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Closing of books i.

20 October 2014

Pursuant to Act C of 2000 on Accounting (hereinafter: the AA (Accounting Act)), business entities shall prepare an annual report on their equity, financial and earnings positions, supported by an accounting system, following the closing of the books pertaining to the financial year in order to inform stakeholders. A consistent use of an appropriate accounting system and an annual report prepared by way of a comprehensive closing of the books greatly facilitate prospective users of the report to formulate a true and fair picture.

The AA also stipulates that the closing of books include the supplementary, corrective, collating and summarising tasks related to bookkeeping, and performed in the interest of making the system of continuous bookkeeping complete. As regards frequency, it only rules that closing should be performed once a year when the annual report is drafted. This, however, does not mean that business entities cannot perform the closing of their books with a frequency that they deem appropriate, e.g. monthly, quarterly or half yearly, if they set forth such frequency in their accounting policy.

The closing of books also means the completion of a general ledger suitable for supporting the report. Several issues of our newsletter will present the main tasks to be performed in connection with the closing of books thinking the individual tasks and valuation procedures through.

The AA states that in the course of closing the books leading to the drafting of the report, the principle of going concern should be the starting point unless the assertion of the principle is inhibited by a statutory provision to the contrary or a factor that is at variance with the principle prevails, i.e. year-end valuation should also comply with the principle. In performing the valuation, it is important that trends in factors affecting book values, i.e. whether they influence assets permanently, should be monitored. Under the interpretation of the AA, a difference between of the book value and the market value qualifies as permanent if, based on historical data or future expectations, it prevails for no less than a period of one year. A difference also qualifies as permanent, irrespective of the length of its prevalence, if it can be deemed permanent based on the information as at the date of valuation.

The AA also stipulates that assets and liabilities be evaluated item by item - principle of item-by-item valuation -, and that each asset and liability be substantiated by way of an inventory count or sub-ledger reconciliation. Another important principle of valuation is the principle of prudence and completeness, pursuant to which all the economic events that affect the assets and liabilities recorded on the books as at the balance sheet date and that become known prior to the closing date of the balance sheet must be taken into account, irrespective of the economic entity’s profit or loss.

Reconciliation of tangible and intangible assets:

A mandatory component of notes to the annual report is a statement of changes to tangible and intangible assets in the reporting year. The basis is the sub-ledger to be reconciled with entries in the general ledger.
Comparing the balance of the depreciation recognised for the reporting year with that of the depreciation in the general ledger is a method of checking the completeness of recognised depreciation.
It should be established whether the rate of depreciation applied to and recognised for non-operational property was realistic.
The completeness of the release of return to be recognised in proportion to depreciation from deferred income and accrued expenses must be checked:
- the amount of any financially settled grant and/or assistance received for development purposes without any obligation of repayment;
- the amount of any liability cancelled or assumed by a third party, as long as such is related to assets acquired to the debit of the liability;
- the book value of assets received without consideration (and without any obligation of repayment), as well as the market value (or, if the law stipulates otherwise, the statutory value) of assets received as a gift or bequest, or that of surplus assets discovered.
A comparison of the net value of the assets derecognised according to the sub-ledger with the value of the expenses recognised in the general ledger in the interest of the substantiation of the accuracy of recognised expenses.
If the assets of an business entity are of significant value, it stands to reason that an inventory count be performed at certain intervals – annually or multi-annually – in order that their whereabouts (availability) and physical condition can be checked. An inventory count is also particularly suitable for testing the obsolescence of physical assets. When analysing the inventory, it is important that extraordinary depreciation should be accounted for on the value of damaged assets identified during inventory-taking or, if an asset is scrapped, it be derecognised. The occurrence of scrapping must be underpinned by appropriate documents because, unless appropriate documents are used, scrapping does not qualify as expenses incurred in the interest of the business operation and must be stated as a tax base increasing item.
The potential influence of events after the balance sheet date, e.g. an extraordinary depreciation write-off to be recognised due to major damage, must be presented.
The interconnection between the market value and the book value of assets must be reviewed: if the market value is permanently and significantly below the book value, extraordinary depreciation must be recognised. If there is an increase in the market value, the extraordinary depreciation can be reversed to book value against other revenues at next year’s closing.
A review of the items of tangible assets in the course of construction: Has each item in use been capitalised? Are there any items in the course of construction for a long time? Are they expected to be capitalised in the near future?
The provisions of the accounting policy on the headings of the balance sheet must be revised and compliance with valuation and classification principles must be checked.
Checking the appropriateness of the balance sheet classification of advance payments made towards fixed assets and related stated values (Have they been stated net of pre-charged VAT?) If advance payments are made in a foreign currency, revaluation must also be performed.
The rule applicable to value adjustments stipulates that valuation be performed annually and that it be approved by an auditor as well. The amount of revaluation reserves must also be updated in the balance sheet under equity.
As regards formation and restructuring and R&D, attention should be paid to the fact that related changes must also be stated in equity (See part 3 of our Newsletter).
Determination of items modifying the corporate tax base.

Reconciliation concerning long-term financial assets:

Checking correspondence between sub-ledger and the general ledger entries.
The provisions of the accounting policy on the headings of the balance sheet must be revised and compliance with valuation and classification principles must be checked.
Separation of fixed assets and current assets in the balance sheet:
- for shares and securities the purpose of purchases and maturity respectively may be an influencing factor;
- as regards loans granted, the relevant contracts are to be applied.
Separation of receivables from related parties in the balance sheet – independent of the classification of current and fixed assets. Performing reconciliation with related parties in respect of receivables (e.g. liabilities, return (yields)) vis-à-vis each other and in respect of expenses may prove useful because such may facilitate year-end consolidation if a corporate group is subject to such.
Existence of shares – prior to other duties the existence of any share as at the balance sheet date must be checked using a certificate of incorporation.
Valuation of shares – independent of the classification of current and fixed assets. The general ledger and the report for the year of the company in which the share concerned is held can serve as a starting point. The most common method is checking changes to the portion of the equity of the company in which the share concerned is held that corresponds to the investment. In addition to this, the Accounting Act mentions a number of other approaches, e.g. the long-term market perception of the business association and trends in such perception, the stock exchange and OTC value of the investment less any (accumulated) dividends, and its long-term trend.
Valuation of securities – independent of the classification of current and fixed assets. On the basis of the prevailing market value and the book value. If there is an increase, impairment should be reversed to the book value.
Valuation of loans – independent of the classification of current and fixed assets,. on the basis of expected recovery. If there are reasons to believe that the borrower cannot repay the loan or it can only repay part of it, impairment should be accounted for the unrecoverable part. If, however, repayment in full materialises at a future date, the recognised impairment can be reversed to book value against other revenues.
Checking the completeness of the recognition of return (yields) and expenses on long term financial assets – e.g. accrual or deferral of the preceding month’s interest income on the basis of the relevant calculations.
Items denominated in foreign currencies must – irrespective of value limits – be re-valued at the exchange rate prevailing as at the balance sheet date this also holds true for shares.
Determination of items modifying the corporate tax base.

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