Auditing Equity: The Why and How Guide

Auditing equity is usually quite easy--until it's not

What are the keys to auditing equity correctly? In this post, we’ll answer this question, showing you how to focus on the important equity accounting issues.

how to audit equity

Auditing Equity — An Overview

In this post, we will cover the following:

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

Primary Equity Assertions

Before we look at assertions, consider various potential equity accounts such as:

  • Common stock
  • Paid in capital
  • Preferred stock
  • Treasury stock
  • Accumulated other comprehensive income
  • Noncontrolling interests
  • Members’ equity (for an LLC)
  • Net assets (for a nonprofit)
  • Net position (for a government)

Certain types of equity accounts are used for certain types of entities. For example, you’ll find common stock in an incorporated business, net assets in nonprofits, and members’ equity in a limited liability corporation. 

Then, the equity accounts used will depend upon what the entity does. Examples include:

  • Has the company purchased treasury stock?
  • Does a commercial entity have unrealized gains or losses on available-for-sale securities?
  • Does a nonprofit organization have restricted contributions?
  • Does a government have restricted net position?

So, it’s a must–before you determine the relevant assertions–that you understand the accounting for (1) the type of entity and (2) the particular equity-related transactions.

The primary relevant equity assertions (often) are:

  • Existence and occurrence
  • Rights and obligations
  • Classification

When a company reflects equity on its balance sheet, it is asserting that the balance exists and that the equity transactions occurred. For example, if common stock is sold, the balance of the account is based upon the actual sale of stock and the monies received. The balance is not fictitiously or erroneously stated. 

Equity instruments also have certain rights and obligations. For example, common stock provides rights to retained earnings. Also, some classes of stock provide voting privileges. Others do not.

Additionally, the classification of equity balances is important. Determining how to present equity is usually easy, but classification issues arise when an entity has equity instruments such as convertible stock. Classification is also relevant when there is a noncontrolling interest

Keep these assertions in mind as you perform your transaction cycle walkthroughs.

Equity Walkthroughs

Early in your audit, perform a walkthrough of equity to see if there are any control weaknesses. As you perform this risk assessment procedure, what questions should you ask? What should you observe? What documents should you inspect? Here are a few suggestions.

Walkthrough Questions and Actions

As you perform your equity walkthrough ask or perform the following:

  • What types of equity does the entity have?
  • How many shares are authorized? How many shares have been issued?
  • Does the company have any convertible debt?
  • Has the company declared and paid dividends?
  • Are there any state laws restricting distributions?
  • Does the company have accumulated other comprehensive income?
  • Inspect ownership documents such as stock certificates.
  • Read the minutes to determine if any new equity has been issued.
  • Does the company have classes of stock? What are the rights of each?
  • Is the entity attempting to raise additional capital?
  • Has the company sold any additional equity ownership?
  • Is there a noncontrolling interest in the company?
  • Does the company have stock compensation plan?
  • For a nonprofit, are there any restricted donations?
  • For a government, is the net position restricted?
  • For a limited liability corporation, are there differing classes of ownership? 

As you perform your walkthroughs, also consider if there are risks of material misstatement due to fraud or error.

Equity-Related Fraud and Errors

Theft seldom occurs in the sale of stock. If fraud occurs, it’s usually an intentional false equity presentation. Inflating an entity’s equity can make the organization appear healthier than it really is. 

Additionally, mistakes can lead to errors in accounting for equity. Such mistakes may occur if the entity sells complex equity instruments. Understanding the rights and obligations of ownership interests is a key to proper accounting.

Directional Risk for Equity

The directional risk for equity is that it is overstated (companies desire strong equity positions). So, audit for existence. 

Primary Risks for Equity

The primary risks for equity are:

  1. Equity is intentionally overstated
  2. Misclassified equity 

As you think about these risks, consider the control deficiencies that allow equity misstatements.

Common Equity Control Deficiencies

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

  • One person performs two or more of the following: 
    • Approves the sale of equity interests,
    • Enters the new equity in the accounting system, 
    • Deposits funds from the sale of the equity instruments
  • Accounting personnel lack knowledge regarding equity transactions

Another key to auditing equity is understanding the risks of material misstatement.

Risk of Material Misstatement for Equity

In auditing equity, the assertions that concern me the most are existence, classification, and rights. So my risk of material misstatement for these assertions is usually moderate to high. 

My response to the higher risk assessments is to perform certain substantive procedures: namely, a review of equity transactions. Why?

A company may desire to overstate its equity. Also, misclassifications occur due to misunderstandings about equity accounting.

Once your risk assessment is complete, you’ll decide what substantive procedures to perform.

Substantive Procedures for Equity

My normal substantive tests for auditing equity include:

  1. Summarizing and reviewing all equity transactions
  2. Reviewing all equity accounts for proper classification
  3. Agreeing all beginning of period balances to the prior period’s ending balances
  4. Reviewing equity disclosures for compliance with the requirements of the reporting framework (e.g., GAAP)

In light of my risk assessment and substantive procedures, what equity work papers do I normally include in my audit files?

Common Equity Work Papers

My equity work papers normally include the following:

  • An understanding of equity-related internal controls 
  • Documentation of any equity internal control deficiencies
  • Risk assessment of equity at the assertion level
  • Equity audit program
  • A copy of (sample) equity instruments 
  • Minutes reflecting the approval of new equity
  • A summary of equity activity (beginning balances plus new equity less equity distributions and ending balance)

In Summary

In summary, today we reviewed the keys to auditing equity. Those keys include risk assessment procedures, determining relevant assertions, performing risk assessments, and developing substantive procedures. The most important issues to address are usually (1) equity accounting (especially when there are more complex types of equity transactions) and (2) the classification of equity.

Look for my next post in The Why and How of Auditing

If you’ve missed my prior posts in this audit series, click here.

Forty Mistakes Auditors Make

Here are 40 technology, planning, and execution deficiencies

Here are forty mistakes auditors make. While the list is (obviously) not comprehensive, you’ll see common technology, planning, and execution mistakes.

forty mistakes auditors make

  1. We aren’t paperless.
  2. We don’t link our trial balances to our work papers.
  3. We haven’t learned to use Adobe Acrobat.
  4. We don’t use optical character recognition (OCR), so we can’t electronically search our documents.
  5. We don’t use project management software such as Basecamp.
  6. We lose team communications (i.e., emails) because we aren’t using Slack.
  7. We use old (slow) computers.
  8. We don’t properly consider and document our independence.
  9. We don’t perform continuance procedures.
  10. We don’t assign appropriate personnel to risky engagements.
  11. We don’t appropriately price the engagement which leads to unattainable time budgets.
  12. We don’t focus our efforts on particular niches (thinking we can audit anything that comes our way).
  13. We keep doing the same thing year after year after year (and then complain we have too much time in the job).
  14. We assume we already know all the risks.
  15. We perform no (real) risk assessment.
  16. We don’t perform walkthroughs because we assume nothing has changed.
  17. We don’t perform walkthroughs because we are afraid of interacting with client personnel.
  18. We don’t consider internal control weaknesses in our risk assessment and audit program development.
  19. We create preliminary analytics in a perfunctory manner, not allowing them to inform us about risks.
  20. We ask perfunctory fraud questions without truly considering fraud risks.
  21. We don’t perform retrospective reviews of estimates.
  22. We don’t link identified risks to our audit plans.
  23. We don’t (really) have an engagement team discussion.
  24. We don’t tailor our audit programs.
  25. We don’t add purpose statements or conclusions on our work papers.
  26. We don’t define our tickmarks.
  27. We receive unnecessary documents from the client and leave them in the audit file.
  28. We leave review notes in the file.
  29. We don’t sign off on work papers, so no one knows who created the document.
  30. We don’t perform post-audit reviews to document the mistakes we made (so they won’t be repeated next year).
  31. We ask clients for certain documents without showing them the prior year example (and they provide the wrong document).
  32. We get on and off the same engagement too many times, losing momentum and wasting time.
  33. We send our audit team into the field even though the client hasn’t provided requested information.
  34. We don’t educate the client regarding the importance of timely information.
  35. We use staff that are not properly trained.
  36. We don’t plan our CPE to address upcoming audits.
  37. We don’t review staff work on a timely basis, so feedback is late (or not provided at all).
  38. We don’t report significant deficiencies or material weaknesses (because of client push-back).
  39. We fail to lock down our files.
  40. We don’t add value to our audits.

Sleeping with Your Decisions as a CPA

Are you struggling with an ethical issue?

Men are alike in their promises. It is only in their deeds that they differ. Molière

We’ve all been there.

Your client wants you to sign off on an issue, one that is in the land of gray–you know, that place where there is no black or white. And, of course, the issue has significant dollars attached to it, so it’s important.

Your anguish rises, so you try to see the Great Oz, but he’s not available. No trips to Kansas today.

You want to do the right thing, but what is it?

Sleeping with Your Decisions as a CPA

Picture courtesy of AdobeStock.com

Four Questions for Clarity

Here are four questions to ask:

  1. How would I feel if my choice was placed on the front-page of the local newspaper (or in the Journal of Accountancy)?
  2. What would my father do (or anyone else I greatly respect)?
  3. What would I advise my child to do? (If your child is three, pretend she is thirty.)
  4. What’s the worst thing that could happen

Four Actions for Clarity

Here are four actions to take:

  1. Call the AICPA Ethics Hotline or the AICPA Technical Hotline (877-242-7212). (They are independent of the issue, so they will give you a straight-up answer.)
  2. Call a CPA with knowledge in the area of concern, and ask his or her opinion.
  3. Create a memo supporting your proposed decision, and share it with a partner, quality control department, or whoever is in charge. (I find that writing creates clarity.)
  4. Sit on it (if you can). I gain clarity as I allow the issue to percolate, and as I pray about it. I try not to make a high-stakes decision quickly. A hurried decision is usually a poor one.

Sleeping Well

Remember, a clear conscience is a precious commodity. If you believe a particular course of action is going to keep you awake at night, then your conscience is speaking to you.

Do the right thing and sleep well. Good evening.

Auditing Debt: The Why and How Guide

A key risk is that debt is classified as noncurrent when it should be current

What are the keys to auditing debt correctly?

While auditing debt can be simple, sometimes it gets tricky. You might even get eclipsed by the accounting! The violation of covenants can darken the sky. Also, some companies keep debt off the books by structuring leases to avoid capitalization. So, put on your shades and let’s take a look at how to audit debt.

auditing debt

Auditing Debt — An Overview

In many governments, nonprofits, and small businesses debt is a significant part of total liabilities. Consequently, it is often a significant transaction area. 

In this post, we will cover the following:

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

Primary Debt Assertions

The primary relevant debt assertions are:

  • Completeness
  • Classification

I believe—in general—completeness and classification are the most important debt assertions. When a company shows debt on its balance sheet, it is asserting that it is complete and classified correctly. By classification, we mean it is properly displayed as either short-term or long-term.

Keep these assertions in mind as you perform your transaction cycle walkthroughs.

Debt Walkthroughs

Early in your audit, perform a walkthrough of debt to see if there are any control weaknesses. As you perform this risk assessment procedure, what questions should you ask? What should you observe? What documents should you inspect? Here are a few suggestions.

Walkthrough Questions and Actions

As you perform your debt walkthrough ask or perform the following:

  • Are there any debt covenants?
  • Does the company have any covenant violations?
  • If the company has violations, is the debt classified appropriately (usually current)?
  • Is the company reconciling the balance sheet to a loan amortization schedule?
  • Inspect amortization schedules.
  • Does the company have any unused lines of credit or other credit available?
  • Inspect loan documents.
  • Has the company refinanced its debt with another institution? Why?
  • Who approves the borrowing of new money?
  • Inspect loan approvals.
  • How are debt service payments made (e.g., by check or wire)?
  • Are there any sinking funds? If yes, who is responsible for making deposits and how is this done?
  • Observe the segregation of duties for persons:
    • Approving new loans,
    • Receipting new loan proceeds, 
    • Recording debt in the general ledger, and 
    • Reconciling the debt on the balance sheet to the loan amortization schedules
  • Is the company required to file any periodic (e.g., quarterly) reports with the lender?
  • Inspect sample quarterly debt reports, if applicable.
  • Does the company have any capital leases?
  • Who is responsible for determining whether a lease should be capitalized?
  • What criteria is the company using to capitalize leases?
  • Has collateral been pledged? If yes, what?
  • What are the terms of the debt agreements?
  • Has all debt of the company been recorded in the general ledger?
  • Have debt issuance costs been netted against debt in the financial statements?
  • Has the company guaranteed the debt of another entity?

If control weaknesses exist, create audit procedures to respond to them. For example, if—during the walkthrough—we see that one person approves loans and deposits loan proceeds, then we will perform fraud-related substantive procedures. 

Debt-Related Fraud

Companies can intentionally omit debt from their balance sheets in order to inflate their equity total. (Since total assets equal liabilities plus equity, then equity goes up if debt is omitted.)

As we saw with Enron many years ago, some entities try to move their debt to other entities. So auditors need to consider that a company may intentionally omit debt from its balance sheet.

Another potential fraudulent presentation is showing short-term debt as long-term. When might this happen? When there is a debt covenant violation. The company may need to present the debt as current when such violations occur. Here’s how to report debt covenant violations.

Additionally, mistakes can lead to errors in debt accounting.

Debt Mistakes

Debt errors may occur when accounting personnel misclassify debt service payments. Also, debt can be mistakenly presented as long-term when it is current.

We also need to consider the directional risk for debt. 

Directional Risk for Debt

The directional risk for debt is that it is understated. So, audit for completeness (and determine that all debt is recorded).

Primary Risks for Debt

The primary risks for debt are:

  1. Debt is intentionally understated (or omitted)
  2. Debt is not classified as current though there is a covenant default that requires such treatment

As you think about these risks, consider the control deficiencies that allow debt misstatements.

Common Debt Control Deficiencies

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

  • One person performs two or more of the following: 
    • Approves the borrowing of new funds,
    • Enters the new debt in the accounting system, 
    • Deposits funds from the new debt
  • Funds are borrowed without appropriate approval
  • Debt postings are not agreed to an amortization schedule
  • The accounting personnel don’t understand the accounting standards for debt covenant violations and lease capitalization

Another key to auditing debt is understanding the risks of material misstatement.

Risk of Material Misstatement for Debt

In auditing debt, the assertions that concern me the most are classification and completeness. So my risk of material misstatement for these assertions is usually moderate to high. 

My response to the higher risk assessments is to perform certain substantive procedures: namely, a review of debt covenant compliance and a review of lease accounting. Why?

A company desires to display debt as long-term (even though it is short-term). Doing so makes working capital (current assets minus current liabilities) stronger. If a debt covenant violation causes debt to be current, working capital can tank quickly. So, the temptation is to show debt as long-term even though it is technically current.

Additionally, debt issuance costs are a deduction from debt. Review the classification of these costs which prior to ASU 2015-03 were assets. See this post for more information.

And one more thing. If capital leases are not capitalized (though they should be), the debt does not appear on the balance sheet, making the company look healthier than it is. (FASB has issued a new lease standard that will require the capitalization of all leases of more than one year, but it’s not presently effective. You can see ASU 2016-02, Leases here.)

Once your risk assessment is complete, you’ll decide what substantive procedures to perform.

Substantive Procedures for Debt

My customary tests for auditing debt are as follows:

  1. Summarize and review all debt covenants
  2. Review all leases for correct classification as capital or operating
  3. Confirm all significant debt with the lender
  4. Determine if all debt is classified appropriately (as current or noncurrent)
  5. Agree the end-of-period balances on the balance sheet to the amortization schedule
  6. Review any significant accrued interest at period-end

In light of my risk assessment and substantive procedures, what debt work papers do I normally include in my audit files?

Common Debt Work Papers

My debt work papers normally include the following:

  • An understanding of debt-related internal controls 
  • Documentation of any debt internal control deficiencies
  • Risk assessment of debt at the assertion level
  • Debt audit program
  • A copy of all significant debt agreements (including leases and line-of-credit agreements)
  • Minutes reflecting the approval of new debt
  • A summary of debt activity (beginning balance plus new debt minus principal payments and ending balance)
  • Amortization schedules for each debt

If there’s any question about debt agreements and their presentation, I include additional representation letter language to address the issue.

In Summary

In summary, today we looked at the keys to auditing debt. Those keys include risk assessment procedures, determining relevant assertions, creating risk assessments, and developing substantive procedures. The most important issues to address are usually (1) the classification of debt (especially if debt covenant violations exist) and (2) lease accounting.

Look for my next post in The Why and How of Auditing. Next week we’ll look at how to audit equity.

If you’ve missed my prior posts in this audit series, click here.

Going Concern in Compilation and Review Engagements

If your compilation and review engagement clients have financial difficulties, then think about going concern disclosures

Do you need to concern yourself with going concern in compilation and review engagements? Yes, if the financial statements are prepared in accordance with the FASB Codification. But is going concern relevant to special purpose frameworks such as the cash basis or tax basis financial statements. Yes, going concern is in play even with special purpose frameworks. This post provides an overview of what you need to know about going concern as it relates to compilation and review engagements.

I recently wrote a post about ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which is effective for years ending after December 15, 2016. This standard requires companies to include certain disclosures when substantial doubt is present. So, we know that financial statements prepared in accordance with GAAP must include these disclosures. Otherwise, there is a GAAP departure. And in an audit, we modify our opinion when there is a departure.

Going Concern

Going Concern in Compilation Engagements

But what about financial statements subject to a compilation engagement, especially when substantially all disclosures are omitted? Is it not permissible for the CPA to ignore the going concern standard since it just requires disclosures? Yes, but be careful. Ask yourself whether the financial statements would be misleading (without the going concern disclosure). If they are misleading, then include a selected disclosure regarding going concern. Also, consider adding an emphasis of matter paragraph (regarding going concern) to your compilation report.

Consider the alternative. Your client (who has significant going concern issues) takes your compilation report and their financial statements (that has no disclosures) to a local bank. It’s obvious that the company is in poor shape. But the bank makes a large loan anyway, and later, the company defaults. Then the bank files suit against you (the CPA) asserting that you issued the compilation report without the emphasis of matter and financial statements without the going concern disclosure–knowing the statements were misleading.

Sample Compilation Report with a Going Concern Paragraph

An emphasis of a matter paragraph (concerning the going concern issue) is not required but may be necessary to ensure clarity. Below is a sample compilation report–with a going concern emphasis of matter–from the AICPA’s Preparation, Compilation and Review Audit Guide.

Management is responsible for the accompanying financial statements of XYZ Company, which comprise the balance sheets as of December 31, 20X2 and 20X1 and the related statements of income, changes in stockholders’ equity, and cash flows for the years then ended, and the related notes to the financial statements in accordance with accounting principles generally accepted in the United States of America. I (We) have performed compilation engagements in accordance with Statements on Standards for Accounting and Review Services promulgated by the Accounting and Review Services Committee of the AICPA. I (We) did not audit or review the financial statements nor was (were) I (we) required to perform any procedures to verify the accuracy or completeness of the information provided by management. Accordingly, I (we) do not express an opinion, a conclusion, nor provide any form of assurance on these financial statements.

As discussed in Note X, certain conditions indicate that the Company may be unable to continue as a going concern. The accompanying financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.

[Signature of accounting firm or accountant, as appropriate]
[Accountant’s city and state]
[Date of the accountant’s report]

Going Concern in Review Engagements

Since review engagements require full disclosure, going concern disclosures–when substantial doubt exists in GAAP financial statements–are not optional. They must be provided. If not, then a GAAP departure exists.

AR-C 90.65 states “The accountant should consider whether, during the performance of review procedures, evidence or information came to the accountant’s attention indicating that there could be an uncertainty about the entity’s ability to continue as a going concern for a reasonable period of time.” So what’s a reasonable period of time? GAAP specifies the period as one year after the date the financial statements are available to be issued. If a financial reporting framework does not specify a period (such as the cash basis of accounting), then use one year from the date of the financial statements being reviewed.

The Accounting and Review Services Committee (ARSC) is presently reviewing AR-C 90 in light of FASB’s going concern standard, ASU 2014-15. ARSC is working to align the review standards with FASB’s going concern standards. Also, expect to see a requirement that an emphasis of matter paragraph be added to the review report when substantial doubt is present. 

Sample Going Concern Paragraph in a Review Report

Here’s a sample emphasis of matter paragraph for a review report.

Emphasis of Matter

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note X to the financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency that raises an uncertainty about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note X. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our conclusion is not modified with respect to this matter.

Special Purpose Frameworks

While the cash, modified cash, or tax bases of accounting do not address going concern, accountants still need to consider the effects of negative financial conditions and trends. Why? When using a special purpose framework (like the tax basis), the accountant should follow the guidance in GAAP. No, that doesn’t mean your disclosures are just like GAAP, but it does mean they are similar to GAAP.

Since GAAP tells the financial statement preparer to consider whether substantial doubt exists, then persons creating cash basis, modified cash basis or tax basis financial statements should do the same. If substantial doubt is present, going concern disclosures are necessary. Follow FASB’s guidance in my going concern post to create your special purpose framework disclosures.

So, what is substantial doubt? The FASB Codification defines it this way:

Substantial doubt about the entity’s ability to continue as a going concern is considered to exist when aggregate conditions and events indicate that it is probable that the entity will be unable to meet obligations when due within one year of the date that the financial statements are issued or are available to be issued.

If substantial doubt is present and going concern disclosures are not included in full disclosure compilations or reviews, then modify your accountant’s report (for the departure). 

Audit Planning Analytics for First-Year Businesses

How to create planning analytics when there is no prior year

How do you create audit planning analytics for first-year businesses? We commonly compare current year numbers to the prior period, but, in this case, there are no prior year numbers. What other options are available?

Audit Planning Analytics for First Year

Courtesy of iStockphoto.com

Planning Analytics for First-Year Businesses

Audit standards don’t require the use of any particular analytics, so let’s think outside the box (of comparing current and prior year numbers). There are at least four alternatives:

  1. Nonfinancial information
  2. Ratios compared to industry averages
  3. Intraperiod totals (e.g., monthly or quarterly)
  4. Budgetary comparisons

How can we use nonfinancial information?

AU-C 315, paragraph .A7 states:

Analytical procedures performed as risk assessment procedures may include both financial and nonfinancial information (for example, the relationship between sales and square footage of selling space or volume of goods sold).

First Option

So one option is to compute expected numbers using nonfinancial information. Then compare the calculated numbers to the general ledger to search for unexpected variances.

Second Option

A second option is to calculate ratios common to the entity’s industry and compare the results to industry benchmarks. While industry analytics can be computed, I’m not sure how useful they are. An infant company often will not generate numbers comparable to more mature entities. But we’ll keep this choice in our quiver, just in case.

Third Option

A more useful option is the third–comparing intraperiod numbers. First, discuss the expected monthly or quarterly revenue trends with the client before you examine the accounting records. The warehouse foreman might say, “We shipped almost nothing the first six months. Then things caught fire. My head was spinning the last half of the year.” Does the general ledger reflect this story? Did revenues and costs of goods sold significantly increase in the latter half of the year?

Fourth Option

The last option we’ve listed is a review of the budgetary comparisons. Some entities, such as governments, lend themselves to this alternative; others, not so–those that don’t adopt budgets.

Summary

So, yes, it is possible to create useful risk assessment analytics–even for the first year of operation.

Remember: planning analytics are for the purpose of detecting risk. If the numbers don’t line up as expected, then you have a risk indicator. It is here that you may need to respond with substantive procedures.

Other Ideas?

What planning analytics do you perform for first-year audit clients?

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Episode 9 – Ten Ways to Prevent Small Business Fraud

You can lessen the threat of fraud even when you can't segregate accounting duties

10 Ways to Prevent Small Business Fraud

10 Ways to Prevent Small Business Fraud

Many small businesses think they can’t prevent fraud. Why? There are not enough people to segregate accounting duties. Also, small businesses may feel like they don’t know how to prevent fraud (even if they had more people). 

Here are ten ways to lessen the threat of fraud regardless of your company’s size. But these suggestions are even more important for the small business that has a limited number of employees.

Check these suggestions out to save yourself plenty of heartaches.

Backdoor Payroll Theft of Withholdings

This relatively unknown fraud can be dangerous

The Theft

Gertrude, the payroll clerk, intentionally overpays state withholding taxes by $25,000. She then amends her own W–2 so that it includes the excess payment (the $25,000 is added to her state withholding total). Once Gertrude files her personal state tax return, she receives an extra $25,000. In effect, she is using the state government as a funnel for theft.

In this business, Gertrude processes payroll, files all related payroll tax reporting information, makes payroll withholding payments and records payroll entries in the general ledger—not uncommon in a smaller organization. Also, no second person reviews the W-2s before mailing.

Backdoor Payroll Fraud

Picture is courtesy of AdobeStock.com

The Weakness

One person is performing all payroll functions, so her actions are not visible to anyone else. Also, no second person–in addition to Gertrude–is reviewing the W-2s before filing.

The Fix

Have someone outside the payroll department review and mail the W-2s. (If the W-2s are returned to the payroll clerk, she could change them.)

The Power of Story in Teaching CPAs

Storytelling enhances communication, but most CPE classes are void of narrative. CPAs need more than information. We need (at least some) emotion.

This post provides information about the power of story in teaching CPAs.

Power of Story in Teaching CPAs

The Power of Story in Teaching CPAs

Think of your last educational class, particularly the slide deck. You recall the presenter saying, “Here’s all the information I have regarding variable interest entities.”

And the bullets began:

  • A variable interest entity is …
  • Obligation to absorb…
  • Scope exceptions include…

It’s here you said to yourself (in a Steve Martin tone), PLEEEASE!

Speakers must first remember we are talking to human beings, people with passion and fears and heartbeats. (Yes, CPAs qualify.)

If a speaker’s goal is to transfer knowledge, what’s the best way to do so? Start with a story.

I hear your rejoinder now, “About variable interest entities?”

Yes.

VIEs are not tantalizing. But dig deeper and you will find the story. (There’s always a story.)

Start with Story

In searching for the spice, you ask yourself questions. Why do the VIE standards exist? What events led to their creation? The result: a story to wet your audience’s appetite.

In teaching the class, you start with Enron and its use of special purpose entities. You describe the immeasurable damage done by Ken Lay and his lieutenants, and that Mr. Lay never served a day of time–his life cut short just before sentencing. You tell the tantalizing story of the courageous whistle-blower, Sherron Watkins (a Time Magazine Person of the Year). And since your audience is full of CPAs, your Arthur Andersen vignette does not fall on deaf ears.

Boring? Not you.

Your story creates context and breathes life into an otherwise tedious set of standards.

Now your listeners are receptive.

The Formula

So your formula is: Story, then content. Create appetitive. Then feed.

Following this path, you find your audience listening, even leaning forward.

Brain Rules

John Medina, in his book, Brain Rules, suggests that teachers “bait the hook” every ten minutes. Medina says, “After 9 minutes and 59 seconds, the audience’s attention is getting ready to plummet to near zero.” Stories are one of those hooks. The book goes on to say, “Fear, laughter, happiness, nostalgia, incredulity–the entire emotional palette can be stimulated, and all work well.”

Brain Rules lists three elements of a hook (to engage your class):

  1. The hook has to trigger an emotion.
  2. The hook has to be relevant.
  3. The hook has to go between segments.

Your Suggestions

How do you use stories to enhance your teaching?