Practice shows that no audit is completed without detecting errors in the maintenance of accounting and tax accounting and the compiling of financial reporting. Of course, some errors occur due to plain carelessness, but a considerable number are a result of misinterpretation of regulations, or ignorance of the latest changes in legislation. Based on our experience, we bring you the 10 most common errors identified during an audit, as well as the advice of our auditors, to help avoid them.
Often companies that use software to automate the creation of financial statements have not paid due attention to control over the result. In such statements there may be a variety of errors – from insignificant accounting data inconsistencies to serious distortions.
We recommend mandatory monitoring and verification of the result of auto-fill of reporting forms.
As a rule, overstatement occurs because of the failure to conduct timely crediting of received or paid advances.
Underreporting of receivables and payables, as a rule, is due to the netting of debt for various counterparties. Such cases include netted reflection of the company’s debts to employees for wages or expense accounts. There are cases of netted reflection of debts for taxes or social insurance contributions.
For the purposes of a correct reflection of receivables and payables, we recommend that you monitor the timely crediting of received / paid advances. We also encourage you to monitor the absence of netted receivables and payables for various counterparties in the financial statements.
In crisis conditions, some companies refuse to accrual reserves entirely or try to reduce their size to a minimum, because the calculation of the reserve directly reduces the profit figure obtained for the current period.
Recall that financial statement indicators should give a fair presentation of the financial state of the organization. In the case of doubtful accounts receivable or inventories that have become obsolete, and the possibility of their further implementation is doubtful, companies are required to accrue the respective reserves in reports.
According to the rules of the tax legislation, companies have the right to carry forward tax losses in the future for 10 years. Often companies, even those that generate tax losses year after year, reflect the deferred tax asset in the balance sheet, while not evaluating the real possibility of the company to use the accumulated tax loss.
According to the rules of accounting, deferred tax assets are recognized in financial statements on the condition that it is probable that the company will have taxable income in subsequent reporting periods. In cases where companies year after year generate tax losses, the probability of using the accumulated loss in its entirety is highly unlikely. Therefore, the recognition of deferred tax assets on tax loss is not always justified, and in some cases can be regarded as improper overstatement of assets.
We recommend that companies reflect deferred tax assets based on an assessment of existing financial prospects and forecasts of tax results.
Very often in the procurement of materials or goods from a foreign supplier, accounting reflects their arrival in accounting as of the Customs date stamp “Release is allowed.” Please note that all the assets of the organization must be capitalized as of the date of transfer of ownership to them. The moment of transfer of ownership, as a rule, is determined by agreement of the parties. Often, the time of transfer of ownership is equated with the time of transfer of risks, which, in turn, passes usually at the time of transfer of the goods from the seller to the carrier. Accordingly, in practice, this means that this is the date the goods must be reflected in accounting.
Incorrect determination of the date to reflect goods in accounting leads to a distortion of reporting indicators, as well as to the incorrect determination of the exchange rate at which the value of the goods should be reflected.
We recommend reflecting acquired assets based on import contracts, taking into account the terms on the transfer of ownership in the contracts.
Contracts for purchase of large equipment, machinery, even real estate, may provide for deferred payment of several months to several years. But, the supplier, for the purpose of security, may provide for transfer of ownership of the object sold only after receiving full payment for it. And yet, the certificate of transfer and receipt of the object is made out immediately, and the Company uses the fixed asset in production activities.
In this case, buyers often reflect the fixed asset in off-balance sheets, guided by the formal lack of transfer of ownership, which is incorrect. In this case, one should refer to the regulations of PBU 6/01 “Accounting of fixed assets”. Among the criteria for recognition of an object as a fixed asset it indicates value of more than RUB 100,000, a period of intended use of more than 12 months, the ability to generate profits, and its readiness for operation. PBU 6/01 does not contain the condition of transfer of ownership.
Moreover, the general principles that underpin accounting and reporting require reflecting in accounting records facts of economic activity that took place not so much on the basis of their legal form, as on their economic substance and business conditions (demanding the priority of substance over form).
We recommend reflecting objects as fixed assets in accordance with the criteria set out in PBU 6/01, without waiting for the formal transfer of ownership.
Company accountants often do not reflect expenses in accounting, guided by the absence of the primary document from the supplier (for example, certificate of services rendered). In many cases, such a position is connected with the desire to bring together the accounting and tax accounting (because expenses cannot be considered deductible for income tax in the absence of primary documents from the counterparty). Given that, in practice, failure to obtain documents from suppliers or their receipt with a significant delay is very common, this approach can lead to significant understatement of expenses relating to the financial year, and as a consequence the improper overstatement of profit for the reporting year. With this approach, the financial result is distorted, and the owners of the company are misled by overstated profit figures.
Expenses should be reflected in accounting on the date of fulfillment of the conditions for their recognition in accordance with PBU “Expenses of an organization” 10/99. According to the norms of this PBU expenses are recognized in accounting under the following conditions:
As can be seen, the presence of a primary document from contractors is not among the conditions for recognition of expenses.
Thus, in cases where expenses are actually incurred, and the above conditions are met, companies should reflect the expenses in accounting. Otherwise, the company’s profit for the reporting year will be unreasonably overstated.
We recommend that companies, on the basis of concluded agreements, analyze expenses actually incurred. When the above conditions are met for the recognition of expenses, we recommend that companies draft an internal primary document based on which the expense will be recognized. Upon receipt of the primary document from the counterparty, if necessary, the accounting can be corrected.
This approach provides a reliable reflection of the financial results of the company.
Often the payment of bonuses to the head of a company that are not directly provided for by the terms of the employment agreement is documented only by an order of the head. Such a position may result in a claim, first, on the part of owners (participants, shareholders) regarding the fact of payment or bonus amount, and secondly, by the tax authorities on the question of the validity and documentary proof of these expenses.
Depending on the terms of the employment agreement, as well as the provisions of the founding documents, paying a bonus to the head may lie within the authority of the general meeting of members (shareholders) or the Board of Directors.
We recommend that companies pay bonuses to heads only on the basis of direct indication in the employment agreement, and in its absence – by a decision of the participants (shareholders) or the Board of Directors.
According to the Tax Code of Russia, amounts ordered to be paid by a court are to be reported in non-sales income as of the date of entry into force of the court decision.
Often companies’ accounting departments do not receive timely information about the status of lawsuits. This leads to the fact that the company does not reflect in income the amount of penalties, fines and other payments awarded by the court. Failure to reflect such income leads to an underpayment of income tax.
We encourage companies to track the results of trials for timely reflection of the results in the accounting.
Companies do not always control the conditions under which loans obtained are recognized as controlled for tax purposes. In particular, this may be when Russian companies, affiliated with respect to the foreign participants of the Russian company, act as guarantors on a debt obligation to an unaffiliated lender. We remind you that in such cases, the debt is recognized as controlled, and interest thereon is recognized in expenses in a special manner.
Also, companies often do not recognize controlled debt in obtaining loans from a “sister” of foreign companies that do not have direct or indirect ownership in the capital of the Russian company. Despite the fact that while tax legislation does not equate such debt to controlled debt, trends in court practice show the high tax risk of the position, which can lead to significant tax assessments.
It is also important to note that in 2017, the concept of controlled debt is amended at the legislative level, and starting from 2017, for example, a loan from a sister company will be recognized as controlled under the provisions of the Tax Code.
You can contact Awara for a detailed and independent expert examination of compliance with the rules of accounting and tax reporting in your company. See a list of our audit services at this link .