Prospective financial information can be issued:
(a) as an internal management tool e.g. to support a possible capital investment
(b) or distribution to third parties, for example
- In a prospectus
- In an annual report
- To inform lenders or to support an application for finance.
The preparation of PFI involves the following steps:
- Make best estimate assumptions about the future e.g. sales will rise by 4%, interest rates will remain stable and exchange rates will fluctuate.
- Determine the accounting policies used in the past which must be used in preparing the PFI.
- Issue the PFI with the material assumptions clearly disclosed, including an indication as to whether they are best estimate assumptions or hypothetical assumptions.
- Prepare the PFI on the basis of the assumptions and accounting policies.
An auditor may be engaged to report on the PFI. The auditor will normally carry out the following procedures:
- Agree a letter of engagement
- Obtain a sufficient knowledge of the business – the auditor should have the knowledge
- Consider the period to be covered – in the case of a forecast this cannot be very long, normally not more than a year.
- Assess the source and reliability of the evidence supporting management’s best estimate assumptions. Evidence can be obtained from internal sources (e.g. past financial statements) and external sources (e.g. the auditor’s knowledge of current economic circumstances). Any plans should be within the client’s capacity.
- The auditor should consider, when hypothetical assumptions are used, whether all implications of such assumptions have been taken into account. Forecasts should consider the capital spending needs, productive capacity, staff recruitment, working capital, cash flow and all other aspects of a proposed plan. Any hypothetical assumptions should be realistic.
- The auditor should make arithmetical checks on the forecasts and supporting schedules (budgeted financial statements). The whole set should be internally consistent and in accordance with proposed management actions and with assumptions.
- The auditor should focus on areas which are particularly sensitive to variation.
- When part of the period, which is the subject of the forecast, has already elapsed, the auditor should examine evidence for the financial results already achieved. If the client’s year end is 31 December, a forecast for the year ending 31 December 20x3 may be made in say May 20x3 when four months or so have already elapsed.
- The auditor should obtain written representations from management on the intended use of the prospective financial information, the completeness of significant management assumptions and management’s acceptance of its responsibility for the prospective financial information.
- The auditor should assess the presentation and disclosure of the prospective financial information.
- Finally the auditor should issue a report.
The PFI should be based on budgeted financial statements. It should take into account the assumptions and ensure that all items are consistent with each other and that accounting policies normally adopted by the company have been used.
The prospective financial information must be properly and comprehensively disclosed and presented, which means that:
- The information is not misleading
- The accounting policies used are clearly disclosed in the notes to the prospective financial information
- The assumptions are adequately disclosed in the notes to the prospective financial information. It needs to be clear whether the assumptions represent management’s best-estimates (e.g. inflation will be at 3% which agree with government forecasts) or hypothetical (let us assume that our market share increase to 46% from 43%, which may be unrealistic). If the assumptions are material and subject to a high degree of uncertainty, the sensitivity of the forecast to these assumptions must be adequately disclosed.
- The date when the forecast was prepared must be disclosed
- Sometimes the forecast is in the form of a range, and the basis of selection of the points on the range must be unbiased and disclosed
- Any change in accounting policy since the last set of financial statements must be disclosed together with the reason for the change and the effect on the prospective financial information.