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:
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. …