Category Archives for "Accounting and Auditing"

audit and work paper mistakes
Apr 23

Forty Audit and Work Paper Mistakes

By Charles Hall | Auditing

Today, I offer you a list of forty audit and work paper mistakes.

audit and work paper mistakes

The list is based on my observations from over over thirty years of audit reviews (and not on any type of formal study).

You will, however, shake your head in agreement as you read these. I know you’ve seen them as well. The list is not comprehensive. So, you can add others in the comments section of this post.

Here’s the list.

  1. No preparer sign-off on a work paper
  2. No evidence of work paper reviews
  3. Placing documents in the file with no purpose (the work paper provides no evidential matter for the audit)
  4. Signing off on unperformed audit program steps
  5. No references to supporting documentation in the audit program
  6. Using canned audit programs that aren’t based on risk assessments for the particular entity
  7. Not documenting expectations for planning analytics
  8. Inadequate explanations for variances in planning analytics (“revenue went up because sales increased”)
  9. Planning analytics with obvious risk of material misstatement indicators, but no change in the audit plan to address the risk (sometimes referred to as linking)
  10. Not documenting who inquiries were made of
  11. Not documenting when inquiries were made
  12. Significant deficiencies or material weaknesses that are not communicated in written form
  13. Verbally communicating control deficiencies (those not significant deficiencies or material weaknesses) without documenting the conversation
  14. Performing needed substantive tests with no related audit program steps (i.e., the audit program was not amended to include the necessary procedures)
  15. Assessing control risk below high without testing controls
  16. Assessing the risk of material misstatement at low without a basis (reason) for doing so
  17. Documenting significant risks (e.g., allowance for uncollectible receivable estimates in healthcare entities) but no high inherent risks (when inherent risk are separately documented)
  18. Not documenting the predecessor auditor communication in a first-year engagement
  19. Not documenting the qualifications and objectivity of a specialist
  20. Not documenting all nonattest services provided
  21. Not documenting independence
  22. Not documenting the continuance decision before an audit is started
  23. Performing walkthroughs at the end of an engagement rather than the beginning
  24. Not performing walkthroughs or any other risk assessment procedures
  25. Not performing risk assessment procedures for all significant transaction areas (e.g., risk assessment procedures performed for billing and collections but not for payroll which was significant)
  26. Not retaining the support for opinion wording in the file (especially for modifications)
  27. Specific items tested are not identified (e.g., “tested 25 disbursements, comparing amounts in the check register to cleared checks” — we don’t know which particular payments were tested)
  28. Making general statements that can’t be re-performed based on the information provided (e.g., “inquired of three employees about potential fraud” — we don’t know who was interviewed or what was asked or their responses)
  29. Retrospective reviews of estimates are not performed (as a risk assessment procedure)
  30. Going concern indicators are present but no documentation regarding substantial doubt
  31. IT controls are not documented
  32. The representation letter is dated prior to final file reviews by the engagement partner or a quality control partner
  33. Consultations with external or internal experts are not documented
  34. No purpose or conclusion statement on key work papers
  35. Tickmarks are not defined (at all)
  36. Inadequately defining tickmarks (e.g., ## Tested) — we don’t know what was done
  37. No group audit documentation though a subsidiary is included in the consolidated financial statements
  38. No elements of unpredictability were performed
  39. Not inquiring of those charged with governance about fraud
  40. Not locking the file down after 60 days 

That’s my list. What would you add?

supplementary information
Apr 11

Supplementary Information, Other Information and Required Supplementary Information

By Charles Hall | Auditing

What’s the difference in supplementary information, additional information, and required supplementary information? What language should be included in the audit opinion when such information is included in the financial statements?  What audit procedures must be performed? Below I provide the answers.

supplementary information

1. Supplementary Information

Supplementary information is defined as information presented outside the basic financial statements, excluding required supplementary information (see below), that is not considered necessary for financial statements to be fairly-presented in accordance with the applicable financial reporting framework (e.g. FASB).  (See AU-C 725 for more guidance about supplementary information.)

Supplementary information may include:

  • Accounting information and
  • Nonaccounting information

Supplementary information examples include:

  • Detail of “Other Income” as shown in the statement of operations*
  • Detail of “General and Administrative” expenses as shown in the statement of operations*
  • Number of employees in a given payroll period**

* Derived from financial statements

** Not derived from the financial statements

Procedures to Perform

Procedures to be performed include:

  • Determine whether the information is fairly stated, in all material respects, in relation to the financial statements as a whole

Sample Opinion Language

Example auditor’s report paragraph:

The [identify accompanying 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.

For examples of presenting the supplementary language (1) in the standard opinion or (2) separately, click here.

Notice that an opinion is rendered on supplementary information. No opinion is given in regard to other information.

2. Other Information

Other information is financial and nonfinancial information (other than the financial statements and the audit report) that is included in a document containing audited financial statements and the audit report (e.g., an annual report), excluding required supplementary information. An auditor can use this option when he or she is not engaged to render an opinion on such information. (See AU-C 720 for more guidance about other information.)

Other information examples include:

  • Financial summaries
  • Employment data
  • Planned capital expenditures
  • Names of officers and directors

Procedures to Perform

Procedure to be performed:

  • Reading the other information in order to identify any material inconsistencies with audited financial statements

Sample Opinion Language

The auditor can use an other-matter paragraph to disclaim an opinion regarding other information. Sample language follows:

Our audit was conducted for the purpose of forming an opinion on the basic financial statements as a whole. The [identify the other information] is presented for purposes of additional analysis and is not a required part of the basic financial statements. Such information has not been subjected to the auditing procedures applied in the audit of the basic financial statements, and accordingly, we do not express an opinion or provide any assurance on it.

3. Required Supplementary Information

Required supplementary information (RSI) is information that a designated accounting standard-setter (e.g., FASB, GASB) requires to accompany the basic financial statements. RSI is not part of the basic financial statements. However, the designated accounting standard-setter has determined that the information is an essential part of financial reporting. (See AU-C 730 for more guidance about required supplementary information.)

Required supplementary information examples include:

  • Management discussion and analysis (MD&A) for governments
  • Estimates of current or future costs of future major repairs and replacements for common interest realty associations

Procedures to Perform

Procedures to be performed include:

  • Inquiry of management about methods used to create information
  • Comparing the information for consistency with management responses and the financial statements
  • Obtaining written representations from management

Sample Opinion Language

Example auditor’s report paragraph:

Accounting principles generally accepted in the United States of America require that the [identify the required supplementary information] on page XX be presented to supplement the basic financial statements. Such information, although not a part of the basic financial statements, is required by the Financial Accounting Standards Board who considers it to be an essential part of financial reporting for placing the basic financial statements in an appropriate operational, economic, or historical context. We have applied certain limited procedures to the required supplementary information in accordance with auditing standards generally accepted in the United States of America, which consisted of inquiries of management about the methods of preparing the information and comparing the information for consistency with management’s responses to our inquiries, the basic financial statements, and other knowledge we obtained during our audit of the basic financial statements. We do not express an opinion or provide any assurance on the information because the limited procedures do not provide us with sufficient evidence to express an opinion or provide any assurance.

Some governments exclude the MD&A. Here is sample opinion wording when the MD&A is omitted.

Supplementary Information in Compilations and Review Engagements

You can see information about supplementary information wording for compilation or review reports here. Also, see my post about presenting supplementary information in compilation and preparation engagements.

How to create energy that sustains you
Mar 06

How to Create Energy that Sustains You

By Charles Hall | Accounting and Auditing

So you are in the middle of your busy season and you are wondering how you will get it all done. Right?

One thing is for sure: Without energy, nothing happens. As Jim Loehr and Tony Swartz say in The Power of Full Engagement: Energy, not time, is the fundamental currency of high performance.

How to create energy that sustains you

I started my career in 1984. It was a time when CPA firm partners would demand that you put your head down and never look up (and if you did, you might get whacked). The thought was that young staff were inexhaustible. After all, we had our youth.

But after being in public accounting for over thirty years, I have found that such an outlook is not only unwise, it is counterproductive. Sometimes squeezing out “just one more job” causes us to implode.

So should we work hard? Absolutely. But we should also recover if we are to perform at our highest levels.

When Do You Need Recovery?

Here are a few signs that you worked too long, and you need recovery:

  • You stare at a financial statement page for several minutes before you realize you are in a daze (not reading, just staring)
  • You can’t stay focused (your mind keeps wondering)
  • You are working with a sense of dread rather than joy
  • You are too stressed to sleep at night
  • You find yourself increasingly rude to your spouse, friends, coworkers
  • You reach for too much caffeine, or worse, alcohol, to get you through the day
  • You feel like a robot
  • You are often short of breath
  • You have a sense of drowning

The body needs balance, and when it doesn’t get it, strange things start to happen. And when this work style–working without recovery–becomes habitual, we lose our vitality and health. Our production begins to decline rather than increase.

How Do You Recover?

Picture is courtesy of DollarPhoto.com

Picture is courtesy of DollarPhoto.com

Here are disciplines that will enable you to excel during your busy season.

  1. Take breaks – Working ten to twelve hours a day (and eating at your desk)–without breaks–is a sure way to deplete yourself. You need to work and recover, work and recover, work and recover — not work, work, work. The recovery can be as simple as taking five minutes to stand and stretch, but you need to move periodically away from your desk. If possible, go outside and walk for five to ten minutes (a couple of times a day). Recovery can be a simple phone call to a family member to tell her (or him) that you love them. Some professionals use the Pomodoro technique to move in and out of their work. There’s even an app for that. It may seem counterproductive to take breaks, but it’s not — as long as we don’t abuse the break time. Remember the purpose of the short break is to recover. For those of you that are runners, you know that Jeff Galloway teaches the same art in running: run and mix in walks (recovery). And many who use Jeff’s technique have found they can run farther and faster.
  2. ExercisingRun, walk, or do some exercise on a consistent basis. I was a smoker in college and–as a way to help me kick the habit–I started running. That was thirty-seven years ago. Today I am fifty-seven, and I still either run or walk at least three times a week. I find that running helps me the most. When I consistently run, I think more clearly and don’t drag late in the day. When I don’t run, I notice my thinking becomes cloudy, and I become moody. When I’m on my routine (run three times a week, at least, two miles a run), I even notice that I have bursts of energy in the middle of the afternoon, something that never happens when I am not exercising.
  3. Drink water – Staying hydrated throughout the day will keep you humming late in the day. I have put a water dispenser in my office, so I don’t have to worry about going to the store to buy bottled water. The cost of the water container (and water that they bring to my office) is about $25 per month — worth every penny.
  4. Sleep – I have read a great deal about how much sleep I need each night. And it seems the consensus is a minimum of 7.5 to 8.0 hours per night. I know this: when I get consistent sleep, I perform better. I have a routine each evening of winding things down about 9:30 and being in bed about 10:00 p.m. so I can rise at 6:00 a.m. (so I can write blog posts like this one). Going back to exercising for a moment, if you work your body hard, you will sleep better. I have noticed the farther I run, the harder I sleep. Also, if I am in bed for more than fifteen to twenty minutes without going to sleep, I get up and take melatonin — this helps me fall asleep.
  5. Eating well – Another method of recovery is eating. Not too much, but enough to provide energy. I eat a healthy breakfast each morning, a light lunch, and dinner. Then about mid-morning and mid-afternoon, I snack (usually nuts or fruit). If you’ve ever watched Tiger Woods play golf, you’ve seen him munching on a banana or energy bar during the middle of a round — he’s feeding his body to maintain energy. Eating too much at one time will throw your body’s metabolism out of balance, so a steady intake (balance) is what we need.
  6. Coffee – Coffee in moderation can stimulate your thinking and mood, at least, it does for me. I drink a cup first thing in the morning. Then I have another cup just after lunch. Too much coffee will drain you of energy. Rather than reaching for another cup, take a short walk, drink more water.
  7. Music – If possible listen to good music while you work. I find that I am more productive with music playing quietly in the background.

Call to Action

Try one or all of these and stay at it. Habit is the key. You may find in the initial days of change that you’ll desire to revert to your old habits, but as you continue, your new ways will become normal. Then you’ll find new energy for the tasks at hand.

Have a great day!

measurement of inventory
Feb 19

Simplifying the Measurement of Inventory (ASU 2015-11)

By Charles Hall | Accounting

Are you up to speed on ASU 2015-11 Simplifying the Measurement of Inventory? This post assists in understanding the new accounting measurement for inventory.

measurement of inventory

Accounting Measurement for Inventory

ASU 2015-11 requires that entities measure inventory at the lower of cost or net realizable value (LCNRV), provided they don’t use the last-in-last-out method (LIFO) or the retail inventory method. Entities using LIFO or the retail inventory method will continue to use the lower of cost or market (where market is replacement cost). Entities using the first-in-first-out (FIFO), average cost, or any other cost flow methods (other than LIFO and the retail inventory methods) should use the lower of cost or net realizable value approach.

So, where applicable, market is being replaced by net realizable value.

The Financial Accounting Standards Board’s glossary defines net realizable value as follows:

Estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.

Why the change? FASB is working to simplify some accounting standards. FASB had received comments from stakeholders that the requirement to subsequently measure inventory was “unnecessarily complex because there are several potential outcomes.”

Why did FASB not require the LCNRV method for all entities? The summary section of ASU 2015-11 says,  “The Board received feedback from stakeholders that the proposed amendments would reduce costs and increase comparability for inventory measured using FIFO or average cost but potentially could result in significant transition costs that would not be justified by the benefits for inventory measured using LIFO or the retail inventory method…Therefore, the Board decided to limit the scope of the simplification to exclude inventory measured using LIFO or the retail inventory method.”

What Disclosure is Required for the Change in Accounting Principle?

BC16 of ASU 2015-11 states the following:

The Board decided that the only disclosures required at transition should be the nature of and reason for the change in accounting principle. The Board concluded that the costs of a quantitative disclosure about the change from the lower of cost or market to the lower of cost and net realizable value would not justify the benefits because a reporting entity would be required in the year of adoption to measure inventory using both existing requirements and the amendments in this Update, and because the change would not be significant for some entities.

An entity is required only to disclose the nature and reason for the change in accounting principle in the first interim and annual period of adoption.

Sample ASU 2015-11 Disclosures

Here is a sample disclosure from Mercer International Inc.’s 10-K:

Accounting Pronouncements Implemented

In July 2015, the FASB issued Accounting Standards Update 2015-11, Simplifying the Measurement of Inventory (“ASU 201511”) which requires that inventory within the scope of this update, including inventory stated at average cost, be measured at the lower of cost and net realizable value. This update is effective for financial statements issued for fiscal years beginning after December 15, 2016. The adoption of ASU 201511 did not impact the Company’s financial position.

Here is a sample disclosure from Delta Apparel, Inc.’s 10-K:

Recently Issued Accounting Pronouncements Not Yet Adopted

In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory, (“ASU 201511“).  This new guidance requires an entity to measure inventory at the lower of cost and net realizable value. Currently, entities measure inventory at the lower of cost or market. ASU 201511 replaces market with net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured under last-in, first-out or the retail inventory method.  ASU 201511 requires prospective adoption for inventory measurements for fiscal years beginning after December 15, 2016, and interim periods within those years for public business entities.  Early application is permitted.  ASU 201511 will, therefore, be effective in our fiscal year beginning October 1, 2017. We are evaluating the effect that ASU 201511 will have on our Consolidated Financial Statements and related disclosures, but do not believe it will have a material impact.

Here is a sample disclosure from Dr. Pepper Snapple Group, Inc.’s 10-K:

Recently Adopted Provisions of U.S. GAAP
 
As of January 1, 2017, the Company adopted ASU 201511, Inventory (Topic 330): Simplifying the Measurement of Inventory (“ASU 201511“). ASU 201511 requires inventories measured under any methods other than last-in, first-out (“LIFO”) or the retail inventory method to be subsequently measured at the lower of cost or net realizable value, rather than at the lower of cost or market. Subsequent measurement of inventory using LIFO or the retail inventory method is unchanged by ASU 201511. The adoption of ASU201511 did not have a material impact on the Company’s consolidated financial statements.

Effective Dates for ASU 2015-11

For public business entities, the amendments are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. The amendments should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period.

Mistakes CPAs Make
Feb 17

Twenty Mistakes that CPAs Make

By Charles Hall | Accounting and Auditing

Here are twenty mistakes that CPAs make:

  1. We hire people without sufficient knowledge and temperament
  2. We accept more work than we can possibly perform
  3. We don’t cull our bad clients (which contributes to #2.)
  4. We work without taking breaks
  5. We don’t exercise
  6. We try to be experts in too many industries
  7. We use outdated computers and software (e.g., we are not paperless)
  8. We don’t plan our continuing education (and take anything we can find at the end of the year)
  9. We have no strategy, moving from one engagement to another because it’s pressing
  10. We work sitting down all day (when standup desks are available)
  11. We bill our clients months after the service is provided (rather than a couple of weeks)
  12. We allow email to drive our day (we are reactive)
  13. We don’t express sincere appreciation to our peers and employees (those fully deserving of “thank you!”)
  14. We don’t use engagement letters to define our work
  15. We have no exit strategy, hoping someone will knock on our door and offer to buy the practice
  16. We ignore those we love (because we are overworked and irritable)
  17. We don’t stay current on evolving standards
  18. We don’t fire unproductive or difficult employees
  19. We don’t deal with problems (bad clients or employees) because doing so is awkward
  20. We never pause to evaluate our lives

Mistakes CPAs Make

Since  1984, I have worked in public accounting, a profession I dearly love. One thing I’ve noticed about CPAs is we are too immersed in our work–to a point of blindness. We don’t step back and evaluate what or how we do things. Would we be better off if we intentionally removed certain responsibilities? Might we not be even more profitable and happier? 

Two things–more than anything else–will sap your energy and productivity: (1) difficult clients and (2) unproductive or difficult employees.

The 80/20 rule is applicable in our profession. We make 80% of our money from 20% of our work. And 80% of our headaches come from 20% of our clients and employees. (Were you awake last night thinking about one of these?) While the exact percentages may not be true for you, the concept is highly relevant. 

I’ve given you twenty mistakes that CPAs make. Are there others you would add?

If you found this article of interest, see my post What Keeps CPAs Awake at Night. Also, here are Forty Mistakes Auditors Make.

ASU 2016-14
Feb 12

Understanding the New Nonprofit Accounting Standard

By Charles Hall | Accounting

Are you ready to implement FASB’s new nonprofit accounting standard? Back in August 2016, FASB issued ASU 2016-14, Presentation of Financial Statements of Not-for-Profit Entities. In this article, I provide an overview of the standard and implementation tips.

new nonprofit accounting

New Nonprofit Accounting – Some Key Impacts

What are a few key impacts of the new standard?

  • Classes of net assets
  • Net assets released from “with donor restrictions”
  • Presentation of expenses
  • Intermediate measure of operations
  • Liquidity and availability of resources
  • Cash flow statement presentation

Classes of Net Assets

Presently nonprofits use three net asset classifications:

  1. Unrestricted
  2. Temporarily restricted
  3. Permanently restricted

The new standard replaces the three classes with two:

  1. Net assets with donor restrictions
  2. Net assets without donor restrictions

Terms Defined

These terms are defined as follows:

Net assets with donor restrictions – The part of net assets of a not-for-profit entity that is subject to donor-imposed restrictions (donors include other types of contributors, including makers of certain grants).

Net assets without donor restrictions – The part of net assets of a not-for-profit entity that is not subject to donor-imposed restrictions (donors include other types of contributors, including makers of certain grants).

Presentation and Disclosure

The totals of the two net asset classifications must be presented in the statement of financial position, and the amount of the change in the two classes must be displayed in the statement of activities (along with the change in total net assets). Nonprofits will continue to provide information about the nature and amounts of donor restrictions.

Additionally, the two net asset classes can be further disaggregated. For example, donor-restricted net assets can be broken down into (1) the amount maintained in perpetuity and (2) the amount expected to be spent over time or for a particular purpose.

Net assets without donor restrictions that are designated by the board for a specific use should be disclosed either on the face of the financial statements or in a footnote disclosure.

Sample Presentation of Net Assets

Here’s a sample presentation:

Net Assets
Without donor restrictions
  Undesignated $XX
  Designated by Board for endowment     XX
     XX
With donor restrictions
  Perpetual in nature     XX
  Purchase of equipmentXX
  Time-restrictedXX
XX
Total Net Assets$XX

Net Assets Released from “With Donor Restrictions”

The nonprofit should disaggregate the net assets released from restrictions:

  • program restrictions satisfaction
  • time restrictions satisfaction
  • satisfaction of equipment acquisition restrictions
  • appropriation of donor endowment and subsequent satisfaction of any related donor restrictions
  • satisfaction of board-imposed restriction to fund pension liability

Here’s an example from ASU 2016-14:

nonprofit statement of activities

Presentation of Expenses

Presently, nonprofits must present expenses by function. So, nonprofits must present the following (either on the face of the statements or in the notes):

  • Program expenses
  • Supporting expenses

The new standard requires the presentation of expenses by function and nature (for all nonprofits). Nonprofits must also provide the analysis of these expenses in one location. Potential locations include:

  • Face of the statement of activities
  • A separate statement (preceding the notes; not as a supplementary schedule)
  • Notes to the financial statements

I plan to add a separate statement (like the format below) titled Statement of Functional Expenses. (Nonprofits should consider whether their accounting system can generate expenses by function and by nature. Making this determination now could save you plenty of headaches at the end of the year.)

External and direct internal investment expenses are netted with investment income and should not be included in the expense analysis. Disclosure of the netted expenses is no longer required.

Example of Expense Analysis

Here’s an example of the analysis, reflecting each natural expense classification as a separate row and each functional expense classification as a separate column.

expenses by function and nature

The nonprofit should also disclose how costs are allocated to the functions. For example:

Certain expenses are attributable to more than one program or supporting function. Depreciation is allocated based on a square-footage basis. Salaries, benefits, professional services, office expenses, information technology and insurance, are allocated based on estimates of time and effort.

Intermediate Measure of Operations

If the nonprofit provides a measure of operations on the face of the financial statements and the use of the term “operations” is not apparent, disclose the nature of the reported measure of operations or the items excluded from operations. For example:

Measure of Operations

Learning Disability’s operating revenue in excess of operating expenses includes all operating revenues and expenses that are an integral part of its programs and supporting activities and the assets released from donor restrictions to support operating expenditures. The measure of operations excludes net investment return in excess of amounts made available for operations.

Alternatively, provide the measure of operations on the face of the financial statements by including lines such as operating revenues and operating expenses in the statement of activities. Then the excess of revenues over expenses could be presented as the measure of operations.

Liquidity and Availability of Resources

FASB is shining the light on the nonprofit’s liquidity. Does the nonprofit have sufficient cash to meet its upcoming responsibilities?

Nonprofits should include disclosures regarding the liquidity and availability of resources. The purpose of the disclosures is to communicate whether the organization’s liquid available resources are sufficient to meet the cash needs for general expenditures for one year beyond the balance sheet date. The disclosure should be qualitative (providing information about how the nonprofit manages its liquid resources) and quantitative (communicating the availability of resources to meet the cash needs).

Sample Liquidity and Availability Disclosure

The FASB Codification provides the following example disclosure in 958-210-55-7:

NFP A has $395,000 of financial assets available within 1 year of the balance sheet date to meet cash needs for general expenditure consisting of cash of $75,000, contributions receivable of $20,000, and short-term investments of $300,000. None of the financial assets are subject to donor or other contractual restrictions that make them unavailable for general expenditure within one year of the balance sheet date. The contributions receivable are subject to implied time restrictions but are expected to be collected within one year.

NFP A has a goal to maintain financial assets, which consist of cash and short-term investments, on hand to meet 60 days of normal operating expenses, which are, on average, approximately $275,000. NFP A has a policy to structure its financial assets to be available as its general expenditures, liabilities, and other obligations come due. In addition, as part of its liquidity management, NFP A invests cash in excess of daily requirements in various short-term investments, including certificate of deposits and short-term treasury instruments. As more fully described in Note XX, NFP A also has committed lines of credit in the amount of $20,000, which it could draw upon in the event of an unanticipated liquidity need.

Alternatively, the nonprofit could present tables (see 958-210-55-8) to communicate the resources available to meet cash needs for general expenditures within one year of the balance sheet date.

Cash Flow Statement Presentation

A nonprofit can use the direct or indirect method to present its cash flow information. The reconciliation of changes in net assets to cash provided by (used in) operating activities is not required if the direct method is used.

Consider whether you want to incorporate additional changes that will be required by ASU 2016-18, Statement of Cash Flows–Restricted Cash. If your nonprofit has no restricted cash, then this standard is not applicable.

You can early implement ASU 2016-18. (The effective date is for fiscal years beginning after December 15, 2018.) Once this standard is effective, you’ll include restricted cash in your definition of cash. The last line of the cash flow statement might read as follows: Cash, Cash Equivalents, and Restricted Cash.

Effective Date of ASU 2016-14

The effective date for 2016-14, Not-for-Profit Entities, is for fiscal periods beginning after December 15, 2017 (2018 calendar year-ends and 2019 fiscal year-ends). The standard can be early adopted.

For comparative statements, apply the standard retrospectively. 

If presenting comparative financial statements, the standard does allow the nonprofit to omit the following information for any periods presented before the period of adoption:

  • Analysis of expenses by both natural classification and functional classification (the separate presentation of expenses by functional classification and expenses by natural classification is still required). Nonprofits that previously were required to present a statement of functional expenses do not have the option to omit this analysis; however, they may present the comparative period information in any of the formats permitted in ASU 2014-16, consistent with the presentation in the period of adoption.
  • Disclosures related to liquidity and availability of resources.
Hosting Services can impair your independence
Jan 09

Hosting Services Impair a CPA’s Independence

By Charles Hall | Auditing

Hosting services impair a CPA’s independence, so says the AICPA. And most firms are providing hosting services (though they may not know it). This article explains why your possession of client records, whether electronic or hard-copy, can affect your independence.

Hosting Services Impair a CPA’s Independence

Starting September 1, 2018, your possession of client documents (e.g., tax records) or information (e.g., the housing of QuickBooks files on our server) can, in some instances, create an independence impairment. (If you temporarily possess original documents (e.g., tax records) but return them to the client in a short period, then the possession of the original documents does not impair your independence.)

The AICPA recently adopted a new interpretation, “Hosting Services,” which appears in the Code of Conduct under nonattest services. See 1.295.143 of the Code.

Why would possessing documents or information potentially impair independence? Because you accepted the responsibility for designing, implementing or maintaining internal controls for the records in your possession. And this is considered a management function.

In effect, the AICPA is saying there is an implicit understanding that you (the CPA) will safeguard the client’s records. And to safeguard the information, you agree to create controls to ensure the safety of the information in your possession.

To understand the actions that would impair your independence, see Catherine Allen’s article in the Journal of Accountancy. Specifically, look at her examples of where independence is impaired and where it is not. 

Continue reading

Better client interviews
Dec 13

Four Keys to Better Client Interviews

By Charles Hall | Auditing

Many times I have interviewed accounting staff and walked away thinking, “I have no idea what they just said to me.” Do you ever have this problem? If yes, this article is for you. Below I provide four keys to better client interviews.

Better client interviews

In my early years–fresh out of college–I would think: “I must be stupid. It’s obvious, he understands what he just said, but I don’t.” Often my anxiety would increase when I realized the interviewee (e.g, accounts payable clerk) had no college degree (and me, a masters in accounting).

Reasons We Don’t Understand

After years of performing interviews, I realized that I wasn’t dense (at least, not as much as I thought), and that I was encountering what The Art of Explanation calls, the “curse of knowledge.”

What is the “curse of knowledge?” It’s when someone knows a subject very well, and, consequently, has a difficult time imagining what it is like to not know it. I was experiencing the “curse of knowledge.” Those I interviewed thought knew what they knew. As a result, they left out details.

Also, those I interviewed had years of experience doing the same job day after day. Of course they understood what they did. But I had less than an hour, in many cases, to grasp their duties.

Additionally, those I interviewed used a language unique to their office, and I, mistakenly, tried to use a different language—one I had learned in college. The result: we did not understand one another. So how can I communicate and comprehend better?

Four Keys to Interviewing

1. Pay attention to their language and use it.

If they call it a thingy, then I call it a thingy.

2. Seek understanding more than trying to impress.

I often want to impress more than I desire to understand. The remedy: Admit (maybe even out loud) I don’t know everything.

I tell the clerk, “Treat me like I don’t know anything. I’ve never been here, so I need your help in understanding what you do.”

To higher level personnel (e.g., CFO), I might say, “I have worked in this industry for fifteen years, but I need your help to understand how you guys operate.”

3. Repeat what is said to you.

For example, “May I repeat what you just said to make sure I understand? ‘The thingy is created once per week on Mondays to ensure that total receipts agree with deposits.’”

4. Use your cell phone to take pictures and to record parts of the interview.

Just last week, I reviewed a complex accounting system (for about three hours). As I did so, I used my cell phone Evernote app to take pictures of computer screens and printed reports. I also used the app to record parts of the conversation. Later, I summarized the conversation in memo form (complete with pictures).

Scanbot is another useful iPhone app if you take pictures of client information. By using your phone to take pictures, you can leave your physical scanner in your office.

Your Interviewing Ideas

Have I left out any key interviewing ideas? Please share your thoughts.

Check out my series of articles about auditing.

how to capture and communicate internal control deficiencies
Nov 29

How to Capture and Communicate Internal Control Deficiencies

By Charles Hall | Auditing

Too many times auditors fail to capture control deficiencies in the audit process. So, today I’ll show you how to capture and communicate internal control deficiencies.

A Common End-of-Audit Problem

We’re concluding another audit, and it’s time to consider whether we will issue a letter communicating internal control deficiencies. A month ago we noticed some control issues in accounts payable, but presently we’re not clear about how to describe them. We hesitate to call the client to rehash the now-cold walkthrough. After all, the client thinks we’re done, and quite frankly, they are tired of seeing us. We know that boiler-plate language will not clearly communicate the weakness or how to fix it. Now we’re kicking ourselves for not taking more time to document the control deficiencies.

Here’s a post to help capture and document internal control issues as we audit.

How to Capture and Communicate Internal Control Deficiencies

Today, we’ll take a look at the following control weakness objectives:

  1. How to communicate them
  2. How to discover them
  3. How to capture them
how to capture and communicate internal control deficiencies

Picture is courtesy of AdobeStock.com

As we begin, let’s define three types of weaknesses:

  • Material weaknesses – A deficiency, or a combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented, or detected and corrected, on a timely basis.
  • Significant deficiencies – A deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness yet important enough to merit attention by those charged with governance.
  • Other deficiencies – For purposes of this blog post, we’ll define other deficiencies as those less than material weaknesses or significant deficiencies.

As we look at these definitions, we see that categorizing control weaknesses is subjective. Notice the following terms:

  • Reasonable possibility
  • Material misstatement
  • Less severe
  • Merits attention by those charged with governance

Categorizing a control weakness is not a science, but an art. With this thought in mind, let’s start our journey with how control weaknesses should be reported.

1. How to Communicate Control Weaknesses

Material weaknesses and significant deficiencies must be communicated in writing to management and those charged with governance. Other deficiencies can be given verbally to management, but you must document those discussions in your work papers.

2. How to Discover Control Weaknesses

Capture control weaknesses as you perform the audit. You might identify control weaknesses in the following audit stages:

  1. Planning – Risk assessment and walkthroughs
  2. Fieldwork – Transaction-level work
  3. Conclusion – Wrapping up

A. Planning Stage

You will discover deficiencies as you perform walkthroughs which are carried out in the early stages of the engagement. Correctly performed walkthroughs allow you to see process shortcomings and where duties are overly concentrated (what auditors refer to as a lack of segregation of duties).

Segregation of Duties

Are accounting duties appropriately segregated with regard to:

  • Custody of assets
  • Reconciliations
  • Authorization
  • Bookkeeping

Notice the first letters of these words spell CRAB (I know it’s cheesy, but it helps me remember).

Auditors often make statements such as, “Segregation of duties is not possible due to the limited number of employees.”

I fear such statements are made only to protect the auditor (should fraud occur in the future). It is better that we be specific about the control weakness and what the potential impact might be. For example:

The accounts payable clerk can add new vendors to the vendor file. Since checks are signed electronically as they are printed, there is a possibility that fictitious vendors could be added and funds stolen. Such amounts could be material.

Such a statement tells the client what the problem is, where it is, and the potential damage. 

Fraud: A Cause of Misstatements

While I just described how a lack of segregation of duties can open the door to theft, the same idea applies to financial statement fraud (or cooking the books). When one person controls the reporting process, there is a higher risk of financial statement fraud. Appropriate segregation lessens the chance that someone will manipulate the numbers.

Within each transaction cycle, accounting duties need to be performed by different people. Doing so lessens the possibility of theft. If one person performs multiple duties, ask yourself, “Is there any way this person could steal funds?” If yes, then the client should add a control in the form of a second-person review.

If possible, the client should have a second person examine reports or other supporting documentation. How often should the review be performed? Daily, if possible. If not daily, as often as possible. Regardless, a company should not allow someone with the ability to steal to work alone without review. The fear of detection lessens fraud.

If a transaction cycle lacks segregation of duties, then consider the potential impact from the control weakness. Three possible impacts exist:

  • Theft that is material (material weakness)
  • Theft that is not material but which deserves the attention of management and the board anyway (significant deficiency)
  • Theft of insignificant amounts (other deficiency)

My experience has been that if any potential theft area exists, the board wants to know about it. But this is a decision you will make as the auditor.

Errors: Another Cause of Misstatements

While auditors should consider control weaknesses that allow fraud, we should also consider whether errors can lead to potential misstatements. So, ask questions such as:

  • Do the monthly financial statements ever contain errors?
  • Are invoices mistakenly omitted from the payable system?
  • Do employees forget to obtain purchase order numbers prior to buying goods?
  • Are new employees ever unintentionally left off the payroll?
  • Do bookkeepers fail to reconcile the bank statements on a timely basis? 

B. Fieldwork Stage

While it is more likely you will discover process control weaknesses in the planning stage of an audit, the results of control deficiencies sometimes surface during fieldwork. How? Audit journal entries. What are audit entries but corrections? And corrections imply a weakness in the accounting system.

When an auditor makes a material journal entry, it’s difficult to argue that a material weakness does not exist. We know the error is “reasonably possible” (it happened). We also know that prevention did not occur on a timely basis.

C. Conclusion Stage

When concluding the audit, review all of the audit entries to see if any are indicators of control weaknesses. Also, review your internal control deficiency work papers (more on this in a moment). If you have not already done so, discuss the noted control weaknesses with management. 

Your firm may desire to have a policy that only managers or partners make these communications. Why? Management can see the auditor’s comments as a criticism of their own work. After all, they designed the accounting system (or at least they oversee it). So, these discussions can be a little challenging.

Now let’s discuss how to capture control weaknesses.

3. How to Capture Control Weaknesses

So, how do you capture the control weakness?

First, and most importantly, document internal control deficiencies as you see them.

Why should you document control weaknesses when you initially see them?

  1. You may not be on the engagement when it concludes (because you are working elsewhere) or
  2. You may not remember the issue (weeks later).

Second, create a standard form (if you don’t already have one) to capture control weaknesses. 

Internal Controls

Picture is courtesy of AdobeStock.com

Internal Control Capture Form

 What should be in the internal control form? At a minimum include the following:

  1.  Check-mark boxes for:
    • Significant deficiency
    • Material weakness
    • Other control deficiency
    • Other issues (e.g., violations of laws or regulations) 
  2. Whether the probability of occurrence is at least reasonably possible and whether the magnitude of the potential misstatement is material
    • If the probability of occurrence is at least reasonably possible and the magnitude of the potential misstatement is material, then the client has a material weakness
  3. Description of the deficiency and the verbal or written communications to the client; also the client’s response
  4. The cause of the condition
  5. The potential effect of the condition
  6. Recommendation to correct the issue
  7. Person who identified the issue and the date when the issue was identified
  8. Whether the issue is a repeat from the prior year
  9. An area for the partner to sign off that he or she agrees with the description of the deficiency and the category assigned to it (e.g., material weakness)
  10. Reference to related documentation in the audit file

Summary

The main points in capturing and communicating internal control deficiencies are:

  1. Capture control weaknesses as soon as you see them
  2. Develop a form to document the control weaknesses

How Do You Capture and Report Control Deficiencies?

Whew! We’ve covered a lot of ground today. How do you capture and report control deficiencies? I’m always looking for new ideas: Please share.

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