How to Identify and Manage Audit Stakeholders

Identifying your audit stakeholders can assist in identifying audit risks

This is a guest post by Harry Hall. He is a Project Management Professional (PMP) and a Risk Management Professional (PMI-RMP). He blogs at ProjectRiskCoach. You can also follow Harry on Twitter.

Some auditors perform the same procedures year after year. These individuals know the drill. Their thought is: been there; done that.

Imagine a partner or an in-charge (i.e., project manager) with this attitude. He does little analysis and makes some costly stakeholder mistakes. As the audit team starts the audit, they encounter surprises:

  • Changes in the client stakeholders – accounting personnel and management
  • Changes in accounting systems and reporting
  • Changes in business processes
  • Changes in third-party vendors
  • Changes in the client’s external stakeholders
Identifying audit stakeholders

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Furthermore, imagine the team returning to your office after the initial work is done. The team has every intention of continuing the audit; however, some members are being pulled for urgent work on a different audit.

These changes create audit risks–both the risk that the team will issue an unmodified opinion when it’s not merited and the risk that engagement profit will diminish. Given these unanticipated factors, the audit will likely take longer and cost more than planned. And here’s another potential wrinkle: Powerful, influential stakeholders may insist on new deliverables late in the project.

So how can you mitigate these risks early in your audit?

Perform a stakeholder analysis.

“Prior Proper Planning Prevents Poor Performance.” – Brian Tracy

The Why and How of Auditing Payables and Expenses

Here's an overview of common payable and expense risks and how to audit them

Are you auditing payables and expenses? In this post, we’ll answer questions such as, “how should we test accounts payable?” and “should I perform fraud-related expense procedures?” We’ll also take a look at common risks and how to respond to them.

auditing payables and expenses

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Auditing Accounts Payable and Expenses — An Overview

What is a payable? It’s the amount a company owes for services rendered or goods received. Suppose the company you are auditing receives $2,000 in legal services in the last week of December, but the law firm sends the related invoice in January. The company owes $2,000 as of December 31, 2016. The services were provided, but the payment was not made until after the period-end. Consequently, the company records the $2,000 in its year-end payables. 

In determining whether payables exist, I like to ask, “if the company closed down at midnight on the last day of the month, would it have a legal obligation to pay for a service or good?” If the answer is yes, then record the payable—even if the invoice is received after the month-end. Has the service been received by month-end? Have the goods been received by month-end? If yes and the company has not paid for the service or good by month-end, then the company has a payable.

In this post, we will cover the following:

  • Primary accounts payable and expenses assertions
  • Accounts payable and expense walkthroughs
  • Directional risk for accounts payable and expenses
  • Primary risks for accounts payable and expenses
  • Common accounts payable and expenses control deficiencies
  • Risk of material misstatement for accounts payable and expenses
  • Substantive procedures for accounts payable and expenses
  • Typical accounts payable and expense work papers

Primary Accounts Payable and Expense Assertions

The primary relevant accounts payable and expense assertions are:

  • Existence
  • Completeness
  • Cutoff
  • Occurrence

Of these assertions, I believe—in general—completeness and cutoff (for payables) and occurrence (for expenses) are most important. When a company records its payables and expenses by period-end, it is asserting that they are complete and that they are accounted for in the right period. Additionally, the company is implying that amounts paid are for legitimate purposes.

Accounts Payable and Expense Walkthroughs

As we perform walkthroughs of accounts payable and expenses, we are looking for understatements of accounts payable and expenses (though they can also be overstated as well). We are asking, “What can go wrong—whether intentionally or by mistake?” 

In performing accounts payable and expenses walkthroughs, ask questions such as:

  • Who reconciles the accounts payable summary to the general ledger?
  • What controls ensure the recording of payables in the appropriate period?
  • Who authorizes purchase orders?
  • How does the company vet new vendors?
  • Who codes invoices and how?
  • Do larger payments require multiple approvals?
  • Which employees record invoices into the general ledger? 
  • Who signs checks or makes electronic payments?
  • Is there adequate segregation of duties for persons:
    • Approving purchases,
    • Paying payables, 
    • Recording payables, and 
    • Reconciling the related bank statements
  • Which persons have access to check stock and where is it stored?
  • Who can add vendors to the payables system?
  • Who reconciles the bank statements and how often?

As we ask these questions, we inspect documents (e.g., payables ledger) and make observations (e.g., who signs checks or makes electronic payments?).

If controls weaknesses exist, we create audit procedures to respond to them. For example, if—during the walkthrough—we see that one person prints and signs checks, records payments, and reconciles the bank statement, then we will perform fraud-related substantive procedures (more about this in a moment).

Directional Risk for Accounts Payable and Expenses

The directional risk for accounts payable and expenses is an understatement. So, in performing your audit procedures, perform procedures to ensure that invoices are properly included. For example, perform a search for unrecorded liabilities (explained below).

Primary Risks for Accounts Payable and Expenses

The primary risks for accounts payable and expenses are:

  1. Accounts payable and expenses are intentionally understated 
  2. Payments are made to inappropriate vendors
  3. Duplicate payments are made to vendors 

Common Accounts Payable and Expense Control Deficiencies

In smaller entities, it is common to have the following control deficiencies:

  • One person performs two or more of the following: 
    • Approves purchases,
    • Enters invoices in the accounts payable system, 
    • Issues checks or makes electronic payments,  
    • Reconciles the accounts payable detail to the general ledger,
    • Adds new vendors to the accounts payable system
  • A second person does not review payments before issuance 
  • No one performs surprise audits of accounts payable and expenses 
  • Bidding procedures are weak or absent
  • No one reconciles the accounts payable detail to the general ledger
  • The vetting of new vendors does not occur
  • The company does not create a budget
  • No one compares expenses to the budget

When segregation of duties is lacking, consider whether someone can use the expense cycle to steal funds. How? By making payments to fictitious vendors. Or intentionally paying a vendor twice—and then stealing the second check.

Risk of Material Misstatement for Accounts Payable and Expenses

In smaller engagements, I usually assess control risk at high for each assertion. When I assess control risk at less than high, I have to test controls to support the lower risk assessment. Therefore, assessing risks at high is usually more efficient (than testing controls). 

When control risk is assessed at high, inherent risk becomes the driver of the risk of material misstatement (controls risk X inherent risk = risk of material misstatement). The assertions that concern me the most are completeness, occurrence, and cutoff. So my RMM for these assertions is usually moderate to high. 

My response to higher risk assessments is to perform certain substantive procedures: namely, a search for unrecorded liabilities and detailed expense analyses. 

Search for Unrecorded Liabilities

How does one perform a search for unrecorded liabilities?  Use these steps:

  1. Obtain a complete check register for the period subsequent to your audit period 
  2. Pick a dollar threshold for the examination of subsequent payments
  3. Determine if the period-end payables suitably include or exclude amounts by examining the subsequent payments and related invoices 
  4. Inquire about any unrecorded invoices 

As the RMM for completeness increases, vouch payments at a lower dollar threshold. 

How should you perform a detailed analysis of expense accounts? First, compare your expenses to budget—if the entity has one—or to prior year balances. If you note any significant variances (that can’t be explained), then obtain a detail of those particular expense accounts and investigate the cause. 

Theft can occur in numerous ways—such as duplicate payments or fictitious vendors. If you see control weaknesses in the expense cycle, consider performing fraud-related procedures. (For information about fraud prevention, check out my book on Amazon.) When fraud-related control weaknesses exist, assess the RMM for the occurrence assertion at high. Why? There is a risk that the expense (the occurrence) is fraudulent. So, how should you respond to such risks?

Auditing for Duplicate Payments

An example of a fraud-related test is one for duplicate payments. How? 

  • Obtain a check register in Excel 
  • Sort by the vendor
  • Scan the check register for payments made to the same vendor for the same amount
  • Inquire about payments to the same vendor for the same amount

In a duplicate payment fraud, the thief intentionally pays an invoice twice. He then steals the second check and converts it to cash.

Substantive Procedures for Accounts Payable and Expenses

My customary audit tests are as follows:

  1. Vouch subsequent payments to invoices using the steps listed above
  2. Compare expenses to budget and examine any unexplained variances 
  3. When control weaknesses are present, design and perform fraud detection procedures

Typical Accounts Payable and Expenses Work Papers

My accounts payable and expenses work papers frequently include the following:

  • An understanding of internal controls as they relate to accounts payable and expenses 
  • Risk assessment of accounts payable and expenses at the assertion level
  • Documentation of any accounts payable and expense control deficiencies
  • Accounts payable and expenses audit program
  • An aged accounts payable detail at period-end
  • Budget to actual expense reports
  • Fraud-related expense work papers (when needed)

So, now you know the why and how of auditing accounts payable and expenses.

Continuing Audit Series

This post is a part of my series titled the Why and How of Audits. If you’ve missed the previous series articles, click here

Next week, we’ll look at how to audit payroll. Subscribe below to see this audit series.

The Little Book of Local Government Fraud Prevention

Whether your government is small or large, this book provides guidance in reducing theft

Have you ever wondered how your local government could lessen the risk of theft? Or maybe you are just curious about how fraudsters get away with their wily schemes. See my book The Little Book of Local Government Fraud Prevention. You can purchase it on Amazon as a paperback. Also, the ebook is available as a Kindle download.

Local Government Fraud Prevention

Fraud occurs in local governments in a multitude of ways, yet many cities, counties, school systems, authorities, and other public entities are ill-prepared to prevent or detect its occurrence. Why is this so? Some governments place too much reliance on annual audits as a cure-all, but clean audit opinions don’t mean that fraud is not occurring. And some governments fail to understand how vulnerable they are–until it’s too late.

Why is local government fraud so common? Many small governments don’t have a sufficient number of employees to segregate accounting duties. It is also these smaller governments that place too much trust in their accounting personnel. This combination of a lack of segregation of duties and too much trust in key employees often leads to significant losses from theft.

The Little Book of Local Government Fraud Prevention provides several real-life stories of fraud. The stories will inform you about how local government employees steal. Then I provide you with prevention techniques to assist you in mitigating fraud risks. In one story, for example, the book shows how a single municipal employee stole over $53 million dollars, all from a city of just 16,000 citizens.

If you audit governments, you will find this book helpful in pinpointing common areas where governmental fraud occurs. The book also includes fraud audit checklists and fraud detection procedures. Whether you are an internal or external auditor, you will find fresh ideas for prevention and detection.

The Little Book of Local Government Fraud Prevention will assist you if you are a:

1. Local government accounting employee
2. Local government elected official
3. Local government auditor
4. Local government attorney
5. Certified Public Accountant
6. Certified Fraud Examiner

Even if you don’t work with governments, you’ll find this book useful. I provide fraud prevention steps for transaction cycles such as billing and collections, payables and expenses, payroll, and capital assets.

Together we can bring down the risk of fraud and corruption in our local governments. Come join the team. We’ll all be better for it.

If you don’t desire to spend money on the book, here’s a free list of controls.

Do Loan Guarantees Create Liabilities?

Sometimes loan guarantees create liabilities

Can a loan guarantees create liabilities that go on the balance sheet of the guarantor?

Yes.

Loan Guarantees Create Liabilities

Picture from AdobeStock.com.

Recording Loan Guarantees

FASB 5 (now ASC 450) has been with us for some time. It states that a company should record a contingent liability if two things occur:

  1. The liability is subject to estimation (you can calculate it)
  2. It is probable that the liability will be paid

ASC 450 addresses these contingent liabilities.

FIN 45 (now ASC 460) was issued in the early 2000s to clarify that some loan guarantees create liabilities–even when there is no loan default. ASC 460 deals with noncontingent liabilities. And it’s the noncontingent piece that confuses everyone (including me). So let’s first take a look at noncontingent liabilities.

Noncontingent Liability

ABC Co. guarantees a $2,000,000 loan of XYZ Co. (an unrelated entity); in exchange, XYZ agrees to pay a fee of $50,000.

Should ABC Co. record a liability for the guarantee? Yes.

What’s the entry?

                                                         Dr.                 Cr.

Accounts Receivable                $50,000

Guarantee Liability                                           $50,000

The standard allows the guarantor to use the guarantee fee as a practical expedient to valuing the loan guarantee.

What if there is no guarantee fee? For instance, let’s say ABC Co. guarantees a loan for Sidewalk Safety Nonprofit, Inc. This guarantee is provided to the nonprofit free of charge. How would ABC Co. record this guarantee?

First ABC Co. would need to determine the value of the guarantee. If Sidewalk Safety’s interest rate is 8% without the guarantee, but now it’s 4%, then you can compute the differential using present value calculations. Let’s say the result is $40,000, what is the entry?

                                                                       Dr.                Cr.

Guarantee Expense (Contribution)      $40,000

Guarantee Liability                                                       $40,000

Guarantee of Related Party Debt

What if the loan guarantee is for an entity owned by the same parties? If the guarantee is on the debt of a related entity under common control, ASC 460-10-25-1 exempts the guarantor from the requirement to record the guarantee liability.

Next, we’ll see how to relieve the guarantee liability.

Guarantee Liability – In Subsequent Periods

After inception, the fair value liability (for both examples above) is taken to income as the guarantor is released from risk; the liability is to be adjusted to fair value at the period end.

ASC 460 does not provide detailed guidance as to how the guarantor’s initial liability should be measured after its initial recognition. Depending on the nature of the guarantee, the guarantor’s release from risk is recognized with an increase to earnings using one of three methods:

  1. Systematic and rational
  2. Deferring until expiration or settlement of the guarantee
  3. Remeasurement at fair value (for guarantees accounted for as derivatives)

You now know how to account for the noncontingent liability, but what if the guaranteed party defaults on the loan. Now the guarantor needs to record the loan as a liability.

Contingent Liability

For example, what if Sidewalk Safety defaults on the loan? Then ABC Co. needs to book a liability for the remaining debt. Sidewalk Safety’s default triggers ASC 450.

This is the contingent piece of the equation (for which no amount is typically recorded at the inception of the guarantee). Upon Sidewalk Safety’s default, the debt amount is subject to estimation and payment is probable. ABC Co. is on the hook for the remaining debt.

Supplementary Information Audit Opinion

You can report on supplementary information in an audit opinion or as a separate report

Are you looking for a supplementary information audit opinion example? Well, here it is.

supplementary information audit opinion

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Two Options for Reporting

You can opine on supplementary information in two ways:

  1. In the financial statement opinion or
  2. In a separate opinion that addresses just the supplementary information

Below you will see sample wording for both options.

The wording for the supplementary information opinion comes from AU-C section 725.A17 (Illustration 1).

The auditor opines on supplementary information in relation to financial statements as a whole

Option 1.

Unmodified Opinion on Supplementary Information—Other-matter paragraph:

INDEPENDENT AUDITOR’S REPORT

To the Board of Directors and Stockholders of  [Name of Company]

Report on the Financial Statements1

We have audited the accompanying financial statements of   [Name of Company] (a  [State of Incorporation] corporation), which comprise the balance sheet as of   [Date], and the related statements of income, retained earnings, and cash flows for the year then ended, and the related notes to the financial statements.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

Auditor’s Responsibility

Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion.  An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of   [Name of Company] as of   [Date], and the results of its operations and cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America.

Report on Supplementary Information

Our audit was conducted for the purpose of forming an opinion on the financial statements as a whole.  The [Identify supplementary information.] is presented for purposes of additional analysis and is not a required part of the financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the financial statements. The information has been subjected to the auditing procedures applied in the audit of the financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the financial statements or to the financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated in all material respects in relation to the financial statements as a whole.

[Firm’s Signature]

[City and State]

[Report Date]

Notes:

1. The heading “Report on the Financial Statements” is optional.

Option 2.

Alternatively, supplementary information may be reported on separately in the following manner.

Unmodified Opinion on Supplementary Information-Separate Report:

INDEPENDENT AUDITOR’S REPORT ON SUPPLEMENTARY INFORMATION

To the Board of Directors and Stockholders of   [Name of Company]

We have audited the financial statements of [Name of Company] as of and for the [Period] ended [Date], and our report thereon dated [Date], which expressed an unmodified opinion on those financial statements, appears on page [Page Number]. Our audit was conducted for the purpose of forming an opinion on the financial statements as a whole. The [Identify the supplementary information] is presented for purposes of additional analysis and is not a required part of the financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the financial statements. The information has been subjected to the auditing procedures applied in the audit of the financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the financial statements or to the financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated in all material respects in relation to the financial statements as a whole.

[Firm’s Signature]

[City and State]

[Report Date]

Additional Information

For an overview of supplementary information, additional information, and required supplementary information, click here.

For information regarding reporting on supplementary information in preparation and compilation reports, click here.

How to Present Supplementary Information in Compilation and Preparation Engagements

Supplementary information can be added to basic financial statements

Are you wondering how to present supplementary information in compilation and preparation engagements? What supplementary information (SI) should be included? How does the accountant define his or her responsibility for SI?

Often accountants, at the request of their clients, add supplementary information to the financial statements. Such information is never required (to be in compliance with a reporting framework) but may be useful.

supplementary information: compilation and preparation engagements

Picture is courtesy of Dollar Photo

You can think of financials with supplementary information in this manner:

Financial statements – Required – The jeep in the picture above

Supplementary Information – Not required – The camper

You’re not going anywhere without a vehicle (it’s required). And your camper (not required) is no good without an automobile to pull it. Kind of a silly analogy, I know, but maybe it will help you remember.

I normally add a divider page between the financial statements and supplementary information (though such as page is not required); the divider page simply says “Supplementary Information” and nothing else.

SSARS 21 defines supplementary information as follows:

Information presented outside the basic financial statements, excluding required supplementary information, that is not considered necessary for the financial statements to be fairly presented in accordance with the applicable financial reporting framework.

Supplementary information normally follows the notes to the financial statements; if the notes are omitted, then the supplementary information usually follows the last financial statement presented in the basic financial statements. (Required supplementary information seldom comes into play; an example, is the inclusion of management, discussion and analysis in governmental financial statements.)

SSARS 21 defines basic financial statements as follows:

Financial statements excluding supplementary information and required supplementary information.

Structure of Financial Statements

Commonly the basic financial statements and supplementary information are arranged as follows:

  • Financial statements
  • Notes to the financial statements
  • Supplementary information

Sample Supplementary Information

Examples include:

  • Schedule of operating expenses
  • Schedule of other income
  • Schedule of other expenses
  • Schedule of the number of employees by division
  • Schedule of inventory locations
  • Schedule of uncompleted construction contracts
  • Schedule of contractual income
  • Consolidating balance sheet
  • Consolidating statement of income

If you need to include information not required by the accounting framework (e.g., GAAP), then consider adding supplementary information. Bankers or owners sometimes desire such information. You won’t find this supplementary information in a disclosure checklist but it may be needed to allow the owner to see how profitable an individual division is or it may provide a banker with additional inventory information. Sometimes the owner has a contract to pay a third party based on a computation. Supplementary information gives you a place for such information. As you will see below, the supplementary information can be subject to compilation procedure–or not.

Consolidating Statements

Typically SI is titled as a schedule to distinguish it from the basic financial statements. Nevertheless, if consolidated statements are presented in the basic financial statements, it is appropriate to include the consolidating financial statements—the presentation of each separate entity in columnar fashion being brought together into a consolidated total—in the supplementary information. Consolidating financial statements should be titled as statements rather than as schedules.

Supplementary Information and a Preparation Engagement

Section 70 of SSARS 21 (the Preparation of Financial Statements guidance) can be applied to supplementary information (see Section 70, .A1). Consider your level of responsibility for such information and communicate clearly in your engagement letter and financial statements that no assurance is provided. Technically, the “no assurance is provided” language is only required for financial statement pages (see Section 70, paragraph .14); nevertheless, consider adding it to your supplementary information pages.

Supplementary Information and a Compilation Engagement

Section 80 of SSARS 21 (Compilation Engagements) does address the inclusion of supplementary information. If SI is included, the accountant should communicate his degree of responsibility in either:

  • An other-matter paragraph in the compilation report or
  • A separate report

If the degree of responsibility is communicated in a separate report, that report usually follows the notes to the financial statement and precedes the supplementary information. To minimize the number of pages in the report, consider communicating your degree of responsibility in an other-matter paragraph in the compilation report.

Did the accountant apply compilation procedures to SI? If yes, then the compilation report wording is as follows (based on SSARS 23 which amends SSARS 21; click here for more information):

The accompanying [identify the supplementary information] is presented for purposes of additional analysis and is not a required part of the basic financial statements. Such information is the responsibility of management. The supplementary information was subject to our compilation engagement. We have not audited or reviewed the supplementary information and do not express an opinion, a conclusion, nor provide any assurance on such information.

If the accountant does not apply compilation procedures to SI, the compilation report wording is as follows (based on SSARS 23; click here for more information):

The accompanying [identify the supplementary information] is presented for purposes of additional analysis and is not a required part of the basic financial statements. Such information is the responsibility of management. The supplementary information was not subject to our compilation engagement. We do not express an opinion, a conclusion, nor provide any assurance on such information.

References

Include a reference to the compilation report on each page of the supplementary information such as:

  • See Accountant’s Report or
  • See Accountant’s Compilation Report

That way, if the SI becomes detached from the report, the reader (of the SI) can see a report was issued.

Supplementary Information – Simple Summary

  • Supplementary information is, by definition, not required in financial statements prepared using the preparation or compilation guidance.
  • Supplementary information is normally included to provide additional details of information that owners or lenders desire to see.
  • Supplementary information is normally titled as a schedule rather than as a statement to differentiate the supplementary information from the basic financial statements. It is appropriate to title consolidating or combining financial statements included in the supplementary information as statements.
  • If supplementary information is included in financial statements issued in a preparation engagement, define your responsibility in the statements/schedules or notes.
  • If supplementary information is included in financial statements issued in a compilation engagement, define your responsibility in the compilation report (using an other-matter paragraph) or in a separate report (which precedes the supplementary information).

SSARS 21 Book

For more information about SSARS 21, check out my book on Amazon.

 

The Why and How of Auditing Property

Here's an overview of how to audit property

Are you wondering about how to audit property?

Today, we’ll answer questions such as, “how should we test additions and retirements of property?” and “what should we do in regard to fair value impairments?” 

how to audit property

Picture is from AdobeStock.com

Auditing Property — An Overview

Property is sometimes referred to as plant, property, and equipment or capital assets. In this post, I’ll use the word “property.”

We will cover the following:

  • Primary property assertions
  • Property walkthroughs
  • Directional risk for property
  • Primary risks for property
  • Common property control deficiencies
  • Risk of material misstatement for property
  • Substantive procedures for property
  • Common property work papers

Primary Property Assertions

The primary relevant property assertions are:

  • Existence and occurrence
  • Completeness
  • Valuation
  • Classification

Of these assertions, I believe—in general—existence, occurrence, and classification are most important. So, the client is asserting that property exists, that depreciation calculations are appropriate, and amounts paid for property are capitalized (and not expensed).

Property Walkthroughs

As we perform walkthroughs of property, we are looking for ways that property is overstated (though it can also be understated as well). We are asking, “What can go wrong—whether intentionally or by mistake?” 

In performing property walkthroughs, ask questions such as:

  • Are property ledgers reconciled to the general ledger?
  • Does the entity use reasonable and consistent depreciation methods?
  • Are the depreciation methods in accordance with the reporting framework (e.g., straight line for GAAP or accelerated for tax basis)
  • Who records depreciation? 
  • Are the economic lives assigned to property appropriate?
  • What controls ensure that property is recorded in the right period?
  • Is there appropriate segregation of duties between persons paying for property, those recording property, and those with physical possession of property?
  • What software is used to compute depreciation?
  • Does the company perform periodic physical inventories of moveable property?
  • Are assets removed from the depreciation schedule upon sale?
  • What controls ensure that all property-related purchases are added to the depreciation schedule (and not expensed as repairs and maintenance)?
  • What is the capitalization threshold (e.g., $5,000)?
  • What controls ensure that all capital leases are reported as additions to the depreciation schedule?

As we ask questions, we also inspect documents (e.g., depreciation reports) and make observations (e.g., who has access to moveable property?).

If controls weaknesses exist, we create audit procedures to respond to them. For example, if—during the walkthrough—we see that one person purchases property, has physical access to equipment, and performs the related accounting, then we will perform theft-related substantive procedures.

Directional Risk for Property

The directional risk for property is overstatement. So, in performing your audit procedures, perform procedures to ensure that property is not overstated. For example, vouch all significant property additions to invoices.

Primary Risks for Property

The primary risks for property are:

  1. Property is intentionally overstated 
  2. Expenses are improperly capitalized as property 
  3. Transactions that should be recorded as property are expensed 
  4. Capital leases are treated as operating leases (and the property is not added to the depreciation schedule)
  5. Depreciation is improperly computed and recorded (e.g., an accelerated depreciation method is used when straight-line is more appropriate)
  6. Moveable property (e.g., equipment) is stolen 

Common Property Control Deficiencies

In smaller entities, it is common to have the following control deficiencies:

  • One person performs one or more of the following: 
    • Buys property, 
    • Enters the property in the general ledger and depreciation schedule, 
    • Has physical custody of the property,  
    • Has responsibility for reconciling the depreciation schedule to the general ledger
  • The person computing depreciation doesn’t possess sufficient knowledge to do so correctly
  • A second person does not review the depreciation methods or economic lives
  • No one performs surprise audits of property 
  • No one performs periodic physical inventories of property 
  • There are no controls over the disposal of property 
  • Bidding procedures are not properly used
  • No one reconciles the depreciation schedule to the general ledger
  • Property is not reviewed for possible impairment of value
  • Company personnel don’t understand capital lease accounting standards

Risk of Material Misstatement for Property

In smaller engagements, I usually assess control risk at high for each assertion. If control risk is assessed at less than high, then controls must be tested to support the lower risk assessment. Assessing risks at high is usually more efficient than testing controls. 

When control risk is assessed at high, inherent risk becomes the driver of the risk of material misstatement (controls risk X inherent risk = risk of material misstatement). The assertions that concern me the most are existence, occurrence, and valuation. So my RMM for these assertions is usually moderate to high. 

My response to higher risk assessments is to perform certain substantive procedures: namely, the vouching of additions to property. As RMM increases I lower the dollar threshold for vouching property additions. 

Substantive Procedures for Property

My customary audit tests are as follows:

1. Vouch property additions to related invoices

2. Agree opening property balances in the depreciation schedule to the prior year general ledger balances

3. Review economic lives assigned to new property 

4. Review the selected depreciation method in light of the property’s life

5. Compute a ratio of depreciation to property and compare the prior periods

6. Review new lease agreements to determine if they should be capitalized 

Common Property Work Papers

My property work papers normally include the following:

  • An understanding of property-related internal controls 
  • Risk assessment of property at the assertion level
  • Documentation of any property control deficiencies
  • Property audit program
  • A copy of the depreciation schedule that agrees to the general ledger
  • A summary of additions and retirements of property in the current audit period

In Summary

Today, we looked at how to perform property risk assessment procedures, the relevant property assertions, the property risk assessments, and substantive property procedures. 

If you audit property differently, please share your ideas in a comment below. 

Continuing Audit Series

This post is a part of my series titled the Why and What of Audits. If you’ve missed the prior series articles, click here

Next week, we’ll look at how to audit accounts payable and expenses.

Solo Accountant or a Partnership: Which is Best?

Some people enjoy working by themselves, others in a partnership

We all live with fear, but accountants have their own variety. I think back on my college years and the wondering about how my life and career would unfold. And I wanted—really wanted—to see the future, but could not. 

At twenty-one, I would have given a prince’s sum for a crystal ball. But even if the seer’s tool existed, I had no money. So I ventured out, hands extended in darkness, hoping things would go well. And why did I desire to know the future? To avoid mistakes. To lessen my fear. But mistakes—not crystal balls—are how you learn.

Through the years, my career evolved blandly, though with a few jerks and screams (I had a brain tumor; shortly after that, my son has born with cystic fibrosis). But, overall, my work life has unfolded—like most—day by day.

My First Job

In the early days of my first job, I realized how little I knew, though I had a masters degree in accounting. Like a new golfer, I felt—and looked—awkward. My college professors trained me well, but I was still a duffer. I muddled my way through the first year, little realizing how much I was learning—and not understanding my firm was doing me a favor. They were paying me to learn. (You only get this perspective—later—when you are an employer.)

Solo accountant

Picture from AdobeStock.co

One year into public accounting, the lights came on. I finally hit shots like a real accountant. I finally felt normal. I finally moved more naturally. But after three years in my junior role, another firm came calling, asking me to move. They offered more money and more opportunity, so I ventured out.

My Second Job

My second job was more of an apprenticeship. My boss mentored and trained me. He allowed me to assume responsibility. I think you could say this is where I came into my own. But even though I liked my boss, we had disagreements. He promised one thing but delivered another. I found myself doing most of the work with no movement to the promised position. My boss was a good man, but at age 68, it was obvious, he had no desire to retire (though that was the agreement).

So, I left with no job. (I know. Not smart, huh?) This was quite scary, especially when you have two children and a wife at home—in other words, no other income. What did I do? I hung my shingle. 

Solo Accountant

In those years, I had my greatest joys and fears. To go from nothing to something was like climbing a mountain. And I am not the adventuresome type. In the early days, there was no cash flow—and I mean none. I recall, like a scene from a Charles Dickens’ story, nights of soup and bread. And much of the time, I had this deep sense of fear. Nevertheless, I survived and—at times—even thrived.  

The joy of owning my own firm came in the freedom to come and go as I pleased, to do what I wanted—and when I wanted. But freedom comes with baggage. Namely, overhead, unsteady cash flows, and legal exposure. Even so, the freedom to make my own decisions was a breath of fresh air. If I wanted to pursue a new strategy, I did so. If I wanted to leave work early, I left. If I wanted to buy a new computer, I bought it. No committees. No boss. No one was telling me what I could or could not do. It was nice.

But in working alone, I learned a few things about myself. I love freedom, but I hate fear. I also found that I am more productive in a group environment. Why? Accountability. Additionally, I discovered I need more wisdom than I (alone) possess. As much as I hate to admit it (call it pride), I need a group of people. 

Partnership

So, for most of my career, partnerships have been my work environment of choice. I like steady paychecks. I enjoy having answers to my questions just down the hallway.

The wisdom of partnerships is a beautiful thing. The Bible provides this word: 

Plans fail for lack of counsel, but with any advisors, they succeed. Proverbs 15:22

I can’t count the times I have seen problems surface—seemingly—with no answer, but then, in a partnership meeting, ideas, disagreements, thoughts are tossed around. And in the end, there is an answer. Creative, wise, sound.

Multiple perspectives meld together to provide insight, a wisdom much greater than my own. But submission is necessary to be a part of a partnership. And I think that’s hard for most people, including me. And while I desire to do as I please, the power of the group is real. People working together often achieve what individuals cannot.   

Solo or Partnership – Which Do You Prefer?

In the end, the decision to work alone or in a group is a personal decision based on our own bents. Some people work better by themselves and want freedom more than anything. I get that. Others find success in a partnership. So which are you? One who likes to work alone or one who loves a group? What makes you the way you are?

Debt Issuance Costs Have a New Parking Place

If ASU 2015-03 has not already been adopted, do so for December 31, 2016 year-ends

Debt issuance costs have a new parking place. For some time now, such costs were booked as a deferred charge (an asset). Now, debt issuance cost will be netted with the related debt

This change is required by Accounting Standards Update No. 2015-03, Interest – Imputation of Interest, Simplifying the Presentation of Debt Issuance Costs (Subtopic 835-30).

If you have not already done so, you need to adopt this standard for years ending December 31, 2016. This is a change in accounting principle.

debt issuance costs have a new parking place

Debt Issuance Costs

Debt Issuance Costs Have a New Parking Place

ASU 2015-03 (ASC 835-30) states the following (bold emphasis mine):

To simplify the presentation of debt issuance costs, the amendments in this Update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts.

Top 10 Technology Tips for Accountants

Here are tips to make your accounting life more productive

Are you looking for technology tips for accountants? Here are ten tips that will make you more productive.

Technology tips for accountants

Ten Technology Tips for Accountants

Here are my top ten technology tips in no certain order (with links to prior blog posts).

  1. Use Skitch to create annotated screenshots.
  2. Use Office 365 to jointly create Word or Excel documents with others.
  3. Use Basecamp to manage projects (such as audits).
  4. Use Scanbot as your phone scanner.
  5. Use a Livescribe pen to take notes with audio.
  6. Use Evernote as your personal digital library.
  7. Travel light as a minimalist auditor.
  8. Use your cell phone in creative ways as an accountant.
  9. Use technology to save your life.
  10. Use technology to make your office work life more efficient.

Those are my ideas. What are yours?