Common Mistakes to Avoid When Preparing Financial Statements

To err is human—you must have heard of this common phrase, which means that it’s normal for people to make mistakes. But in accounting and finance, even the smallest of mistakes or accounting errors can lead to significant loss of time, hefty penalties and revenue. Financial statements are the building blocks of the company’s plans and decisions, which directly contribute to its financial health. Moreover, preparing them is a complex task that requires precision and a good understanding of the latest rules, regulations and accounting principles.

A survey by Gartner revealed that 18% of accountants make financial errors on a daily basis, with a third making at least a few financial mistakes every week and 59% making several errors every month. You would be surprised to learn that even highly experienced accounting and finance professionals make errors when creating financial statements. Here is a quick rundown of the common mistakes to avoid when preparing financial statements for your business or clients.

6 Common Financial Statement Mistakes

1. Data Recording Errors

Inaccurate data recording continues to be one of the key and damaging errors while preparing the financial statement. This is usually due to careless attention of the accountants doing the data entry, the absence of strict internal controls or data entry done in a hurry. Some of the common examples are:

• Missed Provision Entries: Provision is the balance sheet liability that includes possible future liabilities, which may be legal claims or warranties. These entries are important because without them, there are no other financial obligations of the company, leading to poor decisions being taken, which in turn can cause losses.
  A missed provision entry is common in many businesses where such provisions are common-place, and such understanding can have significant implications for the financial results.
• Errors in Income and Expense Classification: Classification errors, such as booking an expense under income or vice versa, create an unrealistic profit/loss statement. For example, incorrectly categorising and sometimes, ‘capitalising’ operating expenditure or incorrectly assigning it to become capital assets causes a problem on profitability. This error does not only affect internal performance incentives but can be very suspicious to investors and the public at large when undertaking due diligence performed on the transactions.

Solution: The errors mentioned above can be offset by putting in place strict measures and routines. However, instead of increasing the burden on data entry staff, it is advisable to fully automate data entry and verification processes to eliminate human error.

2. Missed booking for provision entries

Provision entries indicate future liabilities or expenses that are expected in the business. This can be warranty claims, potential legal settlements, or employee benefits. As companies fail to record these provisions results, there is an inaccurate representation of its financial obligations. The result? Misleading financial statements of the business or clients.

Impact: Omission of the provision entries can cause your financials to understate liabilities and overstate profits. This makes your business appear more financially stable than it actually is in reality. This could lead to cash flow challenges in the future when these unaccounted liabilities become due, thus, affecting your true ability to meet obligations due on your business.

Solution: Regularly review potential liabilities and ensure that all expected future expenses are recorded accurately. Implementing a structured month-end closing process with a checklist for provisions can help ensure that no entries are missed during financial statement preparation.

3. Error in Income and Expense classification

A frequent accounting mistake is classifying income and expenditure in the wrong manner, which may lead to erroneous financial statements compromising the actual profitability of the organisation. For example, if a firm spends capital expenditure cash but records it under operating expenses, or if a company books revenue to the wrong bucket thereby affecting the business’s income statement.

Impact: Such errors in classification may result in the wrong assessment of the profit margin computations, which influences critical financial ratios, and even gives the wrong impression of how the enterprise is performing to the shareholders. It can also result in breaches of other regulations, including those relating to financial reporting errors and could lead to sanctions by the regulators.

Solution: Have a comprehensive and detailed chart of accounts in place for proper and uniform classification of income and expenses. Ensure that regular internal auditing is done to check whether all the transactions are in their right classes, and make sure to invest in a useful accounting software that will guide your business about the appropriate classification to minimise mistakes.

4. Inadequate reporting of contingent liabilities

Contingent liabilities are those that may arise in the future, which may impose some liability or obligation. These could include potential lawsuits, warranty claims or other similar scenarios faced by an entity. Disclosing such liabilities, as a business, would ensure that there is no understatement of the financial position of the entity as reflected in the books of accounts and add up to the financial statement mistakes. The end result is non-adherence to financial reporting and other regulatory requirements, which may invite liabilities.

Let’s say the management is aware that a lawsuit may arise from their business decisions; however, the management does not provide this information on their financial statements. Now, think if the lawsuit goes wrong; what would be the consequences of that? Immediately, they incurred a new cost to them that was not anticipated before – the cost of the lawsuit. This kind of unpleasant experience not only costs profits but also damages the morale of investors who believed that the company was doing well with respect to its finances.

Solution: Follow an approach that enhances open access and guarantees that you are up to date with the accounting practices. Consequently, it earns confidence from the shareholders and potential investors in that the business embraces moral values concerning its financial reporting.

5. Errors in classification of assets and liabilities

Another prevalent error involves the misclassification of assets and liabilities. This mistake can cause misleading financial ratios, affecting your company’s perceived solvency, liquidity, and overall financial stability. Common examples include:

• Short-term assets incorrectly listed as long-term assets: This error can distort working capital calculations, leading to incorrect assessments of liquidity.
• Recording current liabilities as non-current liabilities: This misclassification can make the company’s financial position appear stronger than it actually is, leading to overconfidence or faulty investment decisions.

Solution: Implement a thorough review process where multiple eyes scrutinise classifications before finalising statements. Utilising modern accounting software can automate the classification process, ensuring accuracy and reducing manual intervention.

6. Inaccurate Inventory valuation

Discrepancy in inventory valuation is another significant cause of mistakes in financial reporting, especially for businesses with complex or high volumes of inventories. The most common mistakes involve overvaluing or undervaluing inventory, which directly impinges on profit margins and tax liabilities.

For instance:

• Overvaluation: This gives a jump in your profit figures and might cause overstating of your tax obligations which will almost negatively affect cash flow.
• Undervaluation: This leads to under-reporting profits, which may attract undesirable attention either from the tax authorities or potential investors.

According to Indian financial reporting standards, the inventory should be valued at the lower of cost and market value. Improper valuation affects both profitability and how the investors look at the efficiency of your business.

Solution: Keep performing regular inventory audits and invest in a software that could track the correct levels of inventory, costs, and market values as per the accounting principles.

Conclusion

In this quick-paced world of business, even minor financial statement mistakes can result in substantial setbacks for the business. As entrepreneurs and CFOs, ensuring complete accuracy and regulatory and tax compliance of your financial statements should be a priority. Not only this helps maintain the credibility but also, securing investments and drives sustained growth and success.

Febi.ai offers a cloud-based suite of capabilities to help you achieve end-to-end accuracy. By using Artificial Intelligence-driven automation, one can minimise financial statement mistakes, enhance compliance, and provide real-time insights into your financial health.

Are you ready to eliminate costly mistakes and elevate your financial reporting accuracy?