Directors – What to look for before you sign financial statements!
As 30 June has passed us by, we are now officially in reporting season. It’s time for directors of all entities to fulfil their reporting obligations and report the financial position and performance to ASIC, ACNC, shareholders and banks.
What should I look for before approving the financial statements?
Application of knowledge in relation to the entity’s affairs is required by directors when forming an opinion as to approving financial statements.
Directors have a duty of care to ensure that the financial statements are an accurate representation of the entity’s financial state. A director’s declaration is required and divulges that the financial statements comply with accounting standards and are true and fair. So, to do this what are the key areas directors should be focusing on?
Does the company have the ability to pay debts as and when they fall due? Areas to review and support this assumption are as follows:
Statement of cash flows – does the entity have positive cash flow?
Profit and loss – did the entity make a profit during the year?
Balance sheet – does the entity have positive working capital?
Disclosures – what contingent liabilities and commitments are disclosed in the notes of the financial statements?
2. Reflection of the entity’s operations
After reading the financial statements in their entirety, does this reflect their knowledge and understanding and do they present a realistic view of the results and state of affairs of the entity? This knowledge should have been accumulated throughout the financial year from Board meetings, discussions with management, strategic decisions made and periodic review of management accounts.
Outside the key financial statements of the profit or loss, balance sheet, cash flow statement and statement of changes in equity lives the disclosures. It is the director’s responsibility to determine that the information contained is consistent with the directors’ knowledge of the entity and ensure that all material matters known to you, or that should be known to you, are not omitted from the financial statements.
4. What does the auditor say?
There is a range of communications between the entity and the external auditor within reporting season. Key documents which should be read and understood before signing the financial statements include:
Board report or management letter – within these documents the auditor will communicate corrected and uncorrected audit differences. This is a good indication of where to focus your attention in the financial statements.
Audit report – what type of audit opinion does the auditor plan to issue? Is this a clean unqualified opinion? Or do they have an emphasis of matter or qualification? Again, this is a good indication of where to focus your attention in the financial statements.
As a director you will also have an opportunity to correspond with the auditor, this traditionally would occur with the lead auditor attending a board meeting.
5. Changes and movements year on year
With the continuous introduction of new and amended accounting standards and changes to best practice, financial statements will continue to change accordingly. These changes should be a focus area for directors, as well as new balances or significant movements in balances from prior years. A significant movement could be a dollar amount or the percentage movement relative to the balance in question. If there are significant movements year on year it is the director’s obligation to understand the reasoning behind these movements and to ensure that this reflects your knowledge and understanding of the entity.
When signing financial statements, directors should keep in mind that they can face civil and criminal penalties for failing in their duties. These penalties may take the form of fines, disqualification or a compensation order. Following the above steps should help minimise the risk to the entity and the director.