Compiling Annual Financial Statements: A Practical Guide for the Compiler
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Compiling annual financial statements is more than taking a trial balance and putting the numbers into a set of financial statements.
As the compiler, you are using your accounting knowledge to help management prepare financial statements that are properly presented under the correct financial reporting framework.
However, a compilation is not an audit and it is not an independent review. You do not test transactions, verify balances or give assurance that the financial statements are correct.
The main standard that guides a compilation engagement is ISRS 4410 (Revised), Engagements to Compile Financial Information.
Here is what you need to think about when compiling annual financial statements.
1. Start with the engagement letter
Before you start compiling the financial statements, make sure there is a signed engagement letter.
The engagement letter should clearly explain:
What financial statements you are compiling
The financial year involved
Who will use the financial statements
Which accounting framework will be used, such as IFRS for SMEs
What management is responsible for
What you are responsible for
That the engagement is not an audit or independent review
That you will not provide an audit opinion or review conclusion
What type of compilation report will be issued
This is important because everyone needs to understand exactly what work you are doing.
2. Make sure you understand the business
You cannot properly compile financial statements if you do not understand the business.
Before preparing the statements, understand things such as:
What the business does
How it earns its income
Its main expenses
What assets it owns
How the business is financed
Whether it has loans
Who the shareholders and directors are
Whether there are related parties
What accounting system is used
How transactions are recorded
You do not need the same detailed understanding that an auditor would need, but you need enough information to recognise when something does not make sense.
3. Confirm the correct accounting framework
Do not automatically assume every company uses IFRS for SMEs.
You need to establish which financial reporting framework applies to the entity.
Depending on the circumstances, this could include:
Full IFRS
IFRS for SMEs
Another acceptable financial reporting framework
For South African companies, the company's Public Interest Score (PIS) and other requirements under the Companies Act and Regulations can affect its financial reporting and assurance requirements.
The reporting framework should therefore be confirmed before you start preparing the financial statements.
4. Check whether an audit or independent review is required
This is an important step.
Compilation and assurance are two different things.
A company may have its annual financial statements compiled but still be legally required to have them audited or independently reviewed.
Check the company's circumstances, including its Public Interest Score, ownership and applicable legal requirements.
Do not assume that because you are compiling the statements, nothing further is required.
5. Work from reliable accounting records
Normally, you will start with the client's trial balance, general ledger and supporting accounting information.
Make sure the financial statements can be linked back to the accounting records.
For example:
Trial balance:
Property, plant and equipment: R1,250,000
Financial statements:
Property, plant and equipment: R1,250,000
If you process adjustments during the compilation, keep a proper record of those adjustments.
You should be able to explain how you moved from the client's original trial balance to the final figures appearing in the financial statements.
6. Look for things that do not make sense
You are not performing an audit, but this does not mean you should ignore obvious problems.
While compiling the financial statements, ask yourself:
Does this make sense?
For example:
Bank balance is negative but shown as cash
A large loan has been classified incorrectly
Fixed assets exist but no depreciation was recorded
Inventory has not changed for several years
Large director loans have not been disclosed
Revenue increased significantly without an obvious reason
The company has large losses but no going concern disclosure
Expenses have been recorded as assets
VAT or tax balances appear unusual
Comparative figures do not agree with last year's financial statements
These do not automatically mean something is wrong.
They mean you should ask questions.
7. Pay attention to related parties and directors' loans
This is especially important when compiling financial statements for smaller businesses.
Look carefully at:
Loans to directors
Loans from directors
Shareholder loans
Transactions with related companies
Transactions with family members or connected businesses
Amounts owing between companies with common ownership
Make sure these balances are correctly classified and disclosed under the applicable reporting framework.
Also consider whether requirements of the Companies Act, such as those dealing with financial assistance, may be relevant.
8. Consider going concern
Do not ignore warning signs that the business may be struggling financially.
Examples include:
Continued losses
Negative equity
Serious cash flow problems
Liabilities exceeding assets
Large overdue SARS balances
Difficulty paying suppliers
Heavy dependence on shareholder or director funding
Loans that the business cannot currently repay
Loss of a major customer
This does not automatically mean the financial statements cannot be prepared on a going concern basis.
Management must assess whether the business remains a going concern.
Your role is to make sure the issue is considered and that the financial statements contain the appropriate accounting treatment and disclosures.
9. Check important accounting estimates
Financial statements often contain amounts that cannot simply be taken directly from an invoice or bank statement.
Examples include:
Depreciation
Useful lives of assets
Residual values
Bad debt provisions
Impairment
Inventory write-downs
Provisions
Deferred tax
Leave pay provisions
Management remains responsible for the judgments and estimates used.
You can assist and advise management, but the decisions ultimately belong to management.
10. Consider events after year-end
Ask whether anything important happened between the financial year-end and the date the financial statements are approved.
For example:
A major customer went bankrupt
A large legal claim arose
A property was sold
A major loan was obtained
The business suffered a major loss
A dividend was declared
A major debtor became unrecoverable
Some events may require adjustments to the financial statements. Others may only require disclosure.
11. Check the financial statements as a complete document
Once the financial statements have been compiled, do not immediately issue them.
Read them from beginning to end.
Check:
Do the statements balance?
Does profit agree throughout the financial statements?
Does equity reconcile?
Does cash agree to the cash flow statement?
Do the notes agree to the main statements?
Do comparative figures agree to the previous year's financial statements?
Are accounting policies appropriate?
Are important disclosures included?
Are directors and company details correct?
Is the financial year correct?
Are amounts classified correctly?
Do the financial statements make sense based on what you know about the business?
This final review can identify many simple mistakes.
12. Remember that management is responsible
One of the most important principles in a compilation engagement is that management remains responsible for the financial statements.
Management is responsible for:
The accounting records
The information supplied to you
The accounting policies
Significant judgments
Accounting estimates
The completeness of information
Approval of the annual financial statements
You are helping management compile and present the information.
You are not taking management's responsibility away from them.
Before finalising the engagement, obtain management's acknowledgement of its responsibility for the final financial statements.
A management representation or acknowledgement letter is commonly used as part of the file.
13. Issue the correct compilation report
Your compilation report is important because it tells the reader exactly what you did.
It should make it clear that:
You compiled the financial statements using information provided by management
Management is responsible for the financial statements
You applied your accounting and financial reporting expertise
A compilation engagement is not an audit
A compilation engagement is not an independent review
You do not express an audit opinion
You do not express a review conclusion
You therefore provide no assurance on the financial statements
The report should also properly identify the entity, financial statements, reporting period and applicable financial reporting framework.
14. Keep a proper compilation file
Your working papers matter.
Keep evidence of the work you performed and important matters that arose.
Your file should normally contain items such as:
Signed engagement letter
Client information
Trial balance
Final adjusted trial balance
Adjusting journals
Lead schedules or supporting schedules
Tax calculations where applicable
Fixed asset information
Loan information
Important agreements
Related party information
Significant accounting estimates
Going concern considerations
Important discussions with management
Final annual financial statements
Management acknowledgement or representation
Signed compilation report
The file should tell the story of how you moved from the client's accounting records to the final annual financial statements.
15. What if something is wrong?
This is where professional judgment becomes very important.
If information looks incomplete, incorrect or misleading, do not simply ignore it because you are "only compiling."
Ask management for more information.
If an accounting treatment is incorrect, discuss the required correction.
If an important disclosure is missing, address it.
If management refuses to provide information or make necessary corrections and the financial statements would be materially misleading, you cannot simply attach your name to them.
Under ISRS 4410, there are circumstances where you may have to withdraw from the engagement.
A simple rule to remember
When compiling annual financial statements, keep these three things in mind:
Management owns the information and the decisions.
You are responsible for performing the compilation professionally and applying your accounting expertise.
A compilation provides no assurance.
You are not there to prove that every number is correct.
But you are also not there simply to copy numbers from a trial balance into a set of financial statements.
A good compiler understands the business, understands the accounting framework, asks questions when something does not make sense, ensures the financial statements are properly presented and keeps a clear record of the work performed.
That is what makes a compilation engagement professional and useful.
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