All Posts by Charles Hall

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About the Author

Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses. He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events. Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs. In addition, he consults with other CPA firms, assisting them with auditing and accounting issues.

Preparation Enagement
Jan 12

Bookkeeping, Preparations, Compilations, and Reviews

By Charles Hall | Preparation, Compilation & Review

Today, we’ll answer various questions regarding bookkeeping, preparations, compilations, and review engagement.

Compilation Enagement

Q: Should I issue management letters for preparation, compilation, or review engagements?

A: While not required, it is advisable to provide management letters when performing SSARS services. Why? Two reasons: (1) It’s a way to add value to the engagement, and (2) it’s a way to protect yourself from potential litigation. Clients do–sometimes–sue CPAs in these so-called “lower risk” engagements. If we see control weaknesses (while performing a compilation for example), we should communicate those–even though standards don’t require it. Then, if theft occurs in that area and you are later sued regarding the fraud, you have a defense. If you don’t issue a management letter, at least send an email regarding the issues noted and retain a copy.

Q: Why obtain an engagement letter for nonattest services such as bookkeeping and tax (standards don’t require it)?

A: In all engagements, we want to state exactly what we are doing. Why? So, it is obvious what the client has hired us to do–and what they have not hired us to do. If a client says, “I told you to do my monthly bookkeeping and to file my property tax returns,” but you have no recollection of being asked to perform the latter, you need an engagement letter that specifies monthly bookkeeping (and nothing else).

Q: Should I say–in a bookkeeping engagement letter–the service is not designed to prevent fraud?

A: We should obtain a signed engagement letter for bookkeeping services, even though not required by standards. And yes, by all means, include a statement that the bookkeeping service is not designed to detect or prevent fraud.

Q: If I note fraud while performing a bookkeeping, preparation, compilation, or review engagement, should I report it to the appropriate levels of management?

A: Standards require this communication for review engagements. I would do likewise for the other services.

Q: Am I required to be independent if I perform bookkeeping and preparation services?

A: No, since both are nonattest services.

Q: If I create financial statements as a byproduct of an 1120 tax return, am I subject to AR-C 70 Preparation of Financial Statements?

A: No, you are only subject to AR-C 70 if you are engaged to prepare financial statements.

Q: If I perform bookkeeping services in a cloud-based accounting package such as QuickBooks, am I subject to AR-C 70?

A: It depends. Yes, if you are engaged to prepare financial statements. No, if you were not engaged to prepare financial statements. Who “pushes the button” to print the financial statements has no bearing on the applicability of AR-C 70.

Q: Am I required to have a signed engagement letter for all preparation, compilation and review engagements?

A: Yes.

Q: Can I act as a controller-for-hire and perform a compilation engagement?

A: Yes, but you need to state that you are not independent in the compilation report.

Q: Can I act as the controller-for-hire and perform a review engagement?

A: No. Independence is required for review engagements.

Q: If I prepare financial statements and perform a compilation, am I performing one service or are these considered two separate services?

A: They are two separate services. The preparation is a nonattest service, and the compilation is an attest engagement. Both can be specified in one engagement letter.

Here’s a video explaining the differences in preparation and compilation services.

Using Slack for CPA Project Communications
Jan 04

Are You Using Slack for CPA Project Communications?

By Charles Hall | Technology

Do you ever find yourself digging through hundreds of emails to find one message? You know it’s there somewhere, but you can’t put your electronic finger on it. Use Slack to communicate by project–that way, you’ll have all messages (by project, e.g., individual audit engagement) in one place.

Using Slack for CPA Project CommunicationsWhat is Slack?

Slack is software designed to allow project teams–e.g., audit team–to send and store messages. Why use Slack rather than traditional email? Messages are stored by channel (by project), making it much easier to see project conversations.

The Slack website says the following:

Most conversations in Slack are organized into public channels which anyone on your team can join. You can also send messages privately, but the true power of Slack comes from having conversations everyone on the team can see. This transparency means it’s quick to find out what’s going on all across the team, and when someone new joins, all the information they need is laid out, ready for them to read up on.

How CPAs Use Slack

How can you as a CPA or auditor use Slack?

Create a channel for each project, and ask all team members to communicate using Slack (rather than email).

In CPA firms, some activities are year-round such as quality control reviews (we perform several hundred a year). Other activities are a true project, such as an audit engagement. Either way, you can use a separate (Slack) channel to communicate and store all related messages.

Using Slack for Quality Control Reviews — An Example

Below you see an example of how Heather, my associate, and I use Slack to communicate about file reviews in our quality control department. By doing so, we can see who is doing what and when. Also, all of the messages are searchable by channel. So, suppose I’m wondering when we reviewed the ABC Bank engagement. I can search the CPR (cold partner review) channel to see who performed the review and when. Notice, in this channel, Heather and I are posting status comments. We do so for the following reasons:

  • To create a history of each review
  • To notify each other that the review has commenced (Slack automatically sends a notification message to those included in a channel)

To select our quality control channel, I click the CPR channel on the left (where all the channels appear). Once I click CPR, I see the most recent messages for this channel.

 

Slack

Made with Stitcher

Audits – Another Example

Think about a typical audit. You have three to five team members, with some individuals coming and going. To maintain continuity, you need a message board that allows all audit team members to see what is going on. That’s what Slack does when you create a channel for a particular audit. Think of it as a message board in the cloud since the designated personnel can see the audit communications with their PC, iPad, or cell phone.

Other Advantages of Slack

Advantages of Slack include the following:

  • Accessibility from all devices, including cell phones and tablets
  • Shareability of documents such as PDFs and spreadsheets
  • Integration with other apps such as Trello and Google Calendar
  • Configurable notifications of messages to team members
  • Private messaging (when needed)
  • Basic plan is free

Give It a Try

The best way to see how Slack works is to try it yourself. You don’t need any training since it’s easy to use. To see more information about Slack, click here.

auditor's cell phone
Sep 17

An Auditor’s Cell Phone

By Charles Hall | Accounting and Auditing , Technology

A cell phone is an auditor’s Swiss knife. And with all the options, I am continually looking for another way to use mine. So I’m sharing my ideas with the hope that you will likewise share yours. While I use an iPhone, I realize there are plenty of other nifty cell phones; my comments below are directed not at a particular phone but how I use mine as an auditor.

Below you will see a screenshot of my cell phone home screen and information concerning how I use various apps.

Auditor's Cell Phone

An Auditor’s Cell Phone

 

Camera

I use this iPhone app to capture pictures of documents as I perform internal control walkthroughs. I embed these pictures in my walkthrough documentation. A picture says a thousand words. If the person explaining the accounting system creates pictures on a whiteboard, I take photos of the drawings.

Sometimes I need a copy of a page from a hardback book (e.g., research); rather than using the copy machine, I take a picture of the page and email it.

Keynote

Keynote is Apple’s version of Powerpoint. I build the Keynote slide deck for presentations and use my phone to present. If you use iCloud, the slide deck you create on your iPad will automatically appear on your iPhone (if your settings are right).

You can also present a Keynote slide deck using your iPad as the presentation device and your iPhone as a remote. Your iPhone moves the slides of the iPad slide deck as you stand at a distance. Both devices (iPad and iPhone) must be on the same wifi for the remote feature to work.

Kindle

I buy most of my books using the one-click option in Amazon. Most books are 50% less in price (or more) than physical books. You can highlight books you read and then create a summary of those highlights (which I then place in my searchable Evernote account–see below); you can copy and paste these highlights to Word or other software.

If I am waiting on a plane, taxi, a friend, a doctor, etc., I have all my books handy for reading. You can even purchase my fraud prevention or SSARS 21 books (shameless advertising, yes I’m guilty).

Evernote

I love Evernote! It is my cloud storage, and at $70 per year for the premium version, it provides me with tremendous power. All the research I have performed and stored is available everywhere I go. All the articles I have saved are at my fingertips. (And it is so easy to store information in this application.) At present, I have thousands of screenshots, websites, articles, presentations, conversations, books, pictures, and answered research issues. It’s my knowledge library.

You can use this app to record conversations that are automatically loaded into Evernote.

Dropbox

I also use Dropbox to store some documents. Most apps connect well with Dropbox, and it handles large video or audio files well.

1Password

I save all my passwords in 1Password. No more wondering how I’m going to get into my computer with a password I’ve forgotten–again (I know this never happens to you).

Messages

I text my audit team members to see how things are going. Messaging is much more efficient than calling if the communication is short. (You can also take a picture of anything with Camera and message the picture. If your audit team member needs to see something on your computer screen, take a picture of it and message the shot to them with comments.)

Don’t want to type the message? Just say it out loud, and the app will record your words for sending.

Maps

I use Google maps to get to new audit locations.

Weather

I use the Weather Channel’s app to check the weather before I leave for trips so I can dress appropriately.

Pandora

Mozart or U2 makes my audit day go by much better. If you prefer music without ads, you can pay Pandora for the service. 

Sharefile

Sharefile is my go-to app for sending sensitive client data. With hackers everywhere, I don’t risk sending sensitive client data in emails.

Fantastical

My Fantastical calendar app syncs with my Outlook calendar, so regardless of where I am, I can check my appointments and schedule the same. I can also add reminders in Fantastical, so I don’t forget the milk.

ToDoist

Do I keep a to-do list? Yes, in my ToDoist app. This app integrates with Outlook.

Audible

When I am driving, I listen to books using Audible. If you’re on the road a lot, this is a great way to redeem your time.

WSJ

I read the Wall Street Journal to keep abreast of current events. This WSJ app provides me access to one of the best newspapers in America (and there aren’t many these days).

Siri

While not an app, I push the button on my iPhone and Siri asks me what I want to do. This is how I make phone calls by simply saying, “call my wife,” for example. I also send texts (or emails) the same way by saying “send a text to C.S. Lewis”; then I tell Siri what I want to say–works amazingly well; she even understands my southern accent (and that, my friends, is truly amazing).

What About You?

How do you use your cell phone at work? I would love to hear from you.

Finance and operating leases
Aug 23

Account for Finance and Operating Leases

By Charles Hall | Accounting

Most CPAs grapple with leases from the lessee’s point of view, so in this post, we’ll take a look at leases from the lessee’s perspective. Under the new lease standard, what are the types of leases? Does the accounting vary based on the type of lease? Are lease expenses different?

Finance and operating leases

First, let’s start by defining the types of leases and how to classify them.

The Types of Leases

Upon the commencement date of the lease, the company should classify the lease as either a finance or an operating lease. (Under present lease standards a finance lease is referred to as a capital lease.)

Finance Lease

So what is a finance lease? A lease is considered a finance lease if it meets any of the following criteria:

  1. The lease transfers ownership of the underlying asset to the lessee by the end of the lease term
  2. The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise
  3. The lease term is for the major part of the remaining economic life of the underlying asset (today we use the 75% rule)
  4. The present value of the sum of the lease payments and residual value guarantee equals or exceeds substantially all of the fair value of the underlying asset (today we use the 90% rule)
  5. The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term

While the bright-line criteria (e.g., the lease term of 75% or more of economic life) have been removed, the basis for conclusions in the new lease standard acknowledges some of the old rules of thumb.  It says that one reasonable approach to determining whether the lease is for a major portion of the asset’s life is the 75% threshold. The conclusion goes on to say that “90 percent or greater is ‘substantially all’ the fair value of the underlying asset.” So, in effect, FASB removed the bright-lines as a rule but not in principle–the conclusion says FASB “does not mandate those bright lines.”

Operating Lease

And what is an operating lease? It’s any lease that is not a financing lease.

Accounting Similarities and Differences

Both operating and finance leases result in a right-of-use asset and a lease liability. The subsequent accounting for the two types of leases is quite different.

Finance Lease Accounting

The accounting for a finance lease is similar to capital lease accounting under present standards.

When a company enters into a finance lease, it will record the right-of-use asset and the lease liability. The amortization of the right-of-use asset will be straight-line and the amortization of the liability will be accounted for using the effective interest method. Consequently, lease expenses are front-loaded (i.e., expenses will decline throughout the lease term). The amortization expense and the interest expense will be presented separately on the income statement.

As we are about to see, operating lease accounting is significantly different, particularly with regard to accounting for the lease expense and the amortization of the right-of-use asset.

Operating Lease Accounting

The primary change in lease accounting lies in the operating lease area. Under ASC 842 a company will book a right-of-use asset and a lease liability for all operating leases greater than twelve months in length. (Under current lease standards, no asset or liability is recorded.) Will the operating lease expense be any different than it has been? No. But the recording and amortization of the right-of-use asset and the lease liability is new.

The Initial Operating Lease Entries

Let’s say a company has a five-year operating lease for $1,000 per month and will pay $60,000 over the life of the lease. How do we account for this lease? First, the company records the right-of-use asset and the lease liability by discounting the present value of the payments using the effective interest method.  In this example, the present value might be $54,000. As the right-of-use asset and lease liability are amortized the company will (each month) debit rent expense for $1,000—the amount the company is paying. So the expense amount is still the same as it was under ASC 840.

Amortizing the Right-of-Use Asset and the Lease Liability

Well, how does the company amortize the right-of-use asset and the lease liability? The lease liability is amortized using the effective interest method, and the interest expense is a component of the rent expense. What’s the remainder of the $1,000? The amortization of the right-of-use asset. The $1,000 rent expense is made up of two components: (1) the interest expense for the month and (2) the right-of-use amortization amount which is a plug to make the entry balance. Even though the rent expense is made up of these two components, it appears on the income statement as one line: rent expense (unlike the finance lease which reflects interest expense and amortization expense separately).

Potential Impairments

Due to the mechanics of the straight-line lease expense calculation, the right-of-use asset amortization expense is back-loaded (i.e. the amortization expense component is less in the early part of the lease). One potential consequence of this slower amortization is the right-of-use asset may be subject to impairment, especially toward the end of the lease. The impairment rules do apply to the right-of-use asset.

Your Thoughts

So, what do you think of the new lease accounting? Is it better? Worse?

You can see my first two lease posts here:

Post 1: How to Understand the New Lease Accounting Standard

Post 2: Get Ready for Changes in Leases and the Leasing Industry

Lease Standard
Aug 17

Changes in Leases and the Leasing Industry

By Charles Hall | Accounting

The Leasing Industry will Change

In my last lease post, we saw that bright-line criteria (e.g., lease terms of 75% or more of economic life and minimum lease payments of 90% or more of fair market value) are eliminated with ASU 2016-02. Consequently, almost all leases—including operating leases—will create lease liabilities. This accounting change will alter the leasing industry.

Lease Standard

Picture from AdobeStock.com

Lessees are presently paying high lease interest rates to obtain operating lease treatment (no lease debt is recorded). Now—with the new lease standard—those same operating leases will generate lease liabilities. So why would the lessee pay the higher interest rate? There is nothing to be gained. Lessees will begin to borrow money from banks (at a lower rate). And they will buy the formerly leased asset, or they will demand lower interest rates from the lessor. Lessees, I think, will obtain better interest rates.

The Scope of the Lease Standard

To what does the lease standard apply? It applies to leases of property, plant, and equipment (identified asset) based on a contract that conveys control to the lessee for a period of time in exchange for consideration. The period may be described in relation to the amount of usage (e.g., units produced). Also, the identified asset must be physically distinct (e.g., a floor of a building).

Control over the use of the leased asset means the customer has both:

  1. The right to obtain substantially all of the economic benefits from the use of the identified asset
  2. The right to direct the use of the asset

To what does the standard not apply?

The lease standard does not apply to the following:

  1. Leases of intangible assets, including licenses of internal-use software
  2. Leases to explore for or use minerals, oil, natural gas, and similar resources
  3. Leases of biological assets
  4. Leases of inventory
  5. Leases of assets under construction

Operating or Finance Lease

Upon the commencement date of the lease, the company should classify the lease as either a finance or an operating lease. Under present lease standards, a finance lease is referred to as a capital lease.

So what is a finance lease? A lease is considered a finance lease if it meets any of the following criteria:

  1. The lease transfers ownership of the underlying asset to the lessee by the end of the lease term
  2. The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise
  3. The lease term is for the major part of the remaining economic life of the underlying asset (today we use the 75% rule)
  4. The present value of the sum of the lease payments and residual value guarantee equals or exceeds substantially all of the fair value of the underlying asset (today we use the 90% rule)
  5. The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term

And what is an operating lease? It’s any lease that is not a financing lease.

Both operating and finance leases result in a right-of-use asset and a lease liability. The subsequent accounting for the two types of leases will be different (a topic we’ll cover in my next lease post).

Related Party Leases

Leases between related parties will be classified just as any other lease will be. Companies will look to the legally enforceable terms and conditions of the lease to determine whether a lease contract exists. If a lease contract exists, the agreement will be treated as a lease with the lessor reflecting a sale and the lessee capitalizing the related lease liability and right-of-use asset.

Are there any leases that will not result in a right-of-use asset and a lease liability? Yes, those with terms of twelve months or less.

Lease Terms of Less Than 12 Months

Companies do have the option to not capitalize a lease of 12 months or less. To do so, the company must make an accounting policy election (by class of the underlying leased asset). Companies that use the election will recognize lease expenses on a straight-line basis, and no right of use asset or lease liability will be recorded. If, however, the terms of the short-term lease change, the agreement could become one in which the lease is capitalized–for example, if the lease term changes to greater than twelve months. (Expect to see plenty of leases terms of twelve months or less.)

Month-to-month leases will usually not be capitalized if the accounting policy election is taken. Consider, however, any options to renew or if the leases contain “mutual” renewal options. Once the noncancelable period is over and the contract is no longer enforceable, the lease becomes an “at-will” arrangement.

ASC 842-10-30-1 defines the lease term as the noncancelable period of the lease together with all of the following:

  • Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option
  • Periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option
  • Periods covered by an option to extend (or not to terminate) the lease in which exercise of the option is controlled by the lessor

Getting Ready for the New Lease Standard

Companies can ready themselves for implementation of the new lease standard by doing the following:

  1. Take an educational class that explains the particulars of the lease standard
  2. Create an inventory of all leases (I would use an Excel spreadsheet and create a worksheet summarizing financing leases and another worksheet for operating leases)
  3. Obtain copies of all lease agreements to support the inventory of leases (note–some verbal lease contracts are enforceable)
  4. Determine the terms of the leases (see ASC 842-10-30-1 above)
  5. Segregate the lease and non-lease (e.g., maintenance, cleaning) components in the lease contracts (companies will usually capitalize just the lease portion, though ASC 842-10-15-37 allows a lessee to make an election to not separate the non-lease component)
  6. Document judgments made such as whether the lessee is reasonably certain to exercise a renewal extension 
  7. Compute all lease liabilities and right-of-use asset amounts 
  8. Determine whether the implementation of the standard might adversely affect the company’s compliance with debt covenants (you may want to discuss the impact with your lenders)

While this list is not comprehensive, performing these actions will assist you in preparing for implementation of the lease standard.

Effective Dates for New Lease Standard

ASC 842 (ASU 2016-02), Leases, replaces ASC 840, Leases.

The effective dates for 842 are as follows:

For public entities, the standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those years.

For all other entities, the standard is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020.

Early implementation is permissible for all entities.

More Lease Information Coming

We’ll continue this series of lease posts next week. So stay tuned. 

See How to Account for Finance and Operating Leases.

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