A few months ago, I had compiled a short list of common errors encountered in the consolidation of foreign operations. Now, I wish I had simply waited a few months to publish the post as I have since come across more issues that merit a mention while consolidating financials of related entities or even preparing the separate financials of related entities. Bear in mind that some of these could apply irrespective of whether they are related to foreign entities.
1. Inconsistencies in classification and presentation between the different financials to be consolidated: Now, I know that this is an area that is close to the hearts of CPAs and some of the more serious users of the financial statements. Some of the common classification errors are:
- The misclassification of current assets and liabilities (based on a standard one year operating cycle of the company) across the related entities. E.g. a deposit that is not expected to be converted into cash for more than a year warrants classification as a long term asset. While one entity is cognizant of this standard, the other entity may have included the asset into current assets. This anomaly can impact the key financial ratios such as the current and quick ratios and result in an inaccurate analysis of the financial performance of the entities.
- Incorrectly including other receivables and payables with trade receivables and payables: It is important to distinguish trade accounts from other activities of the company. Misclassifications could result in the inaccurate calculations of turnover ratios, which render financial analysis meaningless.
- Not identifying related party receivables and payables separately from trade or other balances: It is imperative to display relevant information for the readers and what could be more relevant than how much of the other receivable on the balance sheet includes notes receivable from stockholders, employees or related parties?
2. Failure to tie out inter-company balances and track shared costs: Sometimes, the books of related entities are maintained by different individuals which can explain some of the inconsistencies. But at the very least, a quarterly reconciliation of the inter-company balances should be performed and variances addressed and reconciled. Often times, the cash-rich company may pay for expenses of the other related entity and omit to track such shared costs. Depending on the corporate structure of the related entities, the failure to track and claim the expenses at the right entity level could translate to a higher taxable income and higher tax payments.
I’m sure I’ll think of a few more as I drive home today but I think these will have to do for now.