Most common errors in financial statements

Errors in financial statements rarely result solely from incorrect calculations. Much more often, they arise from the improper classification, valuation or interpretation of business events. As a result, the figures themselves may be formally correct while simultaneously leading to inaccurate conclusions regarding the entity’s current financial position, liquidity or business risks.

Importantly, such irregularities often do not affect the balance sheet equilibrium of audited entities, making them less noticeable while at the same time more misleading for investors and other users of financial statements. Drawing on our experience gained through the provision of audit services to both local entities and international groups, we have decided to present those areas of financial reporting in which finance departments regularly make mistakes.

Incorrect recognition and presentation of provisions in the balance sheet structure

One of the most common issues is the incorrect recognition of costs relating to a given reporting period (i.e. presenting them as provisions).

Provisions relate to liabilities of uncertain amount or timing, whereas accruals comprise costs which, despite the absence of an invoice, can be estimated reliably and relate to goods or services already received by the entity.

This distinction is also crucial from the perspective of balance sheet presentation. As a rule, provisions are presented within item B.I, with their classification depending on the nature of the obligation.

Employee-related obligations (and obligations of a similar economic nature) are recognised under item B.I.2 “Provision for pensions and similar obligations”. These include provisions such as: 

• provision for retirement benefits, 
• provision for long-service awards, 
• provision for unused holiday leave, 
• provision for long-term incentive programmes. 

Provisions arising from other risks – including warranties, litigation and restructuring – are presented under item B.I.3 “Other provisions”.

Liabilities qualifying as accruals are treated differently. Although they are sometimes referred to in practice as “provisions”, their nature does not correspond to the definition of liabilities characterised by a high degree of uncertainty. Consequently, they are generally presented as trade payables or – in specific cases – as other accruals (B.IV.2). This applies in particular to unbilled costs, such as energy consumption or services received but not yet invoiced.

An additional practical challenge is posed by borderline items (such as short-term bonuses), where the appropriate presentation depends on the degree of certainty regarding the exact amount of the liability and the timing of its recognition. In such cases, maintaining a consistent approach and applying professional judgement are essential to ensure that the classification reflects the economic substance of the transaction.

Incorrect presentation of liabilities – particularly the classification of certain liabilities as provisions – results in an overstatement of items associated with uncertainty and distorts the picture of the liability structure, which may hinder a proper assessment of the entity’s financial position.

Improper classification of liabilities by maturity

Errors made during the preparation of financial statements frequently also concern the classification of liabilities as current or non-current. This classification is determined by the remaining period to maturity as at the balance sheet date, rather than by the original contractual repayment date.

Failure to separate the current portion of liabilities (for example, loan instalments due within the next 12 months) results in an understatement of current liabilities and an overstatement of the entity’s liquidity ratios.

In practice, however, changes in maturity classification do not always result solely from the passage of time or from the formal renegotiation of contractual terms. This is particularly relevant to loans where covenant breaches occur, as such breaches may entitle the lender to demand immediate repayment of the liability regardless of the originally agreed repayment schedule. Consequently, even where it is highly probable that the lender will not exercise this right, the entire liability must nevertheless be presented as current as at the balance sheet date.

Incorrect presentation of receivable and payable balances in the financial statements

Another common error concerns balances that have the nature of receivables but remain presented as liabilities (or vice versa). Such situations occur particularly frequently where the entity maintains two-sided settlement accounts.

Failure to appropriately reclassify balances results in the simultaneous understatement of receivables and liabilities, thereby distorting the picture of settlements with counterparties presented in the financial statements.

An additional issue in this area is the improper offsetting of balances without meeting the required formal conditions (for example, where no legal right of set-off exists or where there is no intention to settle on a net basis). As a consequence, the company’s financial statements may fail to reflect the true scale of its involvement in commercial relationships with counterparties.

The incorrect presentation of settlement balances also affects ratio analysis, particularly assessments of receivable and payable turnover and working capital levels, potentially leading to misleading conclusions regarding the organisation’s liquidity and management’s effectiveness in managing settlements.

Inappropriate classification of prepayments and advances

Advances and prepayments are another problematic element of financial statements and are often presented inconsistently with their economic substance.

Advances paid for property, plant and equipment should be recognised within non-current assets, advances relating to inventories should be recognised within inventories, while advances received from counterparties should be presented as liabilities. Their incorrect classification affects the structure of the balance sheet and may hinder its interpretation.

In practice, such oversights often result from the automatic settings of accounting systems or from the use of simplified accounting schemes (a good example being the use of a single account to record all types of advances). Inappropriate classification of advances may subsequently lead to inconsistencies in the division between current and non-current assets and may also affect the interpretation of working capital. In addition, such deficiencies make it more difficult to assess the progress of the entity’s investments or the extent to which its operations are financed by counterparties.

Incorrect accounting treatment of leases

Another issue capable of significantly distorting financial statements is lease classification, which should be based on the economic substance of the arrangement rather than, as sometimes happens, on the title of the agreement.

Under the provisions of the Accounting Act, the fulfilment of specific criteria – such as the transfer of substantially all risks and rewards associated with the leased asset – requires the leased asset to be recognised as an asset together with the corresponding financial liability.

In practice, companies often follow the tax classification or rely on contractual wording without analysing the actual allocation of risks and benefits. The consequences of such an approach extend beyond the balance sheet itself (where it results in an understatement of total assets) and also affect profit presentation, as cost structures become distorted (outsourced services versus depreciation and interest), as well as leverage and profitability ratios. As a result, the company’s financial statements may fail to reflect the actual level of financing used in the business and the way in which assets are utilised by the entity.

Incorrectly performed or completely omitted inventory valuation

Inventory valuation is also a significant source of errors. In accordance with the prudence principle, inventories should not be presented at an amount exceeding their net realisable value. In practice, however, this requirement is sometimes ignored, particularly in relation to obsolete, damaged or slow-moving inventory.

Failure to recognise inventory write-downs results in an overstatement of both the entity’s assets and its financial result.

In practice, irregularities are also encountered in relation to the use of standard costing. Inventories may be valued at standard cost without taking variances into account (which are therefore recognised as an expense of the period) or with material variances remaining unadjusted, indicating that standard costs have not been regularly reviewed and updated. As a result, the carrying value of inventories may differ from their actual production or acquisition cost, further distorting both the balance sheet and the financial result of the organisation.

Improper recognition of financial instruments and omitted disclosure obligations

Another particularly significant issue frequently identified by auditors is the failure to identify financial instruments or their incorrect recognition, especially instruments entered into to hedge future cash flows (for example, foreign exchange contracts). This often results from insufficient information flow within the organisation.

It should be remembered that the rules governing the recognition and measurement of financial instruments are established not only by the Accounting Act but also by the dedicated regulation applicable to financial instruments. Failure to comply with these requirements may result in valuation errors and incomplete disclosures in the notes to the financial statements.

In practice, errors in financial statements are not limited to the failure to identify financial instruments. Auditors regularly encounter valuation errors, including in particular the failure to update fair value measurements as at the balance sheet date or the use of simplified valuation methods that are inappropriate for the nature of the instrument (for example, measuring a loan at nominal value rather than at amortised cost).

Presentation errors also occur in this area. A good example is receivables subject to non-recourse factoring arrangements that continue to be presented as ordinary trade receivables. As a result, the financial statements audited by statutory auditors fail to reflect the actual transfer of credit risk and, in extreme cases, may even prevent users from determining whether the entity makes use of factoring as a financing instrument. In addition, entities do not always fulfil their disclosure obligations, omitting information regarding financial risks (such as foreign currency risk or interest rate risk) and the impact of financial instruments on the entity’s financial results and cash flows.

What should be remembered when preparing the financial statements of a Polish company?

The examples presented above demonstrate that the key challenge faced by those responsible for preparing financial statements is not only the correct determination of numerical values, but above all their proper recognition and interpretation. These are the factors that determine whether the financial statements provide a true and useful picture of the entity’s financial position.

In practice, preparing financial statements is not merely a technical exercise. It requires both a thorough understanding of the entity and detailed knowledge of how business transactions should be recorded, classified and aggregated. For companies that rely on external support, the process may be further complicated because limited access to information, or a lack of business context, can materially affect the quality of the data presented. This is precisely why active cooperation between all parties involved in the preparation and audit of the financial statements is so important. Such cooperation ensures an effective flow of information and a common understanding of business events, resulting in a clear and accurate picture of the entity’s situation.