Juggling the financial statements: What to look out for at the end of the financial year

December is both magical and hectic in accounting. Every accounting entity should prepare in advance for one of the highlights of the accounting period, namely the annual financial statements.

In our article, we will remind you of the key steps of the financial statements, so that the “tax Santa” does not turn into the “accounting Grinch”.

Accounting is a complex matter that has its own rules (set out in statutory and internal regulations) and it is not advisable to underestimate them or fail to comply with them.

Below is an overview of some areas of the financial statements that deserve attention and that often determine not only the correct presentation of the financial statements but also, among other things, a smooth course of the audit. As the famous saying goes: “Before everything else, getting ready is the secret of success”.

Inventory of accounts

The basic building block of the financial statements is the recording of individual inventories of balance sheet accounts. The entity must be aware of what constitutes the balances of the individual asset and liability accounts, whether the balances are relevant, or whether there is a need to dissolve or supplement something or to take other steps to correctly report the balance.

A book inventory of all balance sheet accounts verifies that the reported balances correspond to reality and are supported by relevant documentation. For bank accounts, balances are compared with bank statements, and for receivables and payables, balances are checked or reconciled with counterparties. In the area of inventories and assets, the register is compared with the general ledger, while in the area of equity, it is checked whether all decisions of the company’s highest authority (usually the general meeting) have been accounted for, etc.

Inventory of balance sheet accounts is a recurring accounting act, so it is not a status variable. It is necessary to address the balances on an ongoing basis and then respond appropriately.

Internal guidelines

Before commencing closing operations, the accounting entity should verify that it has all the current guidelines, on the basis of which it will close the accounts and prepare the financial statements. Internal guidelines are prepared individually by each accounting entity, as it is documentation of its procedure/approach to certain areas of reporting in the financial statements – e.g. the area of provisions, depreciation plans, reserves, estimates, accruals (e.g., the option of not distinguishing between regular and insignificant transactions).

Accounting policies must not be changed during the accounting period. If the entity identifies a need to make a change, it will assess what the change is. The change may involve stricter/more lenient creation of provisions for receivables/inventories/assets based on an assessment and analysis of past events. The change may also have a material impact on the financial statements, for example, a change in the valuation of inventories (from FIFO to average cost) or a change in the method of accounting for inventories (from method A to B or vice versa). Changes that have a material impact on the financial statements must be evaluated, among other things, for the need to make retrospective adjustments. 

Non-current tangible and intangible assets

In this area, it is crucial to verify its actual existence, condition, and correct reporting at the closing date. These checks include, in particular, a physical inventory of assets, which confirms the accounting entity’s ownership, physical location, and technical condition of individual items. Identified wear and tear, damage or unserviceability may lead to adjustment/updating of the depreciation schedule, creation/reversal of an allowance or removal of the asset from the records. The results of the inventory must be properly documented in inventory lists and the entire procedure must comply with the company’s internal guideline. Closing checks also include reconciling the asset register with the trial balance to ensure that the reported balances are complete and accurate. Assets that cannot be physically verified must be inventoried on the basis of documentation.

Non-current financial assets

These assets, which are most often recorded in the form of a business interest (share) in another entity, must be reviewed at closing to assess the current value and economic position of the companies, in which the entity has an interest. Under Czech accounting regulations, shares may be revalued in two ways as of the balance sheet date (or any other date, at which financial statements are prepared): 1. using the equity method, whereby the shareholding in the subsidiary is revalued through the value of its equity, or 2. at the original acquisition cost, which is tested for impairment and, if there is an indication of impairment, the acquisition cost is adjusted using a provision.

Inventory

One of the crucial areas, where an integral part (as with non-current tangible assets) is to carry out a physical inventory of stock. When taking inventory, the company must have guidelines in place, an appointed inventory committee, a set schedule for inventory, and trained staff. At the same time, it is necessary to verify that all locations where stocks are located, including consignment warehouses or external locations, have been included in the inventory. If there are inventories in the warehouses of the accounting entity that are not owned by the entity, they must be excluded from the inventory and clearly identified. The inventory list used in the course of the inventory taking must comply with the legal requirements and contain any differences (shortages, surpluses) found. In the case of inventory that is found to be unusable/unsaleable, a decision must be made regarding its disposal, proper documentation must be completed, and the disposal must then be reflected in the accounting records. The financial statement also includes a review of the valuation of inventories in relation to expected sales in the next period, i.e., whether the price at which the inventory is recorded in the accounts is not lower than the expected selling price (market price). If an indication of a loss-making sale is identified, an assessment of the provision and its reflection in the accounts should be made as of the balance sheet date. This always involves an individual assessment of items/groups of inventories by the accounting entity.

Receivables

The initial check in the area of accounts receivable is the reconciliation between the general ledger and the balance sheet, as well as the verification of the correctness of the revaluation of receivables recorded in foreign currency. For the purpose of preparing the financial statements, it is necessary to check the maturity and therefore the accuracy of reporting – long term vs. short term.

The accounting entity should continuously (as part of ensuring its duty of care) but no later than the balance sheet date evaluate the age and collectability of its receivables. For doubtful or uncollectible receivables, appropriate provisions must be made in compliance with internal guidelines and applicable legislation, and, where appropriate, related settlements must be made on the basis of ongoing/completed litigation or the results of insolvency proceedings.

Foreign currencies and exchange rate differences

All foreign currency items are to be revalued at the current exchange rate of the Czech National Bank as of the balance sheet date. The obligation applies in particular to receivables, payables, bank accounts, cash, i.e. those items for which the entity bears exchange rate risk. When the above items are revalued, exchange differences are recognized in the  financial result (income/costs). The financial statements also include areas that are required to be revalued in the Czech currency, but the impact of exchange rate movements is not reflected in the current period profit or loss but directly in equity. The accounting entity must therefore correctly identify the titles for revaluation of foreign currency items into Czech currency and account for the exchange rate difference in the relevant area of the financial statements. 

For significant foreign currency movements, the accounting entity usually considers hedging using financial instruments (e.g. derivatives).

Estimated items, reserves, and accruals

In practice, it is often the case that entities do not fully distinguish between the title for an estimate, an accrual and a reserve, but evaluate this area only in terms of tax deductibility. This view is not correct from the point of view of Czech accounting regulations and the accounting entity should ask itself the following 3 questions when deciding on the method of recording: 1. Do I know the amount? 2. Do I know the period? 3. Do I know the grounds?

At the same time, the accounting entity must evaluate all available information about the given transaction and the relevance of its recognition/non-recognition to the financial year, for which it is preparing the financial statements.

In general, we can say that with accruals, we know all the information needed for their accounting (amount, period, and title), with estimates, we usually know the period and title, but estimate the amount, and with reserves, the level of information is lowest.

Accruals

Accruals ensure that costs and income are correctly allocated to the period, to which they are materially and temporally related.   Companies should review individual items that span multiple accounting periods – typically insurance premiums, rents, and subscriptions, which may be invoiced in advance or retrospectively, and the accounting entity must capture them correctly.

Estimated items

Estimated entries are created in situations where a cost/asset or income belongs to the current period but the final accounting document evidencing the purchased/sold transaction is not yet available and the invoicing will be made in the following period. Their purpose is to ensure that costs and income are correctly allocated over time to avoid distortion of the economic result. It is important to verify at the time of closing that the amount of estimated items is based on verifiable evidence (e.g. contracts, orders, actual consumption) and corresponds to economic reality. At the same time, companies should avoid duplicate postings after receipt/issuance of the final invoice and review older estimates that no longer have economic justification.

Reserves

Reserves need to be made only for liabilities (debts), for which there is an objective title and probability of their occurrence, provided that the performance (title) is already recorded as of the balance sheet date. When closing this area, it is important to verify that they are up to date, that they have been calculated correctly, and that the reasons for their creation still apply. Most often, these are provisions for unused leave from work, employee bonuses, litigation, expected property repairs, and reserves for warranty repairs. If the obligation has lapsed or has been fulfilled, the reserves must be adequately reversed.

Costs

When closing the accounts, it is crucial to verify the completeness of costs, i.e., whether all costs that belong to the current period in terms of substance and time have actually been accounted for. In particular, companies should examine services and transactions that are invoiced retrospectively or relate to a longer period. Typical examples are rent and related utilities (water, electricity, gas), insurance premiums or subscription services. This prevents an entity from recognising a cost on a one-off basis if the transaction relates to more than one accounting period. For costs where the final accounting document is not available at the time of closing, the need for an estimate should be assessed to ensure that the result is not distorted, and possible titles for the creation of a reserve should be examined. At the same time, it is necessary to check the operating advances paid during the accounting period to see whether, as of the balance sheet date, there is a title for the creation of a related expense due to the performance already consumed in the given period.

Revenues

For revenues, it is necessary to verify the correct time allocation, i.e. whether the company’s accounting records all the revenues that actually belong to the accounting period or whether it is necessary to verify the distribution of some transactions over several periods. Companies should correctly assess whether the conditions for recognition in the financial statements have or have not been met during the financial year. The contractual arrangement vs. the actual moment of delivery of performance (supplies, services) must be adequately evaluated and captured in the accounting. It is also necessary to examine the revenue accounted for on the basis of estimates or advances received to verify that it corresponds to the actual situation.

Deferred tax

Accounting entities that are required to account for deferred tax must identify all temporary differences between the accounting and tax values of assets and liabilities at the end of the financial year. These most often arise from differences between accounting and tax depreciation, from the creation and use of reserves or from valuation allowances. Another important item can be a registered tax loss, which is sometimes forgotten because it is not visible in the accounting as such. The calculation itself must be properly documented and evaluated in the context of the future impact on the company’s financial statements. The general rule is that we always account for a deferred tax liability and a deferred tax asset when it is probable that it will be utilised in the future. 

Cross-checks or everything is connected

Above, we have summarized the main areas of financial statements that every accounting entity should pay attention to. However, accounting is double-entry, meaning that any entry has two sides. This is where one of the most important tasks in financial statements comes in, namely checking the logical continuity of related accounts or balance sheet account balances.

Let us list some of them, which are sometimes overlooked in practice, even though they are basic checks. 

The cash register must show a balance without any penny differences or negative balances. The stock purchase accounts should be free of balances as of the balance sheet date, confirming that all stock transactions have been correctly accounted for. For accounts receivable and accounts payable, it is necessary to check that they do not show illogical balances, such as negative accounts receivable or an active accounts payable account.

The cross-checks also include an examination of the logical links between the balance sheet and profit and loss accounts. Basic checks include:

• Reconciliation of asset additions (accounts 01x and 02x) vs. disposals for acquisition accounts (accounts 04x)
• Reconciliation of accounts in the context of asset disposals – accounts 541 and 551 (accounting residual value and depreciation) vs. accounts 07x/08x (depreciation reserves
• Reconciliation of the creation and recognition of provisions – accounts 558, 559 and 579 vs. accounts 09x (non-current assets), 19x (inventories), 39x (receivables)
• Reconciliation of provisioning and settlement – 59x accounts vs. 45x accounts

What to say to conclude….

The entire process of completing the financial statements and the subsequent preparation of the financial statements is an intensive period. This can be a month’s work for smaller companies, but it can take longer for larger companies. It always depends on the complexity of the business activity, implementation of continuous checks during the accounting period, the need to contact the individual responsible persons in order to provide supporting documents, especially for the area of the estimates/reserves, and then to prepare supporting documents that will result in the preparation of complete financial statements.

When preparing financial statements, particularly in the form of state reports and notes to the financial statements, the accounting entity should not neglect to comply with the statutory requirements for their content (reporting). An example of this is the change recorded from the 2024 accounting period in the reporting of turnover in the profit and loss statement or individual requirements for the notes to the financial statements according to the category of the accounting entity, as well as the recently much-discussed topic of changes to the limits within the categorization of accounting entities.

The financial statements as a whole represent an output that serves both internal users (owners, statutory body, employees) and third parties – e.g. auditors, potential customer/supplier, investor, etc.

In conclusion, we can say that properly implemented closing procedures simplify not only the preparation of the financial statements themselves, but also a smooth course of the audit (if the entity is obliged to have the financial statements audited), and especially the overall management of the company. What more could the management of a company wish for, not only in the pre-Christmas period.