financial statement

Now or later? When to report subsequent events

Financial statements present a company’s financial position as of a specific date, typically the end of the year or quarter. But sometimes events happen shortly after the end of the period that have financial implications for the prior period or for the future. Here’s a look at what’s reportable and what’s not.

Classifying subsequent events

So-called “subsequent events” happen between the date of the financial statements and the date the financial statements are available to be issued. This lag usually lasts two or three months, because it takes time to record end-of-period journal entries, make estimates, draft footnotes and, if applicable, complete external compilation, review or audit procedures. The two types of subsequent events include:

Recognized. These events provide further evidence of conditions that existed on the financial statement date. For example, a major customer might file for bankruptcy. There was probably evidence of the customer’s financial distress in the prior period, such as a decrease in revenue or a buildup of receivables. The customer’s bankruptcy filing may trigger a write-off for bad debts to be recorded on the balance sheet in the prior period.

Nonrecognized. These subsequent events reflect unforeseeable conditions that didn’t exist at the end of the accounting period. Examples might include a change in foreign exchange rates, a fire or an unexpected natural disaster that severely damages the business.

Generally, the former must be recorded in the financial statements. The latter type of subsequent event isn’t required to be recorded but may have to be disclosed in the footnotes.

Disclosing subsequent events

Nonrecognized subsequent events must be disclosed in the footnotes only if failure to disclose the details would cause the financial statements to be misleading to investors and lenders. Subsequent event disclosures should include 1) a description of the nature of the event, and 2) an estimate of the financial effect (or, if not practical, a statement that an estimate can’t be made).

In some extreme cases, the effect of a subsequent event may be so pervasive that a company’s viability is questionable. This may cause the CPA to re-evaluate the going concern assumption that underlies its financial statements.

Footnotes add value

Subsequent events may not be reflected on a company’s balance sheet or income statement. But, when in doubt, companies typically disclose subsequent events to promote transparency in financial reporting. Contact us for more information about reporting and disclosing subsequent events.

© 2019

What is and isn’t a financial statement audit?

by Tyler Mosley, CPA

Audit Partner at Atchley & Associates, LLP

 

In the public accounting world, we sometimes assume everyone knows what a financial statement audit is and what it isn’t. However, that is a misconception as the term “audit” can be used to describe a variety of compliance related activities.  For example, an income tax audit performed by the IRS is completely different than a financial statement audit performed by an independent auditor. So…what is a financial statement audit?

A financial statement audit is an examination of an organization’s financial statements by an independent auditor who must be a certified public accountant (CPA).  The examination is performed in accordance with Generally Accepted Auditing Standards (GAAS) and a reporting framework chosen by the party who authorizes the audit engagement.  In most cases, the framework chosen is Generally Accepted Accounting Standards (GAAP) as that is what most third parties who request a financial statement audit require.  However, a financial statement audit can be performed using a variety of reporting frameworks, such as but not limited to income tax basis, modified cash basis, cash basis, or statutory basis.

The independent auditors’ role in the engagement is to provide an opinion on whether or not the financial statements presented are materially correct in all respects related to the reporting framework chosen.  An audit involves the independent auditors obtaining an understanding of your organization’s internal control, assessing fraud risk, substantively testing accounting records through inspection, observation, and third-party confirmation or corroborative inquiry.

Now that we have defined what a financial statement audit is, let’s discuss what it isn’t.  A financial statement audit does not serve the same purpose as a financial statement compilation or review.

A financial statement review provides a conclusion as to whether they believe any material modifications should be made to the presented financial statements based on the reporting framework that has been chosen.  In a review engagement, the CPA is required to understand the industry in which the organization operates including accounting principles that are unique to the industry.  The CPA will also ask questions about your financial activity and perform analytical procedures to identify areas in the financial statements where material misstatements are likely to arise.  The CPA does not obtain an understanding of your organization’s internal controls, assess fraud risk, or substantively test accounting records.  As such, the CPA only provides limited assurance on the financial statements.

A financial statement compilation is a service that does not have to be performed by a CPA or even an independent third party. However, if the person preparing the compilation is not independent they must disclose the fact in the compilation.  The CPA does not provide an opinion on if the financial statements presented are materially correct nor do they provide a conclusion like they would for a review.

We encourage all our clients to inform us of the purpose of the compilation, review, or audit engagement services they are requesting so we can assist in determining what level of service is appropriate for their needs.  The time required to perform the engagement increases as you move from compilation to review to an audit.

M&A due diligence: Don’t accept financial statements at face value

The M&A market was hot last year, and that momentum is expected to continue in 2019. Before acquiring another business, however, it’s important to do your homework. Conducting comprehensive due diligence can be a daunting task, especially if you’ve never negotiated a deal before. So, consider seeking input from an experienced accounting professional.

Reviewing historical performance

For starters, the target company’s historical financial statements must be reviewed. This will help you understand the nature of the company’s operations and the types of assets it owns — and the liabilities it owes.

When reviewing historical results, it’s important to evaluate a full business cycle, including any cyclical peaks and troughs. If a seller provides statements during only peak years, there’s a risk that you could overpay.

Historical financial statements also may be used to determine how much to offer the seller. An offer should be based on how much return the business interest is expected to generate. An accounting expert can project expected returns, as well as provide pricing multiples based on real-world comparable transactions.

Evaluating the target’s historical balance sheet also may help you decide whether to structure the deal as a stock purchase (where all assets and liabilities transfer from the seller to the buyer) or as an asset purchase (where the buyer cherry-picks specific assets and liabilities).

Looking to the future

Prospective financial statements are typically based on management’s expectations for the future. When reviewing these reports, the underlying assumptions must be critically evaluated, especially for start-ups and other businesses where prospective financials serve as the primary basis for your offer price.

It’s also important to consider who prepared the prospective financials. If forecasts or projections are prepared by an outside accountant, do the reports follow the AICPA standards? You may have more confidence when reports provided by the seller conform to these standards. However, it’s a good idea to hire your own expert to perform an independent analysis, because management may have an incentive to paint a rosy picture of financial performance.

Digging deeper

A target company’s historical balance sheet tells you about the company’s tangible assets, acquired intangibles and debts. But some liabilities may not appear on the financial statements. An accounting expert can help you identify unrecorded liabilities, such as:

  • Pending lawsuits and regulatory audits,
  • Warranty and insurance claims,
  • Uncollectible accounts receivable, and
  • Underfunded pensions.

You also need to be skeptical of representations the seller makes to seal a deal. Misrepresentations that are found after closing can lead to expensive legal battles. An earnout provision or escrow account can be used to reduce the risk that the deal won’t pan out as the seller claimed it would.

Avoiding M&A mishaps

Do-it-yourself acquisitions can lead to costly mistakes. In addition to evaluating historical and prospective financial statements, we can help identify potential hidden liabilities and misrepresentations, as well as prepare independent forecasts and projections. We also can help you determine the optimal offer price and deal terms based on an objective review of the target’s historical, prospective and unreported financial information.

© 2019

How to prepare for year-end physical inventory counts

As year end approaches, it’s time for calendar-year entities to perform physical inventory counts. This activity is more than a compliance chore. Proactive companies see it as an opportunity to improve operational efficiency.

Inventory basics

Under U.S. Generally Accepted Accounting Principles (GAAP), inventory is recorded at the lower of cost or market value. There are three types of inventory:

  1. Raw materials,
  2. Work-in-progress, and
  3. Finished goods.

Estimating the value of inventory may involve subjective judgment calls, especially if your company converts raw materials into finished goods available for sale. The value of work-in-progress inventory can be especially hard to assess, because it includes overhead allocations and, in some cases, may require percentage-of-completion assessments.

Physical counts

A physical inventory count gives a snapshot of how much inventory your company has on hand at year end. For example, a manufacturing plant might need to count what’s on its warehouse shelves, on the shop floor and shipping dock, on consignment, at the repair shop, at remote or public warehouses, and in transit from suppliers and between company locations.

Before counting starts, you should consider:

  • Ordering or creating prenumbered tags that identify the part number and location and leave space to add the quantity and person who performed the count,
  • Conducting a dry run a few days before the count to identify any potential roadblocks and determine how many workers to schedule,
  • Assigning two-person teams to count inventory to minimize errors and fraud,
  • Carving the location into “count zones” to ensure full coverage and avoid duplication of efforts,
  • Writing off any unsalable or obsolete items, and
  • Precounting and bagging slow-moving items.

It’s essential that business operations “freeze” while the count takes place. Usually, inventory is counted during off-hours to minimize the disruption to business operations.

Auditor’s role

If your company issues audited financial statements, one or more members of your external audit team will be present during your physical inventory count. They aren’t there to help you count inventory. Instead, they’ll observe the procedures, review written inventory processes, evaluate internal controls over inventory, and perform independent counts to compare to your inventory listing and counts made by your employees.

Be ready to provide auditors with invoices and shipping/receiving reports. They review these documents to evaluate cutoff procedures for year-end deliveries and confirm the values reported on your inventory listing.

Making counts count

When it comes to physical inventory counts, our auditors have seen the best (and worst) practices over the years. For more information on how to perform an effective inventory count, contact us before year end.

© 2018

4 steps to auditing AP

At most companies, the accounts payable (AP) department handles an enormous volume of transactions. So, the AP ledger may be prone to errors or used to bury fraudulent journal entries. How do auditors get a handle on AP? They use four key procedures to evaluate whether this account is free from“material misstatement” and compliant with U.S. Generally Accepted Accounting Principles (GAAP).

1. Examination of SOPs

Standard operating procedures (SOPs) are critical to a properly functioning AP department. However, some companies haven’t written formal SOPs— and others don’t always follow the SOPs they’ve created.

If SOPs exist, the audit team reviews them in detail. They also test a sample of transactions to determine whether payables personnel follow them.

If the AP department hasn’t created SOPs — or if existing SOPs don’t reflect what’s happening in the department — the audit team will temporarily stop fieldwork. Auditors will resume testing once the AP department has issued formal SOPs or updated them as needed.

2. Analysis of paper trails

Auditors use the term “vouching” to refer to the process of tracking a transaction from inception to completion. Analyzing this paper trail requires auditors to review original source documents, such as:

  • Purchase orders,
  • Vendor invoices,
  • Journal entries for AP and inventory, and
  • Bank records.

The audit team may select transactions randomly, as well as based on a transaction’s magnitude or frequency. They’ll also ascertain whether the company has complied with invoice terms and received the appropriate discounts.

3. Confirmations

Auditors may send forms to the company’s vendors asking them to “confirm” the balance owed. Confirmations can either:

  • Include the amount due based on the company’s accounting records, or
  • Leave the balance blank and ask the vendor to complete it.

If the amount confirmed by the vendor doesn’t match the amount recorded in the AP ledger, the audit team will note the exception and inquire about the reason. Unresolved discrepancies may require additional testing procedures and could even be cause for a qualified or adverse audit opinion,depending on the size and nature of the discrepancy.

4. Verification of financial statements

Auditors compare the amounts recorded in the company financial statements to the records maintained by the AP department. This includes reviewing the month-end close process to ensure that items are posted in the correct accounting period (the period in which expenses are incurred).

Auditors also review the process for identifying and recording related-party transactions. And they search for vendor invoices paid with cash and unrecorded liabilities involving goods or services received but yet not processed for payment.

Get it right

These four procedures may be conducted as part of a routine financial statement audit — or you may decide to hire an auditor to specifically target the AP department. Either way, your payables personnel can help streamline fieldwork by having the formal SOPs in place and source documents ready when the audit team arrives. Contact us for more information about what to expect during the coming audit season.

© 2018

Why revenue matters in an audit

For many companies, revenue is one of the largest financial statement accounts. It’s also highly susceptible to financial misstatement.

When it comes to revenue, auditors customarily watch for fictitious transactions and premature recognition ploys. Here’s a look at some examples of critical issues that auditors may target to prevent and detect improper revenue recognition tactics.

Contractual arrangements

Auditors aim to understand the company, its environment and its internal controls. This includes becoming familiar with key products and services and the contractual terms of the company’s sales transactions. With this knowledge, the auditor can identify key terms of standardized contracts and evaluate the effects of nonstandard terms. Such information helps the auditor determine the procedures necessary to test whether revenue was properly reported.

For example, in construction-type or production-type contracts, audit procedures may be designed to 1) test management’s estimated costs to complete projects, 2) test the progress of contracts, and 3) evaluate the reasonableness of the company’s application of the percentage-of-completion method of accounting.

Gross vs. net revenue

Auditors evaluate whether the company is the principal or agent in a given transaction. This information is needed to evaluate whether the company’s presentation of revenue on a gross basis (as a principal) vs. a net basis (as an agent) complies with applicable standards.

Revenue cutoffs

Revenue must be reported in the correct accounting period (generally the period in which it’s earned). Cutoff testing procedures should be designed to detect potential misstatements related to timing issues, as well as to obtain sufficient relevant and reliable evidence regarding whether revenue is recorded in the appropriate period.

If the risk of improper accounting cutoffs is related to overstatement or understatement of revenue, the procedures should encompass testing of revenue recorded in the period covered by the financial statements — and in the subsequent period.

A typical cutoff procedure might involve testing sales transactions by comparing sales data for a sufficient period before and after year end to sales invoices, shipping documentation or other evidence. Such comparisons help determine whether revenue recognition criteria were met and sales were recorded in the proper period.

Renewed attention

Starting in 2018 for public companies and 2019 for other entities, revenue must be reported using the new principles-based guidance found in Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. The updated guidance doesn’t affect the amount of revenue companies report over the life of a contract. Rather, it affects the timing of revenue recognition.

In light of the new revenue recognition standard, companies should expect revenue to receive renewed attention in the coming audit season. Contact us to help implement the new revenue recognition rules or to discuss how the changes will affect audit fieldwork.

© 2018

ASU 2016-14: Information about Liquidity

by Colleen Trombetta

Audit Senior at Atchley & Associates, LLP

 

Do you ever find yourself reading a set of financials statements and asking, “So how are we doing cash-wise?” or “Do we have enough cash to pay all our expenses this month… how about the next six months?” It’s clear that the readers of financial statements are concerned with cash. The FASB Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, is going to address this concern of cash and take it one step further by addressing liquidity, which is more complex than just cash-on-hand.

The financial assets that an organization has available to cover operating expenses consist not only of cash, but also of assets that will turn into cash within the coming year, such as accounts receivable, contributions and grants receivable and short-term investments. On the balance sheet, these assets are presented as “Current Assets.” If there are no donor restrictions or board designations, the current assets would be disclosed in the financial statements notes as assets available to cover operating expenses within one year of the balance sheet date.

ASU 2016-14 will require disclosure of the organization’s policies for managing liquidity. The policies should cover areas such as cash reserves, available lines of credit, and investment of cash in excess of current operating needs.

ASU 2016-14 will also require nonprofits to present, on the face of the financial position, the amount for each of two classes of net assets— net assets with donor restrictions and net assets without donor restrictions— as opposed to three.

ASU 2016-14 is effective for fiscal years beginning after December 15, 2017, with early application permitted.

 

 

References.

https://www.aicpa.org/interestareas/centerforplainenglishaccounting/resources/2016/asu-2016-14.html

https://www.nonprofitaccountingacademy.com/asu-2016-14-nonprofit-liquidity/