASB Statement no. 57, Related Party Disclosures.

There also may have been errors of omission for related-party disclosures, but the committee didn't have access to CPAs' workpapers. Specifically, Statement no. 57 requires disclosure of related-party transactions even when no dollar amounts are involved. For example, if the sole shareholder of a closely held corporation allows the corporation to use one of his buildings as a warehouse but receives no rental payments, this transaction should be disclosed.

Some footnotes contained assertions that the related-party transactions were at "amounts that approximate their market value." This may imply the transactions were on terms similar to those of an arm's-length transaction. Accounting literature contains caveats about such assertions for both the asserter and the attester. Representations about related-party transactions should not imply they were consummated on terms equivalent to those that prevail in arm's-length transactions unless such representations can be substantiated. Therefore, CPAs must be able to substantiate comments that the "amounts approximate their market value."

Statement on Auditing Standards no. 45, Omnibus Statement on Auditing Standards--1983, advises auditors that such representations are difficult to substantiate. CPAs also should be aware that they are giving the same level of assurance that the related-party transactions were at fair market value as they are giving to the financial statements as a whole. Since the footnotes are an integral part of the statements, CPAs attest to assertions about fair market values contained in the footnotes. Therefore, if such a representation is included in the footnotes and the auditor believes management does not substantiate it, depending on materiality, he or she should express a qualified or adverse opinion because of a departure from generally accepted accounting principles.

Accompanying information in compilations and reviews. According to Statement on Standards for Accounting and Review Services no. 1, Compilation and Review of Financial Statements, accountants performing compilation or review engagements should indicate clearly the degree of responsibility taken for accompanying information presented for supplementary analysis. Some CPAs submitted financial documents in which supplementary information was presented outside the basic financial statements without mentioning the supplementary information in the compilation or review report. Supplementary information must also be referred to in audit reports, but the committee found such errors to be more common in compilation and review engagements.

Common examples of accompanying information include

* Schedules of general and administrative expenses.

* Schedules of accounts receivable (occasionally required by lending institutions accepting accounts receivable as collateral).

* Work in progress schedules (often required by bonding companies for contractors).

An indication of the degree of responsibility assumed may be made in the accountant's report or in a separate report specifically on the supplementary information.

It isn't necessary to perform the same level of service on both the accompanying information and the financial statements. For instance, it is possible to review the financial statements but only compile the accompanying information. In such cases, the following paragraph could be presented either separately in the accountant's review report or in a report on the accompanying information:

"The schedule of general and administrative expenses on page xx is presented only for supplementary analysis purposes. Such information has not been subjected to the inquiry and analytical procedures applied in the review of the basic financial statements but was compiled from information that is the representation of management, without audit or review and, accordingly, we do not express an opinion or any other form of assurance on such data."

Goodwill. Some balance sheets reported goodwill as an asset but made no provision for its amortization. Even when it can be argued that goodwill has an indefinite life, Accounting Principles Board Opinion no. 17, Intangible Assets, requires amortization over a period not to exceed 40 years. Such amortization applies to all intangible assets acquired after October 31, 1970.

Reference to accountants' reports. Some of the financial statements submitted from compilation or review engagements did not refer to the accountant's compilation report or the accountant's review report on each page of the financial statements, as required by SSARS no. 1. In addition, some statements referred to the "accountant's compilation opinion." An "opinion," of course, can be given only in an audit engagement.

Several submissions had the term "unaudited" on the face of the financial statements. Accounting literature does not expressly prohibit labeling compiled or reviewed financial statements as "unaudited." Technically, however, this term is used in the literature in references to public companies' unaudited interim financial statements. When a public company's interim financial information has been reviewed, each page should be clearly marked "unaudited."

USEFUL AND PRACTICAL INFORMATION

Informing CPAs of the most common financial statement errors helps them address these problems and keeps them informed of the everchanging financial statement presentation and disclosure requirements. We hope other state society review committees will publish summaries of common errors. Doing so provides useful and practical information to CPAs and enhances conformity with current professional standards.

C. Randy Howard, CPA, professor of accounting, Accounting Department, Eastern Montana College, Billings 59101, and chairman of the Montana Society of CPAs financial statement review committee, and Barbara G. Taylor, CPA, PhD, assistant professor of accounting, Accounting Department, Montana State University, Bozeman 59715, and a member of the review committee, discuss potential trouble spots.