How to Prepare Financial Statements from Incomplete Records - a Guide for Accountants
Meticulous record-keeping is necessary for financial transparency and accuracy. However, not all businesses adhere to this practice as meticulously as required, often leaving accountants having to prepare financial statements from "incomplete records." This issue is particularly prevalent among small and medium enterprises (SMEs) and non-profit organisations (NPOs) that lack the resources for full-scale bookkeeping. How can we prepare financial statements from these records? Addressing this is a challenge that requires a methodological finesse that transforms chaos into clarity, ensuring financial statements reflect the true nature of a business's financial health.
What do we Mean by Incomplete Records?
Incomplete records in accounting refer to scenarios where businesses have not maintained a thorough, chronological set of financial records as dictated by standard accounting practices. This could mean missing documents, incomplete transaction details, or haphazardly kept ledgers. The repercussions are significant, not just in terms of assessing financial performance but also in fulfilling legal compliance and preparing for audits.
Steps to Prepare Accounts from Incomplete Records
1. Initial Assessment and Gathering of Available Data
Obtain and take stock of available financial documents. These include bank statements, invoices, receipts, contracts, and even informal notes that might have financial implications. Sometimes, information might also be gathered from conversations with employees or reviewing past business practices.
Steps to take:
Interview business owners and key employees to gather verbal accounts of transactions.
Prepare an affidavit for the client that explains the circumstances regarding the incomplete accounting records, providing a detailed account of the missing or unavailable records and any reasons or explanations provided by the client.
Collect all physical and digital records that can detail financial transactions.
Create a schedule of records or a list of the information and note those missing.
2. Reconstructing Missing Transactions
Once all possible data is collected, you can reconstruct the accounting entries. This involves mapping out the timeline of transactions and correlating entries with bank statements and available invoices. This step might require creative accounting techniques to infer certain transactions based on available partial data.
Steps to take:
Review previous years' financial statements for patterns and recurring transactions. For example, if regular payments are made to a supplier (weekly, monthly etc.), missing payments can be estimated based on the payment patterns from prior years.
For missing sales data, estimate based on known periods of activity or seasonal trends.
Use bank statements to backtrack and confirm transaction dates and amounts.
Align invoices with bank withdrawals or deposits to ensure all sales and expenses are accounted for.
3. How to estimate missing figures
Often, not all data can be recovered or reconstructed. In such cases, you will have to use estimation techniques to fill in the gaps. These might be based on historical data, industry averages, or proportional relationships you have seen in documented months or years.
Use Past Patterns to Guess Missing Numbers (Statistical Methods):
If we have historical data, we can use it to predict missing values. This is like using pieces from an old puzzle to fill gaps in a new one, assuming that past trends will continue.
Look at past financial records to spot trends or repeated amounts such as expenses repeating in given intervals or link to other transactions i.e. customer orders.
Use simple math or statistical tools to extend these trends into the missing periods. For example, if sales increased by 10% every month last year, we might guess a similar increase for missing months this year.
Look at Industry Standards (Industry Benchmarks):
Sometimes, the best insights come from looking at how similar businesses are doing. If most businesses of a similar size and type spend a certain amount on materials, it's a safe bet ours did too.
Gather information on typical financial numbers from industry reports or trade groups.
Compare these industry norms with our partial data to estimate what might be missing.
If our data shows R1,000 in supplies last month and the industry average is R1,200, we might estimate our missing months around this higher average.
Scaling Known Data (Proportional Analysis):
When we have some data but not all, we can use the information we do have to estimate the rest. It's like knowing you spent R10,000 last week and guessing you spent something similar the week you lost your invoices.
Identify partial financial records available, like half-complete lists of transactions or expenses.
Calculate what proportion these known figures represent of the expected total.
Scale up these known amounts to fill in the gaps. For example, if we know we captured 75% of transactions and those totaled R7,500, we might guess that the total for 100% would be around R10,000.
4. Preparing Financial Statements:
You can draft the financial statements using the reconstructed and estimated transactions. These include a balance sheet, income statement, and cash flow statement. These statements must reflect both the actual documented transactions and the estimated entries.
Steps to take:
Draft the financial statements using the standard formats ensuring all known and estimated figures are included. Remember to start reconstructing the opening balance sheet items.
Calculate key financial ratios to check the reasonableness of the prepared statements.
5. Disclosure and Documentation:
You need to inform the users of the financial statement regarding the estimation and reconstruction processes and methods used and that there may be potential inaccuracies.
Steps to take:
Include a detailed note in the financial statements explaining the nature and impact of the incomplete records and the estimation methods used.
Document all assumptions made during the reconstruction and estimation phases.
Maintain a good documentation trail that includes interviews, methodologies, and any communication regarding the financial data collection and estimation process.
6. The practitioner’s report
When the financial statements are prepared from incomplete information, you must include a paragraph in your compilation or accounting officer’s report. The report should outline the adjustments made, considering the limitations of the available information.
Conclusion
Preparing accounts from incomplete records is intricate and requires accounting expertise and investigative skills. Through these detailed steps, an accountant can provide a reasonable, although not perfect, view of a company's financial situation, which is crucial for making informed business decisions, maintaining regulatory compliance, and preparing for audits.
Want to learn more? CIBA’s Non-Profit Accountant license includes guidance on how to prepare financial statement from incomplete records. Register by clicking on the image below.
This course is tailored for Business Accountants with BAP(SA) designations, focusing on enhancing your expertise in managing non-profit organization (NPO) finances. Here’s what you’ll learn:
Handling Incomplete Records: Gain practical skills in compiling complete accounts from incomplete records, crucial for helping non-compliant NPOs avoid deregistration and become compliant.
Marketing Skills: Learn to apply effective marketing strategies and stay updated with the latest industry trends and technologies to boost your earning potential.
Non-Profit Financial Management: Develop your ability to manage finances, including accounting and financial reporting, specifically for charities and non-profit organizations.
Understanding Regulations: Deepen your understanding of the Non-Profit Organisations Act of 1997 and the Income Tax Act as they pertain to Public Benefit Organisations.
NPO Financial Reporting: Master the specific requirements for presenting and disclosing financial information in NPO financial statements.
Compliance Requirements: Get to know the filing requirements with the Department of Social Development and SARS for exempt organizations, including how to handle annual information returns and potential business income tax issues.
Best Practices in Governance: Explore best practices in governance, risk assessment, and internal controls for NPO boards.
Effective Audit Planning: Learn how to effectively plan and communicate during audits, reviews, or engagements as an accounting officer.
