What is a deficiency account?
Deficiency accounts are used to illustrate the extent of which any shortfall in payment of creditors is due to matters that have arisen as a result of the insolvency, as a result of trading losses or for any other reason.
Deficiency accounts form a standard part of reports to creditors in Liquidations but can be of use within any insolvency scenario. Insolvency Practitioners will often use them within their investigations of the conduct of directors to help identify whether there could be evidence of wrongful trading (trading whilst insolvent).
Why prepare a deficiency account?
Parties preparing a Statement of affairs should consider preparing a deficiency account to accompany the supporting documentation for the figures being included in the Statement of Affairs. This would be for the preparer’s own records and would not be provided to the Insolvency Practitioner.
The purpose of preparing the deficiency account is to identify if there are any anomalies within the statement of affairs that does not conform to expectations. In particular within liquidations a deficiency account often highlights significant losses in the final periods of trading and sometimes this may be due to factors that should be included within the Statement of Affairs.
Its preparation also enables explanations to be considered, thought through and corroborative evidence obtained at the time rather than having to deal with questions months later without access to company records.
How to prepare a deficiency account?
A deficiency account is simply a reconciliation from the last balance sheet to the deficit within the statement of affairs. Usually the last audited balance sheet is utilised.
There are 3 main sections to reconcile:
- Write down of assets as a result of the insolvency – i.e. expected difference in book and realisable value. The explanation over these reductions should have been documented as part of the Statement of Affairs preparation.
- Items resulting from the insolvency – such items may include employee redundancy claims or other contingent liabilities that crystallise as a result of the insolvency. The calculation and assumptions used should have been documented in the process of preparing the statement of affairs.
- Trading results – this would be taken from management or other accounts prepared since the balance sheet date being reconciled.
The sum of these 3 items would reconcile to the deficiency towards creditors in the statement of affairs.
What often occurs is that the figures do not reconcile. This figure must fall into one of the above categories. Usually it would form an additional trading loss (especially if management accounts have not been prepared up to the date of insolvency) but could identify that an asset or liability category has been missed.
If there is a big unexpected difference this needs to be investigated and explainable – someone else is likely to notice. If you don’t have an explanation then there is an increased risk that there will be accusations over wrongful trading or failure in the duties as director (e.g. maintaining proper accounting records, misfeasance, etc.)