accounting

3 financial statements you should know

Successful business people have a solid understanding of the three financial statements prepared under U.S. Generally Accepted Accounting Principles (GAAP). A complete set of financial statements helps stakeholders — including managers, investors and lenders — evaluate a company’s financial condition and results. Here’s an overview of each report.

1. Income statement

The income statement (also known as the profit and loss statement) shows sales, expenses and the income earned after expenses over a given period. A common term used when discussing income statements is “gross profit,” or the income earned after subtracting the cost of goods sold from revenue. Cost of goods sold includes the cost of labor, materials and overhead required to make a product.

Another important term is “net income.” This is the income remaining after all expenses (including taxes) have been paid.

2. Balance sheet

This report tallies the company’s assets, liabilities and net worth to create a snapshot of its financial health. Current assets (such as accounts receivable or inventory) are reasonably expected to be converted to cash within a year, while long-term assets (such as plant and equipment) have longer lives. Similarly, current liabilities (such as accounts payable) come due within a year, while long-term liabilities are payment obligations that extend beyond the current year or operating cycle.

Net worth or owners’ equity is the extent to which the book value of assets exceeds liabilities. Because the balance sheet must balance, assets must equal liabilities plus net worth. If the value of your liabilities exceeds the value of the assets, your net worth will be negative.

Public companies may provide the details of shareholders’ equity in a separate statement called the statement of retained earnings. It details sales or repurchases of stock, dividend payments and changes caused by reported profits or losses.

3. Cash flow statement

This statement shows all the cash flowing into and out of your company. For example, your company may have cash inflows from selling products or services, borrowing money and selling stock. Outflows may result from paying expenses, investing in capital equipment and repaying debt.

Although this report may seem similar to an income statement, it focuses solely on cash. It’s possible for an otherwise profitable business to suffer from cash flow shortages, especially if it’s growing quickly.

Typically, cash flows are organized in three categories: operating, investing and financing activities. The bottom of the statement shows the net change in cash during the period. To remain in business, companies must continually generate cash to pay creditors, vendors and employees. So watch your statement of cash flows closely.

Ratios and trends

Are you monitoring ratios and trends from your financial statements? Owners and managers who pay regular attention to these three key reports stand a better chance of catching potential trouble before it gets out of hand and pivoting, when needed, to maximize the company’s value.

© 2017

FAQs about agreed upon procedures

An agreed upon procedures (AUP) engagement uses procedures similar to an audit, but on a smaller and limited scale. Here’s how a customized AUP engagement differs from an audit and can be used to identify specific problems that require immediate action.

How do AUPs compare to audits?

The American Institute of Certified Public Accountants (AICPA) regulates both audits and AUP engagements. But the natures of these two types of accounting services are quite different. When a CPA firm performs an audit, its client is the company. With an AUP engagement, the client is typically the company’s lender or another third party — a fact that usually alleviates potential conflicts of interest.

Another key difference is that of responsibility. Audits require CPAs to provide a formal opinion on whether the company’s financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP).

On the other hand, CPAs make no formal conclusions when performing AUPs; they simply act as finders of fact. It’s the client’s responsibility to draw conclusions based on the CPA’s findings.

AUP engagements may target specific financial data (such as accounts payable, accounts receivable or related party transactions), nonfinancial information (such as a review of internal controls or compliance with royalty agreements), a specific financial statement (such as the income statement or balance sheet) or even a complete set of financial statements.

When do you need AUPs?

AUPs boast several advantages over audits. They can be performed at any time during the year — not just at year end. And because you have the flexibility to choose only those procedures you feel are necessary, they can be cost-effective.

Lenders may, for example, request an AUP engagement, if they have doubts or questions about a borrower’s financials — or if they want to check on the progress of a distressed company’s turnaround plan. Or a business owner may decide to hire a CPA to perform an AUP engagement, if he or she suspects that the CFO is misrepresenting the company’s financial results or the plant manager is stealing inventory. These engagements can also be useful in mergers and acquisition due diligence.

Who can help?

An AUP engagement can be used to dig deeper into financial results and identify specific problems that require immediate action. We can help you customize an AUP engagement that can identify problems and resolve issues quickly and effectively.

© 2017

Accounting for M&As

Many buyers are uncertain how to report mergers and acquisitions (M&As) under U.S. Generally Accepted Accounting Principles (GAAP). After a deal closes, the buyer’s post-deal balance sheet looks markedly different than it did before the entities combined. Here’s guidance on reporting business combinations to help minimize future write-offs and restatements due to inaccurate purchase price allocations.

Purchase price allocations

Under GAAP, buyers must allocate the purchase price paid in M&As to all acquired assets and liabilities based on their fair values. The process starts by estimating a cash equivalent purchase price.

If a buyer pays 100% cash up front, the purchase price is already at a cash equivalent value. But the cash equivalent price is less clear if a seller accepts non cash terms, such as an earnout that’s contingent on the acquired entity’s future performance or stock in the newly formed entity.

The next step is to identify all tangible and intangible assets and liabilities acquired in the business combination. The seller’s presale balance sheet will report most tangible assets and liabilities, including inventory, equipment and payables. However, intangibles are reported only if they were previously purchased by the seller. But intangibles are usually generated internally, so they’re rarely included on the seller’s balance sheet.

Fair value

Acquired assets and liabilities are then added to the buyer’s postdeal balance sheet, based on their fair values on the acquisition date. The difference between the sum of these fair values and the purchase price is reported as goodwill.

Goodwill and other indefinite-lived intangibles — such as brand names and in-process research and development — usually aren’t amortized for GAAP purposes. Instead, companies generally must test goodwill for impairment each year. Impairment testing also is needed when certain triggering events occur, such as the loss of a key person or an unanticipated increase in competition. If a borrower reports an impairment loss, it could mean that the business combination has failed to achieve management’s expectations.

Rather than test for impairment, private companies may elect to amortize goodwill straight-line, generally over 10 years. Companies that elect this alternate method, however, must still test for impairment when certain triggering events occur.

Bottom line

A business combination is a significant transaction, so it’s important to get the accounting right from the start. We can help buyers identify intangibles, estimate fair value and allocate purchase price even when a deal’s cash-equivalent purchase price isn’t readily apparent.

© 2017

Signs of inventory fraud

Is your inventory being stolen by dishonest employees or customers? Inventory is a prime target for fraud schemes, second only to cash. And it doesn’t always involve the physical theft of items. Here are some early warning signs that your inventory has been targeted.

Know your risk profile

Some companies are more at risk for inventory fraud than others. Obviously, service companies with minimal inventory on hand bear little risk of inventory embezzlement; instead, it’s more common among retailers, manufacturers and contractors. In general, higher-value inventory items, such as electronics or jewelry, tend to be more attractive to thieves.

Sometimes, however, the inventory account is just a convenient place to hide financial misstatement ploys, such as skimming or bogus sales. Thousands of journal entries are typically made to the inventory account, and it’s closed out to cost of sales each year. So, thieves with access to the accounting systems may bury their scams in the inventory account. Then, victim-organizations may write off discrepancies between the computerized perpetual inventory records and physical inventory counts as external pilferage, obsolescence or errors — when, in fact, it’s due to intentional manipulation of the accounting systems.

Monitor inventory metrics

If your year-end inventory counts aren’t adding up, don’t just write off the discrepancy as a cost of doing business; investigate why. You can shed light on the situation by computing various inventory ratios, including:

  • Days in inventory (average inventory divided by annual cost of sales times 365 days),
  • Gross margin (sales minus cost of sales) as a percentage of sales,
  • Inventory as a percentage of total assets,
  • Returns as a percentage of annual sales, and
  • Shipping costs as a percentage of sales.

These metrics should be consistent over time and comparable to industry benchmarks. Sudden changes require immediate action.

Catch fraud early

The median duration — from inception to detection of a fraud scam — is 18 months, according to the 2016 Report to the Nations on Occupational Fraud and Abuse by the Association of Certified Fraud Examiners. Many victims are unaware that inventory balances are inaccurate until they’ve accrued substantial losses. Diligent managers know the signs of inventory fraud and can identify anomalies early. Contact us for help investigating a suspected inventory scam.

© 2016

Tips for efficient year-end physical inventory counts

The basics

Inventory includes raw materials, work-in-progress and finished goods. Your physical inventory count also may include parts and supplies inventory. Under U.S. Generally Accepted Accounting Principles (GAAP), inventory is recorded at the lower of cost or market value.

Estimating the value of inventory may involve subjective judgment calls, especially if your company converts raw materials into finished goods available for sale. For example, the value of work-in-progress inventory includes overhead allocations and, in some cases, may require percentage-of-completion assessments.

A moving target

The inventory count gives a snapshot of how much inventory is on hand at year end. The value of inventory is always in flux, as work is performed and items are delivered or shipped. To capture a static value, it’s essential that business operations “freeze” while the count takes place.

Usually, it makes sense to count inventory during off-hours to minimize the disruption to business operations. Larger organizations with multiple locations may be unable to count everything at once. So, larger companies often break down their counts by physical location.

Proactive planning

Planning is the key to minimizing disruptions. Before counting starts, management can:.

  • Order (or create) prenumbered inventory tags,
  • Conduct a dry run to identify roadblocks and schedule workers,
  • Assign workers to count inventory using two-person teams to prevent fraud,
  • Write off any unsalable items, and
  • Precount and bag slow-moving items.

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

Beyond the count

When the inventory count is complete, it’s critical to investigate discrepancies between your computerized accounting records and physical inventory counts. We can use this information to help you evaluate how to stock items more efficiently and safeguard against future write-offs due to fraud, damage or obsolescence.

© 2016

Overview of inventory reporting methods

It’s critical to report inventory using the optimal method. There are several legitimate options for reporting inventory — but take heed: The method you choose ultimately affects how much inventory and profit you’ll show and how much tax you’ll owe.

The basics

Inventory is generally recorded when it’s received and title transfers to the company. Then, it moves to cost of goods sold when the product ships and title transfers to the customer. But you can apply different inventory methods that will affect the value of inventory on your company’s balance sheet.

FIFO vs. LIFO

Under the first-in, first-out (FIFO) method, the first units entered into inventory are the first ones presumed sold. Conversely, under the last-in, first-out (LIFO) method, the last units entered are the first presumed sold.

In an inflationary environment, companies that report inventory using FIFO report higher inventory values, lower cost of sales and higher pretax earnings than otherwise identical companies that use LIFO. So, in an increasing-cost market, companies that use FIFO appear stronger — on the surface.

But LIFO can be an effective way to defer taxes and, therefore, improve cash flow. Using LIFO causes the low-cost items to remain in inventory. Higher cost of sales generates lower pretax earnings as long as inventory keeps growing. To keep inventory growing and avoid expensing old cost layers, however, some companies may feel compelled to produce or purchase excessive amounts of inventory. This can be an inefficient use of resources.

Specific identification

When a company’s inventory is one of a kind, such as artwork or custom jewelry, it may be appropriate to use the specific-identification method. Here, each item is reported at historic cost and that amount is generally carried on the books until the specific item is sold. But a write-off may be required if an item’s market value falls below its carrying value.

Weighing your options

Each inventory reporting method has pros and cons — and what worked when you started your business may not be the right choice today. As you prepare for year end, consider whether your method is still optimal, given your current size and business operations, expected market conditions, and today’s tax laws and accounting rules. Not sure what’s right? We can help you evaluate the options.

© 2016

Month End Accounts and Reconciliations

Quick tips for a more efficient and effective close.

 

By Jeremy Myers, CPA

Audit Supervisor at Atchley & Associates, LLP

 

Businesses, much like your personal finances, balance their books on a monthly basis, or they should. The month end close process of reconciling bank accounts or even credit cards accounts are typically the last item that gets reconciled and closed each month.  This process insures that you have recorded all of the bank transactions such as bank fees or ACH payments/deposits that your business did not already have a paper form of payment.  Also in the sense of reconciling your business’ credit card bill to insure all the charges are proper, have support (receipts kept and attached to the statement), and that no unknown or possible fraudulent charges have made your statement with the end result of showing the complete liability for items that you have not yet paid for. For any control based procedure there is a need to insure the procedure is being performed timely and accurately.

Now that most statements are available online complete the next day after the statement close, the timeliness of the reconciliation can be taken out of the equation.  You just need to set up a schedule and by X day of the month, each month, every month, the account gets reconciled and any entries for transactions that have happened get put into the accounting system.

The other main attribute for effective procedures is accuracy and this attribute is just as much about transcribing the numbers from the statement in to the accounting system as it is as making sure you are reconciling the account to the proper date.  Most bank accounts, unless asked for otherwise, are set up based on the day of the week you opened the account.  For personal use, this might not be a bad thing, however, for businesses, most do not have mid-month closing dates.  Our biggest recommendation is make sure that your statements: bank, investments, credit card, etc… are on a month end basis.  That way you know you are reconciling your statement to each month end, and most importantly, year-end (as each of the months close into the end of the year).  This can be accomplished by simply calling your banker, investment advisor, credit card dealer, etc… and asking them to change your statement to a month end basis; this should cover the months that end in 28, 29, 30, or 31 days.

By performing your reconciliations timely and at the appropriate end date (typically month and year end) you can insure all of the transactions occurring during the month are appropriately recorded in your businesses’ records and for those pesky accruals, you can accrue an entire credit card statement instead of trying to add up the certain transaction that occurred prior to the end of the month.

The IRS Raises Tangible Property Expensing Threshold to $2,500; Simplifies Filing and Recordkeeping for Small Businesses

The IRS has made some changes today and simplified requirements for small businesses regarding paperwork and recordkeeping. According to the Notice 2015-82, the safe harbor threshold for deducting certain capital items has been raised from $500 to $2,500.

Those businesses that do not maintain an audited financial statement will be affected by these changes. Change applies to amounts spent to acquire, produce or improve tangible property that would qualify as capital item. The change in threshold to $2500 applies to any of these that is substantiated by an invoice.

“This important step simplifies taxes for small businesses, easing the recordkeeping and paperwork burden on small business owners and their tax preparers.” said IRS Commissioner John Koskinen.

The new $2,500 threshold takes effect starting with tax year 2016. The IRS will also provide audit protection to eligible businesses by not challenging use of the new $2,500 threshold in tax years prior to 2016.

For further information about this change, check the latest information found in Notice 2015-82, or in the IRS website.

Payroll Service Providers (PSP)

The Spring SSA/IRS Reporter includes a useful article offering tips for organizations that use payroll service providers. A payroll service provider (PSP) can be an excellent option for employers that are looking for assistance with payroll processing and payroll tax deposit requirements. However, it is important to remember that the responsibility for timely filing and payment still lies with the employer. The IRS can hold you and your business ultimately responsible for unpaid taxes, or unfiled or late files returns. The IRS offers a few tips if you use a payroll service:

  1. Check to see if your payroll service is listed on the IRS Payroll Service Providers page. The listed providers have passed IRS testing requirements [Click here to see the full list].
  2. Know your tax due dates. The IRS offers Tax Calendar options that can help [Tax Calendar].
  3. Review your payroll tax reports for accuracy before they are filed.
  4. Enroll in EFTPS. You will be able to login and see the tax payments made under your EIN, and make missed payments, if necessary.
  5. Keep your organization’s address as the address of record with the IRS. This way you are sure to see any correspondence from the IRS and make sure that a response is made quickly.
  6. If you suspect your PSP is not complying with regulations, file a complaint with the IRS using Form 14157.

As always, Atchley & Associates, LLP is happy to answer questions or assist you in any way we can.

Reference. Publication 1693 (Rev. 6-2015) Catalog Number 15060W Department of the Treasury Internal Revenue Service www.irs.gov

Accounting Systems and Chart of Accounts – Foundations for Financial Success

by Jeremy Myers

Audit Supervisor at Atchley & Associates, LLP

Accounting systems come in many shapes and sizes, from the simplest forms of QuickBooks to the more complex and robust forms of SAP and Oracle. The main objective of any accounting system is that it can store and produce meaningful accounting information for its users while being in line with your organizations’ vision, strategies, and needs. The correct accounting system can make the lives of its users better by minimizing the tasks needed to operate the books of any organization.

First your organization must identify the complexities of its operations to discover how the financial information will be used, i.e. provided to owners of the organization, lenders, donors, fundraisers, grantors, department heads, boards or those charged with governance, etc… Once it is determined who and how the financials of your organization will be used the second step is to select a system that fits those needs with potential room to grow or customize to best fit your needs.

Once the proper accounting system is selected, the next step to help achieve the goals of the accounting system is to set up a chart of accounts that is again useful to the users of the information. Setting up a consistent chart of accounting and using consistent numbering and naming convention is key. For example, if all cash accounting have the same starting numbers 1000, 1001, 1002 and the banks name, when it comes time to reconcile the bank accounts, it will be very easy to tell which cash account goes to which bank reconciliation and bank account. If all salary accounts are in the 5000s and all revenue for a certain product or funding source is 4100s then pulling information and grouping in a way that is useful to your organization will be faster. Always remember to use spacing between accounts as you never know when your organization will develop a new product or obtain a new funding source, this will allow you to keep the account numbering consistent, unique, and identifiable.

If your organization has multiple lines of business, be it funding sources, products, or services, setting up a fund code as a part of the account number will help track the performance, restricted assets, debt, revenues, and expenses related to each line of business. By simply adding a few digits to each of the account numbers, 01-1000 – “Bank Name” – maybe related to unrestricted activities, 02-1000 – “Bank Name” – maybe related to restricted activities, and 15-5000 – “Salaries” – would be related to specific program’s salaries.

Once your accounting system has been selected and chart of accounts setup and both are in line with the organization’s vision, strategies, and needs pulling out the revenue and expenses related to new products or projects or to see how division 15 is performing will only be a few keystrokes away. Leveraging your accounting system and chart of accounts to work for your organization is setting up a solid foundation for financial success, no matter how large or small your organization may be.