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Blind Freddy - Common Errors in Presentation of Financial Statements

The document discusses common errors ("Blind Freddy" errors) in classifying assets and liabilities as current or non-current in financial statements under AASB 101 Presentation of Financial Statements. It describes seven specific errors: 1) incorrectly classifying long-term assets as current, 2) misclassifying assets as current that are not intended to be sold within 12 months, 3) treating restricted cash as current, 4) misclassifying current liabilities as non-current, 5) failing to reclassify loans as current when due within 12 months, 6) treating refinancing agreed after the reporting period as making loans non-current, and 7) presenting loans as non-current when loan covenants

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95 views5 pages

Blind Freddy - Common Errors in Presentation of Financial Statements

The document discusses common errors ("Blind Freddy" errors) in classifying assets and liabilities as current or non-current in financial statements under AASB 101 Presentation of Financial Statements. It describes seven specific errors: 1) incorrectly classifying long-term assets as current, 2) misclassifying assets as current that are not intended to be sold within 12 months, 3) treating restricted cash as current, 4) misclassifying current liabilities as non-current, 5) failing to reclassify loans as current when due within 12 months, 6) treating refinancing agreed after the reporting period as making loans non-current, and 7) presenting loans as non-current when loan covenants

Uploaded by

Mika
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Blind Freddy – Common errors in

presentation of financial statements –


Part 2
The ‘Blind Freddy’ proposition is a term used by Justice Middleton in the case of ASIC v Healey & Ors [2011] (Centro
mistakes.

AASB 101 Presentation of Financial Statements is the standard which sets out key principles around
presentation of the four primary financial statements, and is intended to assist users of financial
statements in understanding the performance of that entity.
Any ‘Blind Freddy’ error in applying AASB 101 is by its nature likely to cause a user to either be
misled, or to be provided with insufficient information to make economic decisions, particularly in
respect of investing in that entity. Although AASB 101 does not contain any direct guidance on
measurement of accounting transactions, many of the potential Blind Freddy errors can lead to users
being misled. This in turn results in preparers and auditors opening themselves up to significant
criticism and potential litigation.
AASB 101 is also the standard that led to Justice Middleton coining the phrase ‘Blind Freddy’ in the
Centro case, where even Blind Freddy should have realised that the clear requirement in AASB 101
in respect of classification debt as a current liability had not been followed.
In our April Accounting News article on this topic, we discussed Blind Freddy errors relating to the
following aspects of AASB 101:

1. The need to include four primary statements in a financial report


2. The layout of those primary reports
3. The need to include notes to support those primary statements
4. The need to include comparatives
5. The need to have the third balance sheet when there is retrospective restatement
6. Key guidance as to going concern
7. Key guidance on disclosing estimates and judgements
8. Requirement to refer to the accounting framework
9. Requirement to provide additional disclosures where specific disclosure requirements in
accounting standards are insufficient
10. Offsetting

This month we highlight common errors made when classifying assets and liabilities as current or
non-current, and next month we will conclude our AASB 101 Blind Freddy series with a discussion
on financial statement disclosures.

Blind Freddy error 1 – Incorrectly classifying


assets as ‘current assets’ when not held for the
purpose of trading
In order to present a more favourable financial position to users of financial statements, including to
meet bank covenants and other key performance indicators, many entities may be motivated to
attempt to include as many assets as possible within current assets when they are NOT primarily held
for the purpose of trading.

An entity shall classify an asset as current when:

a. it expects to realise the asset, or intends to sell or consume it, in its normal operating cycle;
b. it holds the asset primarily for the purpose of trading;
c. it expects to realise the asset within twelve months after the reporting period; or
d. the asset is cash or a cash equivalent (as defined in AASB 107) unless the asset is restricted from being exc
least twelve months after the reporting period.

An entity shall classify all other assets as non-current.

AASB 101, paragraph 66


This common Blind Freddy error involves entities incorrectly classifying assets such as investments in
shares as current assets when they are not held for trading.

Blind Freddy error 2 - Presenting an asset as


current when the entity does NOT intend to sell
or consume it within the next 12 months
Again, this Blind Freddy error may include wrongly classifying investments in shares as current
assets where it is not intended to sell these items in the next 12 months.
It may also apply to the presentation of inventory, receivables and work-in-progress (being capitalised
time costs for professional services firms) where realisation is not likely to occur in the next 12
months.
A further example would be receivables with extended credit terms, including retention amounts
invoiced on construction contracts.
Similar misclassification may also occur in respect of prepayments, deposits, rental bonds etc. where
these will not be released in the next 12 months.

An entity shall classify an asset as current when:

a. it expects to realise the asset, or intends to sell or consume it, in its normal operating cycle;
b. it holds the asset primarily for the purpose of trading;
c. it expects to realise the asset within twelve months after the reporting period; or
d. the asset is cash or a cash equivalent (as defined in AASB 107) unless the asset is restricted from being exc
least twelve months after the reporting period.

An entity shall classify all other assets as non-current.

AASB 101, paragraph 66


Blind Freddy error 3 – Presenting restricted
‘cash’ as a current asset
In a number of cases, an entity may be required to place cash on deposit to secure borrowings or
some sort of guarantee. If this cash is not accessible for 12 months, it cannot be shown as a current
asset.
The presentation of an asset as a current asset when it is non-current can lead to a material
misstatement in the financial statements. These Blind Freddy errors are likely to result in users
arriving at the wrong conclusion about the entity’s liquidity position and risks associated with the entity
becoming insolvent, or having to secure expensive finance, raise dilutive share capital, or to dispose
of assets at a discount.
AASB 101 is the standard that sets out very clear rules in respect of which assets are classified as
current. If these rules are broken it is likely ‘Blind Freddy’ accusations will follow – particularly if the
entity does subsequently have liquidity issues.

An entity shall classify an asset as current when:


…..

d. the asset is cash or a cash equivalent (as defined in AASB 107) unless the asset is restricted from being exc
least twelve months after the reporting period.

Extract of AASB 101, paragraph 66

Blind Freddy error 4 - Presenting current


liabilities as non-current
Back where it all began!
As demonstrated in the Cento Case and Justice Middleton coining the phrase ‘Blind Freddy’, failure to
comply with AASB 101’s clear rules about which liabilities are current can lead to material
misstatements.

An entity shall classify a liability as current when:

a. it expects to settle the liability in its normal operating cycle;


b. it holds the liability primarily for the purpose of trading;
c. the liability is due to be settled within twelve months after the reporting period; or
d. it does not have an unconditional right to defer settlement of the liability for at least twelve months after the re
of a liability that could, at the option of the counterparty, result in its settlement by the issue of equity instrume

An entity shall classify all other liabilities as non-current.

AASB 101, paragraph 69


Blind Freddy error 5 – Classification of liabilities
where the original loan was for a period greater
than 12 months but the loan is now repayable
within 12 months
A common area when classifying liabilities occurs where the original loan was for a term greater than
12 months but with the passage of time, the loan is now due for repayment within 12 months. At the
outset these loans would be correctly classified as non-current, but preparers often forget to reclassify
these as current liabilities when settlement is due within 12 months.

An entity classifies its financial liabilities as current when they are due to be settled within twelve months after the rep

a. the original term was for a period longer than twelve months, and
b. an agreement to refinance, or to reschedule payments, on a long-term basis is completed after the reporting
are authorised for issue.

AASB 101, paragraph 72

Blind Freddy error 6 – Classification of liabilities


as non-current when agreement to approve
refinancing is only agreed after the reporting
date
The decision as to whether a loan is current or non-current is made at the reporting date (end of the
reporting period). This means that loans cannot be classified as non-current at reporting date when
they are due to be settled within 12 months from reporting date.
The fact that subsequent to the reporting date there is agreement with a financier to refinance the
loan, does not impact the classification of the loan at the end of the reporting period.

An entity classifies its financial liabilities as current when they are due to be settled within twelve months after the rep

a. the original term was for a period longer than twelve months, and
b. an agreement to refinance, or to reschedule payments, on a long-term basis is completed after the re
statements are authorised for issue.

AASB 101, paragraph 72

Blind Freddy error 7 - Presenting a loan as non-


current where loan covenants are in breach at
reporting date
An entity must present a liability as current if, at the reporting date, it does not have an unconditional
right to defer repayment for 12 months. This AASB 101 requirement is particularly relevant where an
entity, at the reporting date, has breached a borrowing covenant, allowing the lender to demand
repayment.
The liability is current even if the lender has subsequent to the reporting date, agreed to waive the
breach.

When an entity breaches a provision of a long-term loan arrangement on or before the end of the reporting period wi
payable on demand, it classifies the liability as current, even if the lender agreed, after the reporting period and befor
statements for issue, not to demand payment as a consequence of the breach. An entity classifies the liability as curr
period, it does not have an unconditional right to defer its settlement for at least twelve months after that date.

AASB 101, paragraph 74

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