Jul 17

Government Auditing Standards 2018 Revision (Hot Off the Press)

By Charles Hall | Auditing , Local Governments

Government Auditing Standards 2018 Revision

The Government Accountability Office just issued the new Yellow Book titled Government Auditing Standards 2018 Revision.

Government Auditing Standards 2018 Revision

Get Your Free Copy

An electronic version of the 2018 Yellow Book can be accessed on GAO’s Yellow Book web page at http://www.gao.gov/yellowbook.

Major Changes

The introduction to the new Yellow Book summarizes the significant changes as follows:

This revision contains major changes from, and supersedes, the 2011 revision. These changes, summarized below, reinforce the principles of transparency and accountability and strengthen the framework for high quality government audits.

  • All chapters are presented in a revised format that differentiates requirements and application guidance related to those requirements.
  • Supplemental guidance from the appendix of the 2011 revision is either removed or incorporated into the individual chapters.
  • The independence standard is expanded to state that preparing financial statements from a client-provided trial balance or underlying accounting records generally creates significant threats to auditors’ independence, and auditors should document the threats and safeguards applied to eliminate and reduce threats to an acceptable level or decline to perform the service.
  • The peer review standard is modified to require that audit organizations comply with their respective affiliated organization’s peer review requirements and GAGAS peer review requirements. Additional requirements are provided for audit organizations not affiliated with recognized organizations.
  • The standards include a definition for waste.
  • The performance audit standards are updated with specific considerations for when internal control is significant to the audit objectives.

Effective with the implementation dates for the 2018 revision of Government Auditing Standards, GAO is also retiring Government Auditing Standards: Guidance on GAGAS Requirements for Continuing Professional Education (GAO-05-568G, April 2005) and Government Auditing Standards: Guidance for Understanding the New Peer Review Ratings (D06602, January 2014).

Effective Dates

The 2018 revision of Government Auditing Standards is effective for financial audits, attestation engagements, and reviews of financial statements for periods ending on or after June 30, 2020, and for performance audits beginning on or after July 1, 2019.

Early implementation is not permitted.

The 2018 revision of Government Auditing Standards supersedes the 2011 revision (GAO-12-331G, December 2011), the 2005 Government Auditing Standards: Guidance on GAGAS Requirements for Continuing Professional Education (GAO-05-568G, April 2005), and the 2014 Government Auditing Standards: Guidance for Understanding the New Peer Review Ratings (D06602, January 2014). 

Client Acceptance and Continuance
Jul 17

Client Acceptance and Continuance: The Why and How

By Charles Hall | Auditing

Client acceptance and continuance may be the most critical step in an audit, but it’s one that gets little attention. A prospective client calls saying, “Can you audit my company?” and we respond, “sure.” While new business can be a good thing, relationships need appropriate vetting. Not doing so can lead to significant (and sometimes disastrous) consequences.

New Relationships

My daughter recently met a young man on Instagram. Not unusual these days. But now the relationship is entering into its third month. They talk every day for two or three hours. So far, they have not been in the same room—and not even in the same city. Skype, yes. Physical presence, no. That’s happening at the end of this month. (He lives eight hours away.)

So what do Mom and Dad think about all of this? Well, it’s fine. My wife checked him out on Facebook (I know you’ve never done this). And my daughter has told us all about the “fella” and his family. We like what we’re hearing. He has similar beliefs. He has a job (Yay!), and he has graduated from college. His family background is like ours.

Why do we want to know all the details about the young man? Because relationships impact people—my daughter, the young man, his family members, and yes, my wife and I. We want everyone to be happy.

Client Acceptance 

And that’s what good relationships create. Happiness. The same is true with clients. As Steven Covey said, “think win, win.” When the customer wins, and your CPA firm wins, everyone is happy. Mutual needs are met.

Careless CPAs accept business with only one consideration: Can I get paid? 

While getting paid is important, other factors are also critical.

Here are a few things to consider:

  1. Are they ethical?
  2. Are you independent?
  3. Do you have the technical ability to serve them?
  4. Do you the capacity to serve them?

Are They Ethical?

I want my daughter to marry a guy with beliefs that correspond with who she is. Is he honest? Would he steal? Is he transparent? Who are his associates? What do others think of him? 

We ask similar questions about accepting a new client. Audit standards require us to consider whether the prospective client has integrity. If the company is not morally straight, then there’s no need to move forward. 

Are You Independent?

The time to determine your firm’s independence is the beginning—not at the conclusion of the audit.

Consider what happens—during a peer review—when a firm is not independent, and it has issued an audit opinion. The original audit report will be recalled, and I’ll bet the company asks for and receives a full refund of your audit fee. Now, the company needs to be re-audited.  (Oh, and there’s that impact on the peer review report.)

Pay attention to requested nonattest services—such as preparation of financial statements. If the client has no one with sufficient skill, knowledge, and experience to accept responsibility for such services, you may not be independent. See the AICPA’s Plain English Guide to Independence for more information. 

Do You Have the Technical Ability to Serve Them?

If you can pick up a client in an industry in which you have no experience, should you? Possibly, but it depends on whether you can appropriately understand the client and their industry before you conduct the engagement. Some new customers may not be complicated. In those cases, CPE may get you into position to provide the audit. 

But what if the potential engagement involves a highly sophisticated industry and related accounting standards for which you are ill-equipped? It may be better to let the engagement go and refer it to an audit firm that has the requisite knowledge. Or maybe you can partner with the other firm. 

Do You Have the Capacity to Serve Them?

A prospective client calls saying, “Can you audit my company? We have a December 31 year-end, and we need the audit report by March 31.” After some discussion, I think the fee will be around $75,000. But my staff is already working sixty hours a week during this time of the year. Should I take the engagement? 

My answer would be no unless I can create the capacity. How? I can hire additional personnel or maybe I can contract with another firm to assist. If I can’t build additional capacity, then I may let the opportunity pass. 

Far too many firms accept work without sufficient capacity. When this happens, corners are cut, and staff members and partners suffer. Stuffingeven morework into a stressful time of the year is not (always) a wise thing. We lose staff. And if the engagement is deficient, peer review results may take a hit.

When you don’t have the capacity to accept new good clients, consider whether you should discontinue service to existing bad customers.

The Continuance Decision

Quality controls standards call for CPAs to not only develop acceptance procedures, but we are to create continuance protocols as well.

I previously said CPAs often don’t give proper attention to acceptance procedures. So, how about continuance decisions? Even worse. 

Continuance Decision

Picture from AdobeStock.com

Each year, we should ask, “If this was a new client opportunity, would I accept them?” If the answer is no, then why do we continue serving them? 

Here are a few questions to ponder:

  • Has the client paid their prior year fees? 
  • Am I still independent (consider the new Hosting Services interpretation)?
  • Does the client demand more from me than the fee merits?
  • Do I enjoy working with this client?
  • Is the client’s financial condition creating additional risks for my firm?
  • Is the client acting ethically?

Each year, well before the audit starts, ask these questions.

And then consider, is the bottom 10% of my book of business keeping me from accepting better clients? My experience has been that when I have the capacity, new business appears. When capacity is lacking, I don’t. The decision to hold on to bad clients is a decision to close the door to better clients. Don’t be afraid to let go.

Risk Assessment Starts Now

When should we start thinking about risk assessment? Now.

Whether you are going through the initial acceptance procedures or you are making your continuance decision, start thinking about risk assessment now. Assuming you accept the client, you’ll be a step ahead as you begin to develop your audit plan. Ask questions such as:

  • How is your cash flow?
  • Do you have any debt with covenants?
  • Who receives the financial statements?
  • Has the company experienced any fraud losses?
  • How experienced is management?
  • Why are you changing auditors?

Keep these notes for future reference and audit planning. 

Next Post in this Series

The above is the first post in The Why and How of Auditing. My next post will be Audit Risk Assessment: The Why and How. Subscribe to my blog (see below) to make sure you don’t miss anything.

Review Quiz

The Why and How of Auditing
Jul 10

The Why and How of Auditing: A Blog Series about Basics

By Charles Hall | Auditing

Do you struggle with what needs to be done in an audit–and what does not? Do you perform audit procedures (because they are in a standard audit program) but you’re not sure why? Do you want to be more efficient? You are not alone.

While audit forms—like risk assessment, audit planning, and audit program—are necessary, they can make us feel like a blind man being led by the hand. If you’re like me, you want to see, to know where you’re going and why. To gain sight, we need to go back to the basics. 

Each year, Vince Lombardi (the revered coach of the Green Bay Packers) held a pigskin up and said, “This is a football.” And he did so with the best players in the world. He knew that winning is all about basics: blocking, tackling, passing, running. Understanding fundamentals brings clarity and power. And that’s what I’m after in The Why and How of Auditing. I’ll strip away the technical mumbo-jumbo and make auditing accessible, even for beginners. Moreover, experienced auditors will profit as you revisit what matters (and what does not).

The Why and How of Auditing

Here’s an overview of the upcoming posts:

Moving from Wasteful to Efficient Auditing

In the cartoons I read as a kid, Lucy would say to Charlie Brown, “I will hold the ball, and you kick,” but as Charlie Brown would lean into his launch, she would pull away. And you remember the result: Charlie Brown, lying on his backside. 

Some audit procedures (like the invitation to kick) are tempting. They call us (like a familiar friend), but they are a waste of time–even if we have done these steps for years. In the end, they leave us staring at the sky. So, we need to know what is best and what is necessary. Then, we can avoid waste.

This series provides you with what you need to know—without excess baggage. By design, the series is simple. Why? To provide clarity. I want you to understand the basics of auditing. 

When you’re done, you’ll understand auditing, possibly in a way you never have. Then you’ll work with greater confidence and effectiveness. So, let’s begin.

changes in accounting for equity securities
Jul 10

ASU 2016-01 – Changes in Accounting for Equity Securities

By Charles Hall | Accounting

Are you aware of the coming changes in accounting for equity securities?

In the past, FASB required that changes in the fair value of available-for-sale equity investments be parked in accumulated other comprehensive income (an equity account) until realized--that is, until the equity investment was sold. In other words, the unrealized gains and losses of equity investments were not recognized in net income until the investments were sold. This is about to change.

Changes in equity investments will generally be reflected in net income as they occur--even before the equity investments are sold. 

changes in accounting for equity securities

Changes in Accounting for Equity Securities

First, ASU 2016-01 removes the current guidance regarding classification of equity securities into different categories (i.e., trading or available-for-sale)

Secondly, the new standard requires that equity investments  generally be measured at fair value with changes in fair value recognized in net income (see exceptions below). Companies will no longer recognize changes in the value of available-for-sale equity investments in other comprehensive income (as we have in the past).

Exceptions

ASU 2016-01 generally requires that equity investments generally be measured at fair value with changes in fair value recognized in net income. There are some equity investments that are not treated in this manner such as equity method investments and those that result in consolidation of the investee.

Is the accounting for equity investments without readily determinable fair values different? It can be.

Equity Investments without Readily Determinable Fair Values

An entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment.  This election should be documented at the time of adoption (for existing securities) or at the time of purchase for securities acquired subsequent to the date of adoption. The alternative can be elected on an investment-by-investment basis.

Why make the election to measure equity investments that do not have readily determinable fair values at cost minus impairment? Because of the difficulty of determining the fair value of such investments. This election will probably be used by entities that previously carried investments at cost. (The cost method of accounting is eliminated.)

ASU 2016-01 requires that equity investments without readily determinable fair values undergo a one-step qualitative assessment to identify impairment (similar to what we do with long-lived assets and goodwill). 

At each reporting period, an entity that holds an equity security shall make a qualitative assessment considering impairment indicators to evaluate whether the investment is impaired. Impairment indicators that an entity considers include, but are not limited to, the following:

  • A significant deterioration in the earnings performance, credit rating, asset quality, or business prospects of the investee
  • A significant adverse change in the regulatory, economic, or technological environment of the investee
  • A significant adverse change in the general market condition of either the geographical area or the industry in which the investee operates
  • A bona fide offer to purchase, an offer by the investee to sell, or a completed auction process for the same or similar investment for an amount less than the carrying amount of that investment
  • Factors that raise significant concerns about the investee’s ability to continue as a going concern, such as negative cash flows from operations, working capital deficiencies, or noncompliance with statutory capital requirements or debt covenants.

So what happens if there is an impairment?

321-10-35-3 of the FASB Codification states, "An equity security without a readily determinable fair value that does not qualify for the practical expedient to estimate fair value in accordance with paragraph 820-10-35-59...shall be written down to its fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than its carrying value." (820-10-35-59 deals with measuring the fair value of investments in certain entities that calculate net asset value per share.)

How is the change in value to be reflected in the income statement?

If an equity security without a readily determinable fair value is impaired, the entity should include the impairment loss in net income equal to the difference between the fair value of the investment and its carrying amount.

Presentation of Financial Instruments

Entities are to present their financial assets and liabilities separately in the balance sheet or in the notes to the financial statements. This disaggregated information is to be presented by:

  • Measurement category (i.e., cost, fair value-net income, and fair value-OCI
  • Form of financial asset (i.e., securities or loans and receivables)

So, financial assets measured at fair value through net income are to be presented separately from assets measured at fair value through other comprehensive income.

Debt Securities Accounting 

U.S. GAAP for classification and measurement of debt securities remains essentially the same. The unrealized holding gains and losses on available-for-sale debt securities are to be shown in other comprehensive income.

Disclosure Eliminated - Financial Instruments Measured at Amortized Cost

ASU 2016-01 removes a prior disclosure requirement. In the past, entities disclosed the fair value of financial instruments measured at amortized cost. Examples include notes receivables, notes payable, and debt securities. ASU 2016-01 removes this disclosure requirement for entities that are not public business entities

Effective Dates for ASU 2016-01

ASU 2016-01 says the following concerning effective dates:

For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.

For all other entities including not-for-profit entities and employee benefit plans within the scope of Topics 960 through 965 on plan accounting, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. All entities that are not public business entities may adopt the amendments in this Update earlier as of the fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.

Also, the provision exempting nonpublic entities from the requirement to disclose fair values of financial instruments can be early adopted.

Initial Accounting

An entity should apply the amendments by means of a cumulative-effect
adjustment to the balance sheet as of the beginning of the fiscal year of adoption
.

The amendments related to equity securities without readily determinable fair
values
(including disclosure requirements) should be applied prospectively to
equity investments that exist as of the date of adoption of ASU 2016-01.

Potential Management Letter Comment

If you are an external auditor, consider advising your clients about the changes in accounting for equity securities. Entities with certain debt covenants (e.g., net income requirements) could be adversely affected when this standard is adopted, particularly if they have declining equity investments. 

Livescribe
Jun 26

Livescribe: Note Taking Magic (for CPAs)

By Charles Hall | Accounting and Auditing , Technology

Livescribe: Note taking magic. Here’s an overview of how auditors are making their lives easier using the Livescribe pen.

Have you ever interviewed a client, feverishly taking notes, and straight away forgot critical facts? You wish you had a recording of the conversation. Better yet, you wish you could touch a particular word in your notes and hear the words that were being spoken at that moment. What if I told you, “you can”?

Livescribe: Note taking magic

How? Livescribe.

Think about what you could record with such a tool:

  • CPE class lectures
  • Walkthroughs of transaction cycles
  • Board or committee or partnership meetings
  • Fraud interviews

Livescribe: Note Taking Magic

What is Livescribe? It’s an electronic pen/recorder. As you write on special coded paper, you simultaneously record the conversation (the recorder is built into the pen). Once done, you touch a particular letter in a word (with the tip of your pen) and you hear–from the pen–the words spoken at that moment. No more forgetting and not being able to retrieve what was said. And it’s efficient since you can go to any particular part of the conversation using your notes as signposts.

To start a recording, you press the tip of the pen to the “record” icon at the bottom of the page.

IMG_0002

To stop the recording you press the “stop” icon above.

Once the recording is complete, you simply touch the tip of the pen to any letter and the audio recording will start playing–from the pen–at that point.

IMG_0004

You can upload the pen notes and the audio to your computer desktop Livescribe software using a USB cord that connects to the pen. (See below.)

IMG_0003

You can also play back notes from your uploaded desktop copy just as you can with your pen. Click a letter with your mouse and the recording will play.

I was surprised by the clarity of the sound from the pen and the audio capacity200 hours (for the Echo version that you see below).

There are different versions of the pen. I bought the Echo version due to the lower price. You can review the available pens on Amazon. I also bought additional Livescribe notebooks (they come in packs of four) and a portfolio (binder) to hold the notebook and pen.

My Experience with Livescribe

I have used a Livescribe pen for four years. After using to it to record hundreds of hours of audio, I consider my Livescribe pen to be one of my best audit tools. I recommend it.

What if you don’t desire to shell out the $155 for the pen? Consider using the Notability app. 

Another Option 

If you have an iPad, you can buy the Notability app for $9.99 and record conversations with your notes (with play-back similar to Livescribe). You will need a stylus (I use an Apple pen) to take notes since you write on your iPad screen. See my article about using Notability.

One More Thought

If you are performing a walkthrough of a complex transaction cycle, consider using your phone to take pictures of what you are seeing (e.g., computer screens, documents). I use the Scanbot app. Between your notes (with audio) and your pictures, you will have a good understanding of what you have seen and heard.

You might also be interested in my article Four Keys to Better Client Interviews.

financial statements with GAAP departure
Jun 20

Financial Statements with a GAAP Departure (How to Issue)

By Charles Hall | Accounting and Auditing

Can CPAs intentionally issue financial statements with a GAAP departure? Yes. And sometimes it might be preferable. 

financial statements with GAAP departure

I received a phone call last week from a CPA asking if he could issue a balance sheet with a GAAP departure? His client's bank requested a GAAP balance sheet with an intentional departure (the bank wanted one number to be shown at fair value and GAAP calls for cost). 

I advised the CPA how to issue financial statements with an intentional GAAP departure. Watch the video to see how..

One caution in issuing financial statements with a GAAP departure: The AICPA Code of Conduct does not allow a CPA to issue financial statements that are intentionally misleading. So, always communicate the departure. Departures from reporting frameworks should never be hidden.

The video refers to selected disclosures. You can see information about selected disclosures here.

The video also discusses AR-C 70, Preparation of Financial Statements. You can see information about AR-C 70 here.

going concern
Jun 20

Going Concern: How to Understand the Accounting and Auditing Standards

By Charles Hall | Accounting , Auditing

Are you preparing financial statements and wondering whether you need to include going concern disclosures? Or maybe you’re the auditor, and you’re wondering if a going concern paragraph should be added to the audit opinion. You’ve heard there are new requirements for both management and auditors, but you’re not sure what they are.

This article summarizes (in one place) the new going concern accounting and auditing standards.

going concern

Going Concern Standards

For many years the going concern standards were housed in the audit standards–thus, the need for FASB to issue accounting guidance (ASU 2014-15). It makes sense that FASB created going concern disclosure guidance. After all, disclosures are an accounting issue. 

Accounting Standard

ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, provides guidance in preparing financial statements. This standard was effective for years ending after December 15, 2016.

GASB Statement 56, Codification of Accounting and Financial Reporting Guidance Contained in the AICPA Statements on Auditing Standards, is the relevant going concern standard for governments. GASB 56 was issued in March 2009. (GASB 56 requires financial statement preparers to evaluate whether there is substantial doubt about a governmental entity’s ability to continue as a going concern for 12 months beyond the date of the financial statements. As you will see below, this timeframe is different from the one called for under ASU 2014-15. This post focuses on ASU 2014-15 and SAS 132.)

Meanwhile, the Auditing Standards Board issued their own going concern standard in February 2017: SAS 132.

Auditing Standard

Auditors will use SAS 132, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, to make going concern decisions. This SAS is effective for audits of financial statements for periods ending on or after December 15, 2017. SAS 132 amends SAS 126The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern.

So, let’s take a look at how to apply ASU 2014-15 and SAS 132.

Two Stages of Going Concern Decisions

In the past, the going concern decisions were made by auditors in a single step. Now, it is helpful to think of going concern decisions in two stages:

  1. Management decisions concerning the preparation of financial statements 
  2. Auditor decisions concerning the audit of the financial statements

First, we’ll consider management’s decisions.

Stage 1. Management Decisions

 

ASU 2014-15 provides guidance concerning management’s determination of whether there is substantial doubt regarding the entity’s ability to continue as a going concern.

Going Concern

What is Substantial Doubt?

So, how does FASB define substantial doubt? 

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.

What is Probable?

So, how does management determine if “it is probable that the entity will be unable to meet obligations when due within one year”?

Probable means likely to occur

If for example, a company expects to miss a debt service payment in the coming year, then substantial doubt exists. This initial assessment is made without regard to management’s plans to alleviate going concern conditions. 

ASC 205-40-50-4 says:

The evaluation initially shall not take into consideration the potential mitigating effect of management’s plans that have not been fully implemented as of the date that the financial statements are issued (for example, plans to raise capital, borrow money, restructure debt, or dispose of an asset that have been approved but that have not been fully implemented as of the date that the financial statements are issued).

But what factors should management consider?

Factors to Consider

Management should consider the following factors when assessing going concern:

  • The reporting entity’s current financial condition, including the availability of liquid funds and access to credit
  • Obligations of the reporting entity due or new obligations anticipated within one year (regardless of whether they have been recognized in the financial statements)
  • The funds necessary to maintain operations considering the reporting entity’s current financial condition, obligations, and other expected cash flows
  • Other conditions or events that may affect the entity’s ability to meet its obligations

Moreover, management is to consider these factors for one year. But from what date?

Timeframe

The financial statement preparer (i.e., management or a party contracted by management) should assess going concern in light of one year from the date “the financial statements are issued or are available to be issued.”

So, if December 31, 2017, financial statements (for a nonpublic company) are available to be issued on March 15, 2017, the preparer looks forward one year from March 15, 2017. Then, the preparer asks, “Is it probable that the company will be unable to meet its obligations through March 15, 2018?” If yes, substantial doubt is present and disclosures are necessary. If no, then substantial doubt does not exist. As you would expect, the answer to this question determines whether going concern disclosures are to be made and what should be included.

Substantial Doubt Answer Determines Disclosures

If substantial doubt does not exist, then going concern disclosures are not necessary.

If substantial doubt exists, then the company needs to decide if management’s plans alleviate the going concern issue. This decision determines the disclosures to be made. The required disclosures are based upon whether:

  1. Management’s plans alleviate the going concern issue
  2. Management’s plans do not alleviate the going concern issue

1. What if Management’s Plans Alleviate the Going Concern Issue?

If conditions or events raise substantial doubt about an entity’s ability to continue as a going concern, but the substantial doubt is alleviated as a result of consideration of management’s plans, the entity should disclose information that enables users of the financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the footnotes):

  1. Principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern (before consideration of management’s plans)
  2. Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
  3. Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern

Management’s plans should be considered only if is it probable that they will be effectively implemented. Also, it must be probable that management’s plans will be effective in alleviating substantial doubt.

So, if management’s plans are expected to work, does the company have to explicitly state that management’s plans will alleviate substantial doubt? No. 

When management’s plans alleviate substantial doubt, companies need not use the words going concern or substantial doubt in the disclosures. And as Sears discovered, it may not be wise to do so (their shares dropped 16% after using the term substantial doubt even though management had plans to alleviate the risk). Rather than using the term substantial doubt, consider describing conditions (e.g., cash flows are not sufficient to meet obligations) and management plans to alleviate substantial doubt.

Sample Note – Substantial Doubt Alleviated

An example note follows:

Note 2 – Company Conditions

The Company had losses of $4,525,123 in the year ending March 31, 2017. As of March 31, 2017, its accumulated deficit is $11,325,354. 

Management believes the Company’s present cash flows will not enable it to meet its obligations for twelve months from the date these financial statements are available to be issued. However, management is working to obtain new long-term financing. It is probable that management will obtain new sources of financing that will enable the Company to meet its obligations for the twelve-month period from the date the financial statements are available to be issued.

Notice this example does not use the words substantial doubt.

2. What if Management’s Plans Do Not Alleviate the Going Concern Issue?

If conditions or events raise substantial doubt about an entity’s ability to continue as a going concern, and substantial doubt is not alleviated after consideration of management’s plans, an entity should include a statement in the notes indicating that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are available to be issued (or issued when applicable). Additionally, the entity should disclose information that enables users of the financial statements to understand all of the following:

  1. Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern
  2. Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
  3. Management’s plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern

Sample Disclosure – Substantial Doubt Not Alleviated

An example disclosure follows:

Note 2 – Going Concern
 
The financial statements have been prepared on a going concern basis which assumes the Company will be able to realize its assets and discharge its liabilities in the normal course of business for the foreseeable future.  The Company had losses of $1,232,555 in the current year. The Company has incurred accumulated losses of $2,891,727 as of March 31, 2017. Cash flows used in operations totaled $555,897 for the year ended March 31, 2017.
 
Management believes these conditions raise substantial doubt about the Company’s ability to continue as a going concern within the next twelve months from the date these financial statements are available to be issued. The ability to continue as a going concern is dependent upon profitable future operations, positive cash flows, and additional financing.
 
Management intends to finance operating costs over the next twelve months with existing cash on hand and loans from its directors. Management is also working to secure new bank financing. The Company’s ability to obtain the new financing is not known at this time.
 
Notice this note includes a statement that substantial doubt is present. Though management’s plans are disclosed, the probability of success is not provided.

ASU 2014-15 Summary

ASU 2014-15 focuses on management’s assessment regarding whether substantial doubt exists. If substantial doubt exists, then disclosures are required. Here’s a short video summarizing 2014-15:

Thus far, we’ve addressed the stage 1. management decisions. As you can see management’s considerations focus on disclosures. By contrast, auditors focus on the audit opinion. Now, let’s look at what auditors must do.

Stage 2. Auditor Decisions

 

SAS 132 provides guidance concerning the auditor’s consideration of an entity’s ability to continue as a going concern.

Going Concern

Objectives of the Auditor

SAS 132, paragraph 10, states the objectives of the auditor are as follows:

  • Obtain sufficient appropriate audit evidence regarding, and to conclude on, the appropriateness of management’s use of the going concern basis of accounting, when relevant, in the preparation of the financial statements
  • Conclude, based on the audit evidence obtained, whether substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time exists
  • Evaluate the possible financial statement effects, including the adequacy of disclosure regarding the entity’s ability to continue as a going concern for a reasonable period of time
  • Report in accordance with this SAS

These objectives can be summarized as follows:

  1. Conclude about whether the going concern basis of accounting is appropriate
  2. Determine whether substantial doubt is present
  3. Determine whether the going concern disclosures are adequate
  4. Issue an appropriate opinion 

In light of these objectives, certain audit procedures are necessary.

Risk Assessment Procedures

In the risk assessment phase of an audit, the auditor should consider whether conditions or events raise substantial doubt. In doing so, the auditor should examine any preliminary management evaluation of going concern. If such an evaluation was performed, the auditor should review it with management. If no evaluation has occurred, then the auditor should discuss with management the appropriateness of using the going concern basis of accounting (the liquidation basis of accounting is required by ASC 205-30 when the entity’s liquidation is imminent) and whether there are conditions or events that raise substantial doubt. 

The auditor is to consider conditions and events that raise substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time. What is a reasonable period of time? It is the period of time required by the applicable financial reporting framework or, if no such requirement exists, within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued, when applicable). The governmental accounting standards require an evaluation period of “12 months beyond the date of the financial statements.”

Auditors should consider negative financial trends or factors such as:

  • Working capital deficiencies
  • Negative cash flows from operating activities
  • Default on loans
  • A denial of trade credit from suppliers
  • Need to restructure debt
  • Need to dispose of assets
  • Work stoppages or other labor problems
  • Need to significantly revise operations
  • Legal problems
  • Loss of key customers or suppliers
  • Uninsured catastrophes
  • The need for new capital

The risk assessment procedures are a part of planning an audit. You may obtain new information as you perform the engagement.

Remaining Alert Throughout the Audit

The auditor should remain alert throughout the audit for conditions or events that raise substantial doubt. So, after the initial review of going concern issues in the planning stage, the auditor considers the impact of new information gained during the subsequent stages of the engagement.

Audit Procedures When Substantial Doubt is Present

If events or conditions do give rise to substantial doubt, then the audit procedures should include the following (SAS 132, paragraph 16.):

  1. Requesting management to make an evaluation when management has not yet performed an evaluation
  2. Evaluating management’s plans in relation to its going concern evaluation, with regard to whether it is probable that: 
    1. management’s plans can be effectively implemented and 
    2. the plans would mitigate the relevant conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time
  3. When the entity has prepared a cash flow forecast, and analysis of the forecast is a significant factor in evaluating management’s plans: 
    1. evaluating the reliability of the underlying data generated to prepare the forecast and 
    2. determining whether there is adequate support for the assumptions underlying the forecast, which includes considering contradictory audit evidence
  4. Considering whether any additional facts or information have become available since the date on which management made its evaluation

Sometimes management’s plans to alleviate substantial doubt include financial support by third parties or owner-managers (usually referred to as supporting parties). 

Financial Support by Supporting Parties

When financial support is necessary to mitigate substantial doubt, the auditor should obtain audit evidence about the following:

  1. The intent of such supporting parties to provide the necessary financial support, including written evidence of such intent, and
  2. The ability of such supporting parties to provide the necessary financial support

If the evidence in a. is not obtained, then “management’s plans are insufficient to alleviate the determination that substantial doubt exists.”

Intent of Supporting Parties

The intent of supporting parties may be evidenced by either of the following:

  1. Obtaining from management written evidence of a commitment from the supporting party to provide or maintain the necessary financial support (sometimes called a “support letter”)
  2. Confirming directly with the supporting parties (confirmation may be needed if management only has oral evidence of such financial support)

If the auditor receives a support letter, he can still request a written confirmation from the supporting parties. For instance, the auditor may desire to check the validity of the support letter.

If the support comes from an owner-manager, then the written evidence can be a support letter or a written representation.

Support Letter

An example of a third party support letter (when the applicable reporting framework is FASB ASC) is as follows:

(Supporting party name) will, and has the ability to, fully support the operating, investing, and financing activities of (entity name) through at least one year and a day beyond [insert date] (the date the financial statements are issued or available for issuance, when applicable). 

You can specify a date in the support letter that is later than the expected date. That way if there is a delay, you may be able to avoid updating the letter.

The auditor should not only consider the intent of the supporting parties but the ability as well.

Ability of Supporting Parties

The ability of supporting parties to provide support can be evidenced by information such as:

  • Proof of past funding by the supporting party
  • Audited financial statements of the supporting party
  • Bank statements and valuations of assets held by a supporting party

After examining the intent and ability of supporting parties regarding the one-year period, you might identify potential going concern problems that will occur more than one year out.

Conditions and Events After the Reasonable Period of Time

So, should an auditor inquire about conditions and events that may affect the entity’s ability to continue as a going concern beyond management’s period of evaluation (i.e., one year from the date the financial statements are available to be issued or issued, as applicable)? Yes.

Suppose an entity knows it will be unable to meet its November 15, 2018, debt balloon payment. The financial statements are available to be issued on June 15, 2017, so the reasonable period goes through June 15, 2018. But management knows it can’t make the balloon payment, and the bank has already advised that the loan will not be renewed. SAS 132 requires the auditor to inquire of management concerning their knowledge of such conditions or events. 

Why? Only to determine if any potential (additional) disclosures are needed. FASB only requires the evaluation for the year following the date the financial statements are issued (or available to be issued, as applicable). Events following this one year period have no bearing on the current year going concern decisions. Nevertheless, additional disclosures may be merited.

Thus far, the requirements to evaluate the use of the going concern basis of accounting and whether substantial doubt is present have been explained. Now, let’s see what the requirements are for:

  • Written representations from management
  • Communications with those charged with governance
  • Documentation

Written Representations When Substantial Doubt Exists

When substantial doubt exists, the auditor should request the following written representations from management:

  1. A description of management’s plans that are intended to mitigate substantial doubt and the probability that those plans can be effectively implemented
  2. That the financial statements disclose all the matters relevant to the entity’s ability to continue as a going concern including conditions and events and management’s plans

Communications with Those Charged with Governance

Remember that you may need to add additional language to your communication with those charged with governance.

When conditions and events raise substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time, the auditor should communicate the following (unless those charged with governance manage the entity):

  1. Whether the conditions or events, considered in the aggregate, that raise substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time constitute substantial doubt
  2. The auditor’s consideration of management’s plans
  3. Whether management’s use of the going concern basis of accounting, when relevant, is appropriate in the preparation of the financial statements
  4. The adequacy of related disclosures in the financial statements
  5. The implications for the auditor’s report

Documentation Requirements

When substantial doubt exists before consideration of management’s plans, the auditor should document the following (SAS 132, paragraph 32.):

  1. The conditions or events that led the auditor to believe that there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time.
  2. The elements of management’s plans that the auditor considered to be particularly significant to overcoming the conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern, if applicable.
  3. The audit procedures performed to evaluate the significant elements of management’s plans and evidence obtained, if applicable.
  4. The auditor’s conclusion regarding whether substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time remains or is alleviated. If substantial doubt remains, the auditor should also document the possible effects of the conditions or events on the financial statements and the adequacy of the related disclosures. If substantial doubt is alleviated, the auditor should also document the auditor’s conclusion regarding the need for, and, if applicable, the adequacy of, disclosure of the principal conditions or events that initially caused the auditor to believe there was substantial doubt and management’s plans that alleviated the substantial doubt.
  5. The auditor’s conclusion with respect to the effects on the auditor’s report.

Opinion – Emphasis of Matter Regarding Going Concern

If the auditor concludes that there is substantial doubt concerning the company’s ability to continue as a going concern, an emphasis of a matter paragraph should be added to the opinion.

An example of a going concern paragraph is as follows:

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring losses from operations, has a net capital deficiency, and has stated that substantial doubt exists about the company’s ability to continue as a going concern. Management’s evaluation of the events and conditions and management’s plans regarding these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to this matter.

The auditor should not use conditional language regarding the existence of substantial doubt about the entity’s ability to continue as a going concern. 

Opinion – Inadequate Going Concern Disclosures

Paragraph 26. of SAS 132 states that an auditor should issue a qualified opinion or an adverse opinion, as appropriate, when going concern disclosures are not adequate.

SAS 132 Summary 

Now, let’s circle back to where we started and review the objectives of SAS 132.

The objectives are as follows:

  • Conclude about whether the going concern basis of accounting is appropriate
  • Determine whether substantial doubt is present
  • Determine whether the going concern disclosures are adequate
  • Issue an appropriate opinion 

Conclusion

As you can see ASU 2014-15 and SAS 132 are complex. So, make sure you are using the most recent updates to your disclosure checklists and audit forms and programs.

Finally, keep in mind that going concern is also relevant to compilation and review engagements.

Steal Like a Boss
Jun 18

Steal Like a Boss (and Feel Good About It)

By Charles Hall | Fraud

Can you steal like a boss? White collar crime takes special skills and thoughts. Do you have what it takes? Here’s my tongue-in-cheek look at how I would steal.

Steal Like a Boss

 

Six Steps to Steal Like a Boss

To steal, I need to:

  1. Be Believable
  2. Have a Cause
  3. Calm My Conscience
  4. Develop My Plan
  5. Execute My Plan
  6. If Caught, Settle Out of Court

1. Be Believable

Look trustworthy. The more age, experience, and education I have, the better. The longer I work for the organization, the more I am trusted.

And while I’m at it, I’ll do what I can to move to positions of higher authority which will provide me with greater opportunities. Being in authority enables me to steal like a boss.

If possible, I will gain the ability to authorize or initiate purchases. Kickbacks (paid to those who authorize payments) are difficult to detect, even by professional fraud examiners, and the dollars can be significant. Like taking candy from a baby.

But before I steal, I need motivation. 

2. Have a Cause

Any financial pressure will do–a gambling or drug habit, an affair, medical bills, or maybe I just want to appear more successful than I am. If I don’t have a need, I will create one. I am my own cause.

My unshareable need (cause) must not be known by others lest they suspect my need for cash. 

One problem I must take care of before I steal is my conscience.

3. Calm My Conscience

I hate when that little voice starts talking: “Charles, you can’t do this. You’ll embarrass your wife.” It takes skill and fortitude, but I must calm my conscience. All the more reason to have a cause (see point 2.). The nobler I can make my reasons, the better. Something like, “I’ve earned this. The company should realize my greatness and provide me with appropriate compensation. I have three kids in college, and they need my support. You know I want to be a good provider for my family.”

I may need to start stealing borrowing or compensating myself in small amounts and then build up. Such wise reasoning will make it easier to calm my conscience.

Thinking correctly is important. When that little voice speaks, I will rephrase the words. I know I can. After all, I’ve done so for years.

Now I need to develop a plan.

4. Develop My Plan

I will pay attention to control weaknesses.

Our auditors have told us for years that we lack appropriate segregation of duties in regard to purchasing. Opportunity awaits.

If I am going to steal be compensated appropriately, I need to make it worth my while. Be bold. Think big. I have noticed that one of our key vendors has been very kind to me, a free week-long trip to Vegas for the last three years.

A key contract renewal is coming up. The vendor should be more generous to me. Besides, last year the CFO received a nicer trip than I did (two weeks in Austria). And bribes gifts don’t hurt anyone; the vendor pays for them (though I have noticed the vendor’s pricing seems to be increasing…actually, exploding).

It’s game time. I need to “just do it.” But how?

5. Execute My Plan

Take I must compensate myself in a steady under-the-radar kind of way. Most folks get greedy. I must be diligent to work in a measured way, not taking receiving noticeable amounts. Greed is my enemy. Excess might land me on the front page of the paper.

Also, I think I can steal borrow money from the receipts cycle since I am in charge of daily deposits and all related accounting duties. This might cost me my vacation though. I need to be on the job to continue to hide perform my duties. But if the funds taken compensation is enough, it might be worth it.

But what if my actions become known to others?

6. If I Get Caught, Settle Out of Court

If I am discovered someone notices that I have borrowed funds, then I may have to beg for forgiveness and promise to pay it back. And, of course, I need to make sure the company understands my concern for its reputation. News like this does not support the company’s mission statement: Honesty and Compassion for Those We Serve.

I don’t need a criminal record, especially if I need to steal borrow funds from my next employer. It is comforting to know that in many cases companies don’t prosecute for fear of public embarrassment. 

More Fraud Information

You’ll find more information about fraud prevention in my book: The Little Book of Local Government Fraud Prevention.

See my series of fraud articles at White Collar Crime is Knocking at Your Door.

Key fraud findings
Jun 11

2018 ACFE Fraud Report to the Nations (Key Findings)

By Charles Hall | Fraud

Here are key findings from the 2018 ACFE Fraud Report. The survey is titled the 2018 Report to the Nations.

Key fraud findings

Every two years the Association of Certified Fraud Examiners (ACFE) issues a fraud report based on hundreds of actual fraud cases. The report provides great insights into how fraud occurs (the method), the persons stealing (the fraudster), and the damage (the amount of losses). 

If you are an auditor (internal or external), then you need to be familiar with the findings in this report. Understanding how theft occurs will enable you to detect and prevent it in the future.

Here are key points from the report.

2018 ACFE Fraud Report Findings

  • Organizations lose 5% of their revenues to fraud
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    The median duration of a fraud was 16 months
  • The median loss per case was $130,000
  • The median loss per case when owners or executives were involved was $850,000
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    Businesses with a 100 or fewer employees suffered a median loss per case of $200,000
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    Businesses with more than 100 employees suffered a median loss per case of $104,000
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    In 40% of the cases, tips were the initial detection method (53% of the tips came from employees of the organization; 32% of the tips came from vendors, customers, and competitors)
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    Fraud losses were 50% smaller for organizations with fraud hotlines
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    Only 4% of the fraudsters had a prior fraud conviction
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    Occupational fraud was committed in the following categories: (1) asset misappropriation (89%), (2) corruption (38%), and (3) financial statement fraud (10%) -- in some cases, the fraudster used multiple schemes
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    The median losses were (1) $114,ooo for asset misappropriation, (2) $250,000 for corruption, and (3) $800,000 for financial statement fraud
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    70% of corruption cases were committed by someone in a position of authority
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    82% of corruption cases were committed by males
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    50% of corruption cases were detected by a tip
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    Internal control weaknesses led to nearly half of the fraud
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    Small businesses typically have fewer anti-fraud controls than larger organizations, leaving them more vulnerable
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    Data monitoring/analysis and surprise audits were correlated with the largest reductions in fraud losses and duration (yet only 37% of victim organizations implemented these controls)
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    A majority of the victim organizations recovered nothing
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    Fraudsters that were with the company for more than five years stole an average of $200,000
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    Fraudsters that were with a company for less than five years stole an average of $100,000
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    The industries with the highest levels of fraud were (1) Banking and Financial, (2) Manufacturing, (3) Governments, and (4) Health Care
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    The departments with the highest level of fraud were (1) Accounting (14%), (2) Operations (14%), (3) Sales (12%), and (4) Executive/upper management (11%)
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    69% of frauds were commented by males with a median loss of $156,000 (the median loss from female thefts was $89,000)
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    61% of the fraud cases involved someone with a university degree or postgraduate degree
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    When one fraudster was involved, the median loss was $74,000
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    When two fraudsters were involved, the median loss was $150,000
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    When three or more fraudsters were involved, the median loss was $339,000
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    Living beyond their means was the primary behavioral red flag (41% of cases) 
89%
of fraud from asset misappropriations

Get Your Free Copy of ACFE Report

Join the ACFE 

I have been a member of the Association of Certified Fraud Examiners since 2004. Why? Because I want to be a better auditor. And I have found that the ACFE has given me a much greater understanding of how fraud happens and how to prevent it. The organization has made me a much better auditor. Consider joining this organization. (You can join without becoming a Certified Fraud Examiner (CFE), though I recommend doing that as well. Learn more about becoming a CFE.) You'll be glad you did.

CPA Hall Talk Fraud Articles

For more information about fraud, see White Collar Crime is Knocking at Your Door. There you will see a list of fraud-related articles that I have written.

Fraud Prevention Book

Also check out my book on Amazon: The Little Book of Local Government Fraud Prevention. While the book focuses on governments, there is plenty of information relevant to all organizations.

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CPAHallTalk.com is now live
Jun 01

CPAHallTalk.com is Now Live

By Charles Hall | Accounting and Auditing

CPAHallTalk.com is now live!

CPAHallTalk.com is now live

My blog’s name was formerly CPAScribo.com. Now it’s CPAHallTalk.com. Why the change? To make it more recognizable and memorable. 

I started CPAScribo.com six years ago. At the time, I had no readers, and honestly, the blog was not very good. Still, it was my way of serving CPAs. Limited, yes, but over time, more effective and useful to you–my reader. 

And that’s what CPAHallTalk.com is all about–you. I want—in my own small way—to make you better. Someone in the know. Someone efficient. Someone effective.

Over time, the information in CPAScribo.com (now CPAHallTalk.com) has increased—numbering in the hundreds of articles. Also, the readership has grown. For 2018, I anticipate over 180,000 unique visitors. Additionally, over 1,500 subscribers receive my free periodic newsletters by email.

What’s my focus? To provide information to CPAs (mainly in the United States) concerning auditing, accounting, fraud, and technology

What’s my style? I try to write in a manner that feels like a chat, some Hall Talk if you will. My desire is to make the difficult easy (or at least easier).

What’s to come? I will provide more information to assist you in staying current. In what areas? Accounting and auditing standards, fraud prevention and detection, and the use of technology in your CPA firm. We are in a period of unprecedented change. Artificial intelligence. Data analytics. Blockchain. New accounting and auditing standards. New audit software. So, I want to help you keep up.

Your suggestions? If you have suggestions for future posts, please email me or include them in the comment box below.

Here at CPAHallTalk.com I look forward to serving you and building an even stronger relationship. Cheers.

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