financial statement

Evaluating going concern issues

Financial statements are generally prepared under the assumption that the business will remain a “going concern.” That is, it’s expected to continue to generate a positive return on its assets and meet its obligations in the ordinary course of business. But sometimes conditions put that assumption into question.

Recently, the responsibility for making going concern assessments shifted from auditors to management. So, it’s important for you to identify the red flags that going concern issues exist.

Make the call

Under Accounting Standards Update No. 2014-15, Presentation of Financial Statements — Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, management is responsible for assessing whether there are conditions or events that raise “substantial doubt” about the company’s ability to continue as a going concern within one year after the date that the financial statements are issued — or available to be issued. (The alternate date prevents financial statements from being held for several months after year end to see if the company survives.)

When going concern issues arise, auditors may adjust balance sheet values to liquidation values, rather than historic costs. Footnotes also may report going concern issues. And the auditor’s opinion letter — which serves as a cover letter to the financial statements — may be downgraded to a qualified or adverse opinion. All of these changes forewarn lenders and investors that the company is experiencing financial distress.

Meet the threshold

When evaluating the going concern assumption, look for signs that your company’s long-term viability may be questionable, such as:

  • Recurring operating losses or working capital deficiencies,
  • Loan defaults and debt restructuring,
  • Denial of credit from suppliers,
  • Dividend arrearages,
  • Disposals of substantial assets,
  • Work stoppages and other labor difficulties,
  • Legal proceedings or legislation that jeopardizes ongoing operations,
  • Loss of a key franchise, license or patent,
  • Loss of a principal customer or supplier, and
  • An uninsured or underinsured catastrophe.

The existence of one or more of these conditions or events doesn’t automatically mean that there’s a going concern issue. Similarly, the absence of these conditions or events isn’t a guarantee that your company will meet its obligations over the next year.

Comply with the new guidance

Compliance with the new accounting standard starts with annual periods ending after December 15, 2016. So, managers of calendar-year entities will need to make the going concern assessment starting with their 2016 year-end financial statements. Contact us for more information about making going concern assessments and how it will affect your financial reporting.

© 2017

Are you ready for audit season?

It’s almost audit season for calendar-year entities. A little preparation can go a long way toward facilitating the external audit process, minimizing audit adjustments and surprises, lowering your audit fees in the future and getting more value out of the audit process. Here are some ways to plan ahead.

The mindset

Before fieldwork begins, meet with your office team to explain the purpose and benefits of financial statement audits. Novice staff members may confuse financial audits with IRS audits, which can sometimes become contentious and stressful. Also designate a liaison in the accounting department who will answer inquiries and prepare document requests for auditors.

Reconciliation
Enter all transactions into the accounting system before the auditors arrive, and prepare a schedule that reconciles each account balance. Be ready to discuss any estimates that underlie account balances, such as allowances for uncollectible accounts, warranty reserves or percentage of completion.

Check the schedules to reveal discrepancies from what’s expected based on the company’s budget or prior year’s balance. Also review last year’s adjusting journal entries to see if they’ll be needed again this year. An internal review is one of the most effective ways to minimize errors and adjusting journal entries during a financial statement audit.

Work papers
Auditors are grateful when clients prepare work papers to reconcile account balances and transactions in advance. Auditors also will ask for original source documents to verify what’s reported on the financial statements, such as bank statements, sales contracts, leases and loan agreements.

Compile these documents before your audit team arrives. They may also inquire about changes to contractual agreements, regulatory or legal developments, additions to the chart of accounts and major complex transactions that occurred in 2016.
Internal controls

Evaluate internal controls before your auditor arrives. Correct any “deficiencies” or “weaknesses” in internal control policies, such as a lack of segregation of duties, managerial review or physical safeguards. Then the auditor will have fewer recommendations to report when he or she delivers the financial statements.

Value-added
Financial statement audits should be seen as a learning opportunity. Preparing for your auditor’s arrival not only facilitates the process and promotes timeliness, but also engenders a sense of teamwork between your office staff and external accountants.

© 2016

Beware of accounts deceivable

More than half of financial statement frauds involve sales and accounts receivable, according to the Committee of Sponsoring Organizations of the Treadway Commission. (COSO is a joint initiative of five private sector organizations that develops frameworks and guidance on enterprise risk management, internal control and fraud deterrence.) But why do fraudsters tend to target accounts receivable?

For accrual-basis entities, accounts receivable is typically one of the most active accounts in the general ledger. It’s where companies report contract revenue and any other sales that are invoiced to the customer (rather than paid directly in cash). The sheer volume of transactions flowing through this account helps hide a variety of scams. Here are some examples.

Fictitious sales

Sometimes fraudsters book phony sales — and receivables — to make their company’s performance appear rosier than reality. Increased sales assure stakeholders that the company is growing and building market share. They also increase profits artificially, because bogus sales generate no costs. And, overstated receivables inflate the collateral base, allowing the company to secure additional financing.

Timing differences

Unscrupulous owners or employees might manipulate cutoffs to boost sales and receivables in the current accounting period. For example, a salesperson could prematurely report a large contract sale even though material uncertainties exist. A retail chain CFO could hold the accounting period open a few extra days to boost year-end sales. Or a contractor might use aggressive percentage-of-completion estimates to boost revenues.

Lapping

Some employees divert customer payments for their personal use. Then, the fraudster applies a subsequent payment from another customer to the customer whose funds were stolen. The second customer’s account is credited by a third customer’s payment, and so on. Delayed payments continue until the fraudster repays the money, makes an adjusting journal entry or gets caught.

Know the red flags

Accounts receivable fraud can be hard to unearth. Fortunately, experienced forensic accountants know to look for such anomalies as:

  • Dramatically increased accounts receivable compared to sales or total assets,
  • Revenues increasing without a proportionate increase in cost of sales or shipping costs,
  • Deteriorating collections, and
  • Significant write-offs and returns in subsequent periods.

If something seems awry with your accounts receivable, we can help verify your outstanding balances and find holes in your internal controls system to safeguard against future scams.

© 2016

The basics of pushdown accounting

Both public and private companies can elect to use “pushdown” accounting when there’s a merger, acquisition or other change-in-control event. What does this mean — and when might this alternative reporting method be advantageous?

Understanding your options

Pushdown accounting refers to the practice of adjusting an acquired company’s standalone financial statements to reflect the acquirer’s accounting basis rather than the target’s historical costs. Typically, this means stepping up the target’s net assets to fair value and, to the extent the purchase price exceeds fair value, recognizing the excess as goodwill.

In 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-17, Business Combinations (Topic 805): Pushdown Accounting (a consensus of the FASB Emerging Issues Task Force). The updated guidance made pushdown accounting optional for all companies.

Reporting post-M&A performance

Whether pushdown accounting is appropriate depends on a company’s particular circumstances. For some companies, there may be advantages to reporting assets and liabilities at fair value and adopting consistent accounting policies for both the parent and subsidiary. Other companies may prefer not to apply pushdown accounting to avoid the negative impact on earnings, often associated with a step-up to fair value.

Previously, U.S. Generally Accepted Accounting Principles (GAAP) provided little guidance on when pushdown accounting might be appropriate. For public companies, SEC guidance generally prohibited pushdown accounting unless the acquirer obtained at least an 80% interest in the target, and it generally required pushdown accounting when the acquirer’s interest reached 95%. The SEC has rescinded portions of its pushdown accounting guidance, bringing it in line with the FASB’s new standard.

Weighing your options

For each individual change-in-control event, acquired companies must evaluate the option to apply pushdown accounting. And once pushdown accounting is applied, the election is irrevocable. Acquired companies that apply pushdown accounting in their standalone financial statements are required to include disclosures in the current reporting period to help users evaluate its effects. Contact our A&A specialists for help deciding whether to elect this reporting option.