Financial statements are a set of accounting statements prepared by an entity for a reporting period as of the balance sheet date. There are three types of financial statements: ordinary, extraordinary and interim. In the following article, we will take a closer look at the third one in particular. When does an entity prepare interim financial statements and what are their specifics?
What are financial statements?
The principal output of the accounting work of any reporting entity is the financial statements. The content of the financial statements is stipulated by Act No. 563/1991 Coll., on Accounting, as amended. The financial statements as a whole comprise:
- Balance sheet
- Profit and loss account
- Notes to the financial statements, which explain and supplement the information contained in the balance sheet and profit and loss account.
- Cash flow statement, which provides information on the company’s cash flows and, at the same time, divides cash flows into three categories according to activity: operating, investing and financing.
- Statement of changes in equity, which contains a summary of the items of equity, including the changes that occurred during the reporting period.
The cash flow statement and the statement of changes in equity are not prepared by small and micro reporting entities or selected reporting entities if they do not meet the limits set by the Accounting Act. Some public interest entities (banks, insurance companies, reinsurance companies and pension companies) also do not prepare a cash flow statement.
The financial statements of individual companies may differ as to their extent – we distinguish between full and condensed financial statements. When reporting on a condensed basis, it is not necessary to prepare a statement of changes in equity and a cash flow statement. At the same time, the content and scope of the notes to the financial statements are also different.
Only entities that are not required to have their financial statements audited may prepare condensed financial statements.
Types of financial statements
The Accounting Act recognises three types of financial statements:
Ordinary – prepared as of the last day of the reporting period
Extraordinary – prepared as of other than the last day of the reporting period, e.g. as of the date of termination of the obligation to keep accounting records before the company enters into liquidation or becomes bankrupt.
Interim – prepared during the reporting period when required by specific legislation, or at a point in time different from the end of the balance sheet date. Unlike the previous two types of financial statements, the interim financial statements are usually preceded by a limited stocktaking and do not result in the closing of the books.
Next, we will look in more detail at the interim financial statements.
When are interim financial statements required?
Most often, interim financial statements are required in the following situations:
• If more than 6 months have passed between the balance sheet date of the last ordinary or extraordinary financial statements and the realisation date of the project, interim financial statements have to be prepared. This is primarily to ensure that the owners of entities participating in the transformation have the latest information on the economic situation of those entities. The period between the balance sheet date of the interim financial statements and the realisation date of the project of merger, demerger or transfer of assets to the owner cannot exceed 3 months. This period of protection of the owners of entities participating in the transformation is stipulated by Section 11 of Act No. 125/2008 Coll., on Transformations of Commercial Companies and Cooperatives, as amended (the “TCC”).
Owners of all entities participating in the transformation may agree that the interim financial statements do not have to be prepared, even though the above period of 6 months has passed. This option is widely used in practice to simplify the whole transformation process, most commonly in single-owner entities (Section 11a of the TCC).
Interim financial statements are also not required for entities participating in the transformation if they publish a half-yearly financial report in accordance with the law governing capital market business and make it available to owners or members in the prescribed manner (Section 11a of the TCC).
• The company or cooperative is obliged to prepare interim financial statements as of the date when the project of change of legal form was prepared, unless such date is the balance sheet date (Section 365 of the TCC). Another obligation of the company under Section 366 of the TCC is to prepare final financial statements as of the date preceding the date of registration of the change of legal form in the Commercial Register. This obligation applies only to public companies as well as companies and cooperatives that file a tax return on the day preceding the date of registration of the change of legal form in the Commercial Register. In other cases, only interim financial statements are prepared as of the date preceding the date of registration of the change of legal form in the Commercial Register. “As a general rule, a change of the legal form of a capital company or cooperative to another capital company or cooperative does not give rise to an obligation to prepare final financial statements, whereas a change of the legal form from a commercial partnership to a capital company or cooperative does.” (Zákon o přeměnách obchodních společností a družstev: komentář. Prague: C. H. Beck, 2010. Beckova edice komentované zákony. ISBN 978-80-7400-056-0, p. 1050–1051.)
• In connection with filing a proposal for the registration of transformation in the Commercial Register, it should be added that in the case of a change of the legal form of a company, the TCC does not provide for a maximum period of time from the date on which the project of the change of legal form was prepared, within which the company is obliged to file a proposal for registration of the transformation in the Commercial Register. Contrarily, in the case of other forms of transformation (merger, demerger or transfer of assets to the owner), the transformation project is cancelled in accordance with Section 15b of the TCC on the date on which the period of 12 months from the decisive date expires, unless a proposal for registration of the transformation in the Commercial Register is filed within that period.
2. Profit share prepayments
The Business Corporations Act (the “BCA”) stipulates that profit share prepayments can only be made on the basis of interim financial statements which show that the company has sufficient resources to distribute profit. To determine the prepayments, the TCC sets out the rules for making profit share prepayments:
- The sum of profit share prepayments cannot exceed the sum of the profit or loss for the current reporting period and profit or loss from prior years. Alternatively, if the limited liability company creates funds under its Memorandum of Association, the balances of these funds are added to the profit or loss and the allocations to them are deducted.
- Even in the case of prepayments, the limited liability company may not pay out a share of profits or other own resources if this would cause its bankruptcy.
The profit share prepayment must be returned within 3 months from the date when the ordinary or extraordinary financial statements were or should have been approved, unless the amount of profit to be distributed resulting from the ordinary or extraordinary financial statements is at least the sum of the profit share prepayments made in accordance with the law and the general meeting or the sole owner has decided to distribute that amount.
The topic of payment of profit shares and profit share prepayments following the amendment to the TCC was discussed in detail in our article.
3. Determining the settlement share of the owner
The termination of an owner’s participation in a business corporation during its existence without a legal successor gives rise to a right to settlement. If the Memorandum of Association does not provide for another appropriate method of determining the amount of the settlement share, the settlement share will be determined as of the date of the termination of the owner’s participation in the business corporation from the company’s equity identified from the interim, ordinary or extraordinary financial statements prepared as of the date of the termination of the owner’s participation in the business corporation. This does not apply if the fair value of the company’s assets differs materially from their valuation in the accounting records. In such a case, the fair value of the assets less the amount of the debts reported in the financial statements is used to determine the settlement share (Section 36).
Interim financial statements, by the nature of the situations for which they are prepared, are used in the following scenarios: entities are dealing with changes of the legal form, payment of profit share and other non-routine or even routine events. Let’s take a look at what makes interim financial statements specific.
Specifics of interim financial statements
Interim financial reporting that corresponds to the financial statements in its scope, i.e. includes all the standard components of the financial statements set out in the Accounting Act (financial statements and notes to the financial statements), and that is repeated regularly (e.g. semi-annually, quarterly, monthly) is generally subject to the same accounting rules as the preparation of the ordinary financial statements.
Where interim financial statements are prepared, entities do not close the books but perform all the other closing operations:
- stocktaking is required only to a limited extent to fulfil the prudence principle and to take account of asset impairment (Section 25 (3) of the Act)
- accrued and deferred expenses and income
- recognising amortisation/depreciation (not tax depreciation)
- unrealised exchange differences
- remeasurement at fair value (e.g. securities)
- deferred tax
- current income tax or income tax reserve (no income tax return is prepared)
Given the limited stocktaking, entities do not normally perform physical stocktaking at the balance sheet date of the interim financial statements. However, if the interim financial statements are audited by an auditor, the auditor normally tests the existence of inventories.
The current tax and deferred tax deserve a separate comment. In practice, there are often complications with the calculation of estimated tax for the period covered by the interim financial statements. Software cannot simulate tax depreciation and tax book values on a monthly basis, often on a full taxation period basis. Therefore, an accounting professional often has to perform a simulation by additional calculation in Excel to have inputs for estimating the current tax and calculating the deferred tax.
The National Accounting Board issued an interpretation in 2014, providing a methodical guideline for the preparation of financial statements. It recommends, among other things, what comparative information should be disclosed in the interim financial statements:
- the comparative period for the balance sheet items at the end of all interim reporting periods is always the balance at the last balance sheet date of the ordinary financial statements;
- the comparative period for the items in the profit and loss account, cash flow statement or statement of changes in equity is always the same interim period of the previous reporting period;
- the interim profit and loss account is always reported both for the interim reporting period and cumulatively from the beginning of the reporting period (for example, for the second quarter and the first half of the year).
Establishing rules for interim financial reporting is important because it is used to provide ongoing information about the entity’s current performance and financial position, which is used by a range of users (capital market investors, lenders, etc.) to make critical decisions. In the absence of accounting legislation governing the content of such statements and given the fact that they are not always required to be audited (see below), such information may be misleading if not properly prepared. So, what about the obligation to audit interim financial statements?
Audit of interim financial statements
When the prescribed criteria are met, the audit obligation is directly imposed by Section 20 of the Accounting Act only in the case of ordinary and extraordinary financial statements, not interim financial statements. Therefore, the Accounting Act does not directly imply an obligation to have the interim financial statements audited. It can be inferred from the introduction of the second sentence of Section 19 (3) of the Accounting Act that the reference to the analogous application of the provisions relating to financial statements applies only to the preparation of interim financial statements. Thus, the same accounting principles and procedures are to be followed in the preparation of interim financial statements as in the preparation of ordinary or extraordinary financial statements, but there is no obligation to audit them.
The obligation to have the interim financial statements audited by an auditor must be established by another legal regulation. It is therefore always necessary to assess the reason for which the interim financial statements are being prepared, or which legislation requires them to be prepared and whether it also imposes an obligation to audit them.
In certain cases, the obligation to have the interim financial statements audited by an auditor is expressly provided for in the TCC (e.g. in Section 12). This obligation can also be inferred from the text of the Act in the case of an increase in share capital from own resources (Section 227 (1) in conjunction with Section 231 (1) and (3) of Act No. 90/2012 Coll., on Business Corporations and Cooperatives, as amended (the “BCA”), for limited liability companies and Section 495 (1) in conjunction with Section 497 of the BCA for joint stock companies.
When must the financial statements be published?
The preparation of the financial statements is not the end of the process, as the financial statements must still be approved by the general meeting within 6 months from the end of the reporting period.
Once the financial statements have been approved and audited (for companies that are obliged to do so), they must be published in the Commercial Register within 30 days of these conditions being met; however, no later than 12 months after the end of the reporting period. Even if the company does not have the financial statements audited or approved, they must be published nevertheless.
The financial statements are published to the same extent as they are prepared; only small and micro reporting entities without the obligation to have their financial statements audited do not have to publish a profit and loss account.
A fine of up to 3% of the company’s assets may be imposed for non-disclosure, failure to comply with the prescribed requirements, failure to have the financial statements audited, or failure to retain the financial statements. Therefore, we recommend fulfilling legal obligations properly and on time.