Knowing your client = better financial statements
Why Accountants Need to Know Their Client
When compiling financial statements, accountants organise the financial information provided by the client into a structured format. Unlike audits or reviews, the accountant doesn't verify the data, so there's no guarantee of its accuracy or completeness. Despite this, accountants are tasked with creating financial statements that are both coherent and compliant with business and legal standards. For instance, according to the Companies Act in South Africa, sections 29 and 30 require that financial statements must accurately present the company's situation and adhere to the relevant accounting standards, such as IFRS for SMEs.
Before an accountant fully grasps the nature of a business, they can't pinpoint which records, documents, or explanations might be missing, incorrect, or not satisfactory. This understanding, along with knowledge of the applicable financial reporting framework (AFRF), is crucial for the accountant to meet necessary ethical standards.
Following the International Standard on Related Services, ISRS 4410 (Revised), accountants have a structured guide to compile financial statements thoughtfully. ISRS 4410 mandates that accountants get to know the business and its operations well, including how its accounting system and records are set up, and how the financial reporting framework applies to that specific industry. If the financial statements they're compiling could potentially mislead someone or contain significant errors without further clarification, the accountant needs to suggest changes to avoid such issues.
How Deep Do You Need to Go?
Understanding the client's business goes beyond a surface-level review. Accountants need to grasp the essence of the business within its industry context, focusing on:
Business Model and Operations: Understanding the client's business model, like the production and distribution process is crucial for accurately reflecting financial health and operational efficiency. Considering a vineyard as an example, accountants need to comprehend the entire production chain from grape cultivation to wine distribution. This includes recognising the seasonality of operations, the impact of climate conditions on harvests, and the costs associated with each stage of production. Such detailed understanding enables accountants to accurately allocate costs, assess operational efficiency, and prepare financial statements that truly reflect the business's financial status. Additionally, understanding the distribution channels and sales strategies employed by the vineyard can impact how revenue is recognised and reported.
Industry-Specific Accounting Principles: Different industries have unique accounting challenges that require specialised knowledge. For instance, in the mining sector, accountants must navigate the complexities of exploration costs, which may include distinguishing between expenses to be capitalised versus those to be treated as operational costs. This distinction affects the balance sheet and income statement significantly. In agriculture, the valuation of biological assets, such as livestock or crops, demands an understanding of biological transformation and market prices to reflect true value accurately. The technology sector poses challenges in recognizing revenue, especially for companies offering software as a service (SaaS) where revenue recognition criteria based on customer usage or subscription milestones must be carefully applied. Accountants must adapt their methodologies to these nuances to ensure the financial statements are both accurate and reflective of industry standards.
Industry Landscape and Trends: Being informed about the client’s industry helps in compiling financial statements that are both relevant and compliant. For example, the renewable energy sector in South Africa is subject to a dynamic regulatory environment, influenced by both global trends towards sustainability and local government policies promoting renewable energy. Changes in regulations, such as tax incentives or subsidies for renewable energy projects, can have a significant impact on financial statements. Accountants need to be aware of these factors to ensure that financial reporting is compliant with current regulations and reflects the potential impact on the company's finances. This knowledge enables accountants to provide strategic advice to clients, helping them navigate the regulatory landscape effectively.
Competitive Environment: In competitive sectors like telecommunications, understanding market dynamics and technological advancements is vital for accurate financial representation.
Techniques to Gather Insights
Direct engagement with the client's personnel provides a deeper understanding of the financial data's nuances.
Engagement and Inquiry: Direct conversations with management and staff can illuminate the context behind the numbers, providing insights into transaction recording and internal controls.
Asking the Right Questions: Tailored inquiries, such as how a Johannesburg retail chain manages customer payments, can reveal important details about cash flow and financial stability.
Learn from Prior Experience: A longstanding relationship with a business offers a unique view into its evolution, challenges, and successes, enriching the financial statements' depth and accuracy. Reviewing past financial statements, audit reports, and management meeting minutes can offer valuable insights into the business's operations and financial history.
This guide aims to equip accountants with the knowledge and insights needed to compile financial statements that not only meet statutory requirements but also provide a true reflection of the client’s business and industry standing.
Compilation Engagement Checklist: Knowing Your Client
The checklist below provides key considerations for accountants to acquire the necessary understanding of their client's business operations, industry context, financial structure, and risk exposure, leading to more accurate and meaningful financial statement compilation.
