Common Mistakes Frequently Observed in Financial Statements for Corporate Entities

Introduction

Financial statements play a critical role in reflecting a company's financial position and performance. However, corporate entities often make common mistakes in their preparation and presentation, which can lead to misinterpretation, compliance issues, or audit observations. This article highlights frequently observed errors to help improve accuracy and transparency in financial reporting.

Following are the common mistakes frequently observed in Financial Statements for Corporate Entities:

AS-10 - Misclassification of Capital and Revenue Expenditure

• AS Provision: Capital expenditures should be capitalized; repairs and maintenance are to be charged to revenue.
• Error: Misclassification of Capital and Revenue Expenditure
• Impact: Misstatement of assets and profits; incorrect depreciation; distorted financial performance.

Schedule II - Incorrect Depreciation Calculation

• AS Provision: Depreciation should be based on useful life and method prescribed under Schedule II of the Companies Act, 2013.
• Error: Incorrect Depreciation Calculation
• Impact: Incorrect depreciation affects both asset values and net profit.

AS-9 - Revenue Recognition

• AS Provision: Revenue must be recognized only when significant risks and rewards of ownership are transferred and realization is reasonably certain.
• Error: Companies sometimes recognize revenue before actual delivery of goods or completion of services.
• Impact: Premature recognition overstates revenue and profit.

AS-18 - Related Party Disclosures

• AS Provision: All material related party transactions and relationships (subsidiaries, associates, directors, etc.) must be disclosed.
• Error: Many companies fail to disclose loans, guarantees, or transactions with related parties.
• Impact: Conceals conflicts of interest and leads to regulatory non-compliance.

AS-29 - Provisions, Contingent Liability and Contingent Assets

• AS Provision: Contingent liabilities must be disclosed unless the outflow is remote.
• Error: Companies sometimes omit disclosure of significant contingent liabilities.
• Impact: Omission leads to incomplete risk presentation.

AS-1 - Disclosure of Accounting Policies

• AS Provision: Significant accounting policies must be clearly disclosed and applied consistently.
• Error: Changes in methods (e.g., depreciation) or assumptions are made without disclosure.
• Impact: Lack of transparency and comparability; may mislead stakeholders.

AS-5 - Prior Period Items and Changes in Accounting Policies

• AS Provision: Prior period items must be disclosed separately.
• Error: Companies mix prior period expenses or incomes with current period results.
• Impact: Distorts current period performance.

AS-22 - Deferred Tax Assets Without Profitability Assessment

• AS Provision: Recognize DTA only when future taxable profits are reasonably certain.
• Error: Deferred Tax Assets Without Profitability Assessment
• Impact: Overstates assets and net worth; may lead to reversals later.

AS-12 - Incorrect Recognition of Government Grant

• AS Provision: Recognize government grants only when compliance with conditions and receipt is reasonably assured.
• Error: Incorrect Recognition of Government Grant
• Impact: May overstate assets and net worth.

AS-14 - Provisions for Warranty or After Sales Service

• AS Provision: Provision required based on historical trends.
• Error: Not creating any provision where warranty liability exists.
• Impact: Lack of provision affects transparency and comparability.

AS-18 - Key Management Personnel (KMP) Disclosure

• AS Provision: Remuneration and transactions with KMP must be disclosed.
• Error: Not disclosing benefits or loans to non-executive KMP or their relatives.
• Impact: Governance transparency compromised; risk of non-compliance.

AS-10 - Asset Retirement Obligation (ARO)

• AS Provision: Provision required for future obligations like site clearance.
• Error: Companies ignore provisioning for such future obligations (e.g., warehouse restoration or plant site clearance).
• Impact: Understates fixed assets and liabilities; future financial impact.

AS-15 - Employee Benefits

• AS Provision: Gratuity and leave encashment must be provided on actuarial basis.
• Error: Non-provision or provision based on management estimate without actuarial valuation.
• Impact: Understatement of liabilities and expenses; risk of audit qualification.

AS-9 - Revenue from Loyalty Points / Coupons

• AS Provision: Revenue for future obligations (like loyalty programs) must be deferred and recognized on redemption.
• Error: Recognizing full sale value as revenue without deferring part for reward obligation.
• Impact: Inflated revenue and profit in the current period, possible reversal in future.

AS-26 - Impairment of Intangible Assets

• AS Provision: Intangible assets must be tested annually for impairment.
• Error: Skipping Impairment of Intangible Assets
• Impact: Skipping leads to overstated assets.

AS-3 - Non-Preparation of Cash Flow Statement

• AS Provision: Mandatory for all companies (except small/dormant under Companies Act, 2013).
• Error: Non-Preparation of Cash Flow Statement
• Impact: Financials incomplete; may lead to audit qualification or limited assurance.

Conclusion

Financial reporting errors can significantly impact a company's credibility, compliance status, and decision-making. The recurring mistakes outlined here-such as misclassifications, inadequate disclosures, and non-compliance with accounting standards-highlight the need for greater attention to accuracy and transparency. By addressing these issues proactively, companies can enhance the quality of their financial statements and build stronger trust with stakeholders.