How to Verify Financial Statements - A Step by Step Guide
Promoting financial transparency and regulatory compliance is becoming more critical than ever for accountants. Maintaining the highest quality standards in financial reporting and delivering accurate, clear, and reliable financial statements isn't just about verifying numbers—it's about establishing a proactive, ongoing quality management system. With the introduction of the International Standard on Quality Management 1 (ISQM1), accounting practices now have a comprehensive framework to effectively manage risks, safeguard their reputation, and uphold the trust of both clients and regulators. There is a common misunderstanding that ISQM1 only applies to firms – but this is far from correct.
Producing Quality Financial Statements – the basics
Traditionally, quality control in accounting focused on reviewing work at the end of an engagement to detect and correct errors. While this remains important, ISQM1 introduces a more comprehensive approach to quality management. Rather than reacting to mistakes after they occur, this approach is about building robust processes and systems that actively prevent errors.
In our previous article on the implementation of ISQM1 you can read more about the step-by-step approach for a small practice to set up basic quality management systems, including defining the quality objectives, assigning responsibilities and implementing controls to reduce risks. In this article we provide you with further guidance on how to check the accuracy of your draft financial statement.
Checking Draft Financial Statements
One of the quality objectives of an accounting practice is compiling accurate financial statements.
This can be achieved by ensuring the financial information is recorded and presented correctly. Compiling a comprehensive file with supporting documents is the first step, but checking the draft financial statements for accuracy and completeness is equally essential. This review includes multiple elements, cross-references supporting documents, and compares them with prior year data. Here’s a step-by-step process you can follow:
Compare Information to the Prior Year Financial Statements
Compare the prior year's figures disclosed in the draft AFS year against the prior year’s final–signed financial statements. By doing this ensure that:
The figures in the statements and notes are the same as in the prior year’s AFS. Pay specific attention to the fact that the opening retained earnings should agree to the closing retained earnings of last year.
Management reports and information have been correctly disclosed, i.e. names of directors/shareholders, addresses, etc.
The accounting policies used are consistent with prior years or clearly state any changes.
If mistakes are noted, they should be corrected. This may seem unnecessary, but leaving an error like this can be pretty embarrassing if picked up by the client, independent reviewer, or auditor.
Cross-check with Supporting Documents and Schedules
Ensure that each figure in the financial statements is supported by relevant documentation. Confirm every figure in the financial statements with its corresponding document:
Cash Balances: Match cash balances in the financial statements with the closing balances on the bank statements and reconciliations.
Loan Balances: Cross-reference liabilities with loan agreements and loan confirmations to ensure they reflect the accurate terms and balances of loans.
Long-Term Obligations: Review lease agreements, warranties, and other contracts to verify long-term liabilities and commitments in the financial statements.
Payroll Expenses: Compare employee costs, bonuses, and related expenses in the income statement to payroll records and schedules.
Income and Expenses: Cross-check income and expense balances with lead or supporting schedules to ensure they are consistent with the financial statements.
Tax Balances: Confirm to SARS statements of accounts, returns and supporting calculations where applicable.
Fixed Assets: Confirm that the balances disclosed in the notes agree to the fixed asset register.
Other information: Check the client’s registration documents and meeting minutes to identify changes in directors/shareholders/members.
Check the consistency between the different statements
To ensure consistency across financial statements, follow these key steps:
Retained Earnings: Cross-check retained earnings in the statement of changes in equity with the income statement and statement of financial position.
Cash Balances: Verify that the closing cash balance in the cash flow statement matches the cash and cash equivalents on the statement of financial position.
Net Income: Ensure net income from the income statement matches the starting point in the operating activities section of the cash flow statement.
Depreciation and Amortisation: Confirm that these figures match those in the income statement, cash flow statement (where they’re added back), and notes.
Working Capital: Ensure changes in receivables, payables, and inventory on the balance sheet align with adjustments in the cash flow statement.
Long-Term Assets & Liabilities: Reconcile any changes in long-term assets or liabilities across the balance sheet, cash flow statement, and notes.
Dividend Payments: Match dividend cash outflows in the cash flow statement with reductions in retained earnings in the statement of changes in equity.
Income Tax Expense: Confirm income tax expense in the income statement matches the tax paid in the cash flow statement and check that taxes payable are accurately reflected in the statement of financial position.
Verify Information in the Financial Statements to the Disclosure Notes
The notes provide additional context and breakdowns of figures in the primary statements. It’s essential to ensure consistency between the figures and explanations in the notes, and for this, you should:
Confirm that there is a corresponding note breaking down each material balance disclosed in the statements.
Verify that the totals in the notes agree with the totals in the financial statements.
Confirm that the stated accounting policies are correctly applied in the notes, i.e. depreciation rates.
Ensure that disclosures about future commitments (e.g., leases, lawsuits) are accurate and complete.
Check if any transactions between related parties (e.g., owners, directors) are fully disclosed and documented.
Reconcile with Trial Balance and Ledgers
The trial balance provides a detailed summary of all accounts used in the financial period. It should match the financial statements:
Trial Balance Check: Ensure that the totals for assets, liabilities, revenue, and expenses in the financial statements match the trial balance.
Subsidiary Ledgers: Check individual ledgers, such as accounts payable and receivable, for consistency with the reported figures in the financial statements.
Check for Mathematical Accuracy
Ensure there are no mathematical errors, such as:
Addition and Subtraction Errors: Double-check that adding figures, especially in subtotals and totals, is correct.
Formula Errors in Spreadsheets: If using software like Excel, ensure formulas are accurate and consistent across periods.
Action: Use an automated tool or manually check for calculation errors throughout the statements.
Review for Compliance with Accounting Standards
Ensure the financial statements comply with the relevant accounting standards (e.g., IFRS for SMEs or IFRS). This includes:
Classification of Items: Check that assets, liabilities, equity, income, and expenses are appropriately classified according to the standards.
Disclosures: Confirm that all required disclosures, such as accounting policies, contingent liabilities, and significant accounting judgments, are included in the notes.
Action: Review checklists or guidelines specific to the accounting framework your firm follows to ensure compliance.
Validate Adjusting Entries and Accruals
Ensure that all adjusting entries (e.g., for depreciation, amortisation, accruals, and deferrals) have been correctly calculated and entered:
Accruals: Confirm that revenue earned but not yet received and expenses incurred but not yet paid have been appropriately recorded.
Depreciation and Amortisation: Check that these figures are calculated according to the relevant accounting policies and match asset schedules.
Action: Review adjusting entries and compare them to supporting schedules and documentation.
Final Review for Consistency and Presentation
Perform a final review to confirm that the presentation is clean, consistent, and meets the expected standards.
Consistency of Presentation: Ensure that the format and structure of the financial statements are consistent with prior years and meet regulatory requirements.
Footnote Consistency: Make sure that footnotes provide complete information, especially regarding changes in accounting policies or estimates.
Material Disclosures: Check that all material transactions and balances are fully disclosed and nothing significant is missing.
10. Document your work
Always document your work! Use tickmarks and use different colours to make it fun!
Learn how to draft better financial statements - register for CIBA’s CPD Course on Compilation of Annual Financial Statements: Navigating Companies Act Requirements, PI Score Implications, and Accounting Framework Essentials 2024
What you will learn
By attending this webinar you will gain the following competencies:
The key requirements of the Companies Act related to the compilation of Annual Financial Statements.
How to accurately calculate the Public Interest (PI) Score and understand its implications for financial reporting.
The application and importance of relevant Accounting Frameworks in the preparation of financial statements.
Best practices for ensuring compliance with statutory requirements and accounting standards.
The impact of the PI Score on audit requirements and other compliance obligations.
How to effectively apply accounting frameworks to different types of entities, considering size, structure, and industry.
The significance of aligning financial statement preparation with both legal and ethical standards.