Nonprofit Financial Statements Video Overview

By Charles Hall | Accounting

Nonprofit financial statements are unique and can be confusing to understand.

The Financial Accounting Standards Board (FASB) provides the accounting standards for nonprofit entities such as ASU 2014-16, Presentation of Financial Statements of Not-for-Profit Entities. Those standards require certain presentation requirements such as a statement of functional expenses and liquidity disclosures.

The best way to understand the not-for-profit financial statement requirements is to take a look at an example.

In the video below, I take you through the statement of financial position, the statement of activity, the statement of functional expenses, the cash flow statement and related disclosures. 

Click the picture below to watch this video now. Whether you are an experienced CPA, an auditor, a nonprofit board member, a nonprofit accountant, or an accounting student, you’ll find this helpful.

Journal Entries Made Easy: New Book

By Charles Hall | Accounting

Journal Entries Made Easy, an Introduction to Accounting is my new book available on Amazon.

Are you an accounting student or new to accounting? Or maybe you need a journal entry (JE) handbook. Then here’s an aid to assist you. 

Introduction to Accounting

In the first six chapters I explain how accounting happens, the basic building blocks. I tell you about how financial statements are the result of the following:

• Chart of accounts
• JEs
• General ledgers
• Subsidiary ledgers
• Trial balances

The first six chapters are as follows:

Chapter 1 – Financial Statements
Chapter 2 – Chart of Accounts
Chapter 3 – Understanding Journal Entries
Chapter 4 – Types of Journal Entries
Chapter 5 – Solving Accounting Problems
Chapter 6 – Creating Good Journal Entries

In reading the first six chapters, you’ll gain an understanding of how accounting happens—even if you’ve never done any accounting.

Entry Examples

In the remainder of the book I provide sample JEs by account balance (e.g., cash) or transaction cycles (e.g., receivables/revenues). Here are those chapters:

Chapter 7 – Cash
Chapter 8 – Receivables/Revenues
Chapter 9 – Inventory/Cost of Goods Sold
Chapter 10 – Investments
Chapter 11 – Plant, Property & Equipment
Chapter 12 – Intangibles
Chapter 13 – Accounts Payable/Expenses
Chapter 14 – Accrued Salaries Payable/Salary Expenses
Chapter 15 – Debt
Chapter 16 – Equity

Video Overview of the Book

Here’s a video providing an overview of the book and those who assisted me in its development. 

Get Your Copy Now

Get your copy of Journal Entries Made Easy on Amazon. 

AICPA Consulting Standards – The Swiss Army Knife

By Charles Hall | Accounting and Auditing

In this post, I tell you how to use the AICPA Consulting Standards (Statement on Standards for Consulting Services). I will also compare AUP engagements with consulting engagement options.

Are you ever asked to perform unusual engagements such as reporting on a city’s water losses, or reviewing a company’s internal controls for billing, or performing test counts of widgets.

When such client requests are made, you might wonder “what professional standards should I follow?” Often the answer is in the AICPA Consulting Standards.

AUP or a Consulting Engagement?

Regarding unusual engagements, I am sometimes asked, “Should this be an agreed-upon-procedures (AUP) engagement or a consulting engagement?” 

My answer is usually, “It depends.”

Allow me a moment to compare AUPs with Consulting engagements, and then I’ll explain how to make this decision.

Agreed Upon Procedures Engagement

First, consider the AUP option.

AUPs are mainly composed of the following:

1. Procedures
2. Findings

An example of a procedure and finding follows:

Procedure – Agreed all January 2020 disbursements greater than $20,000 to checks that cleared the bank statement; also compared the payee on each check to the payee per the check register.

Finding – All check payees agreed with the exception of check 2394 for $45,000. The payee for this check was I. Cheatum, and the check register reflected a payment to King’s Supply Company.

CPAs must be independent of the client to perform AUP engagements.

CPA Consulting Engagement

Second, we’ll consider the consulting engagement option.

A consulting engagement (sometimes called management advisory services) is less precise than an AUP and does not necessarily follow the procedures/findings format. There are no specific reporting standards for a consulting engagement, so a CPA can more easily design the engagement to meet various needs. The consulting standards are more flexible than the attestation standards. And this flexibility enables you to be more creative in designing the engagement.

Independence is not required when performing consulting engagements, though the CPA still needs to be objective. For example, the CPA needs to be free of conflicts of interest. 

A consulting report might address the following:

1. Reading of minutes
2. Interviews of individual employees
3. Flowcharting of internal controls
4. Summary of production statistics
5. Narrative of business goals and enterprise risks

As you can tell, there are no procedures and findings (though you are not prohibited from doing so). Most CPAs usually perform AUPs when there are specific procedures.

The Best Option

So which is better? An AUP or a consulting engagement?

I’ll say it again: It depends. On what? Third party reliance.

Consider the following:

1. Will there be external parties (e.g. creditors) placing reliance on the report?
2. Is the purpose of the report to add credibility to the information (by having the CPA attest to procedures and findings)?

If the answer to either of these questions is yes, then consider the AUP option. Why? The Attestation Standards–the guidance for AUPs–are more defined and rigorous. And AUP procedures tend to be more specific than those in a consulting engagement.

If no third party reliance, then a consulting engagement may be the better option. Always ask, “Who will receive the report?” You need to know who will read and potentially place reliance upon the report. Then design the work product accordingly. 

Litigation Exposure

Are consulting engagements riskier than AUPs? Generally, yes—at least, in my opinion.

The safer option is to perform an AUP. In such engagements, you are asked by the client to perform particular procedures or you design procedures that the client approves (see SSAE 19). This specificity lowers the risk of potential litigation as it relates to your work product.

The flexibility of a consulting engagement, while helpful in designing creative deliverables, can be riskier because of the lack of specific client requirements. (This is why the consulting engagement letter is so important. You can clearly define what the client wants done.)

Now, let me provide you with an overview of the Consulting Standards. 

AICPA Consulting Standards 

You might call the AICPA Consulting Standards the CPA’s Swiss army knife. Why? Because of the diversity of services you can perform.

What services fall under these standards?

The consulting standards specifically address six areas:

1. Consultations – e.g., reviewing a business plan
2. Advisory services – e.g., assistance with strategic planning
3. Implementation services – e.g., assistance with a merger
4. Transaction services – e.g., litigation services
5. Staff and other support services – e.g., controllership services
6. Product services – e.g., providing packaged training services

CPAs often provide consulting services such as the following:

• Consultations with regard to complex transactions
• Fraud investigation services
• Internal control services
• Bankruptcy services
• Divorce settlement services
• Controllership services
• Business plan preparation
• Cash management
• Software selection
• Business disposition planning

Now, let’s review the characteristics of consulting engagements.

Characteristics of a Consulting Engagement

The characteristics of a consulting engagement include the following:

• Generally nonrecurring
• Requires a CPA with specialized knowledge and skills
• More interaction with client
• Generally performed for the client (usually, no third party sees the information)

But, what are the workpaper requirements for a consulting engagement?

Consulting Workpaper Requirements

Consulting workpaper requirements are minimal. Nevertheless, documentation is always wise.

The understanding with the client can be oral or in writing (I recommend the latter).

The consulting standards do not require the CPA to prepare workpapers, but you should do so anyway. The workpapers are the link between your work and your report. Also, the general standards of the profession, contained in the AICPA Code of Professional Conduct, apply to all services performed by members. The general standards state:

Sufficient Relevant Data. Obtain sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to any professional services performed.

By now, you’re probably thinking the Consulting Standards sound easy, I’ll bet the reporting requirements are challenging. Not so, my friend.

Consulting Reports

A report is not required, but if one is provided, the client and CPA determine the content and format. Again, define the particulars in an engagement letter. How’s that for flexibility? 

No Opinion or Attestation Report

For consulting engagements, the CPA does not issue an opinion or any other attestation report.

Subject to Peer Review?

Are deliverables created under the Consulting Standards subject to peer review? No.

Where Can I Find the AICPA Consulting Standards?

Here are the AICPA Consulting Standards. They are only a few pages in length. 

AICPA Consulting Standards Summary

The Consulting Standards provide us with a breath of options, enabling you and I to craft services and reports in the manner desired by our clients. This is one Swiss army knife that I will continue to use. 

Here is a table comparing consulting and AUP services. If needed, the table below scrolls horizontally.

Consulting vs. AUP

Question	Consulting	AUP
Procedure and finding format?	Usually no, but permissible to do so	Yes
Engagement letter required?	No, but best to obtain a signed agreement with specifications of what is to be done and the type of report to be issued (if any)	Yes
Work papers required?	Must obtain obtain sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to any professional services performed	Yes
Report required?	No; report can be provided but no specific wording is required	Yes; specific wording is required
Opinion provided?	No	No
Offers a high level of flexibility in terms of structuring the engagement?	The approach and report (if one is issued) is very flexible	Accountants can design the AUP procedures but the client has to approve them
An attest service?	No	Yes
Provides assurance to third parties?	No, report can be provided to third parties but it is not an assurance report	Yes
Subject to peer review?	No	Yes

When a report is to be provided to third parties, consider using the AUP approach since it is an assurance service.

 

Read my article about AUPs (SSAE 19). 

AR-C 80: Definitive Guide to Compilations

By Charles Hall | Preparation, Compilation & Review

Eight Types of Accounting Journal Entries

By Charles Hall | Accounting

In this article, I provide eight different types of accounting journal entries.

Understanding journal entries is critical to understanding accounting. So, read on.

Journal entry types include the following:

1. Recurring
2. Nonstandard
3. Accruals and deferrals
4. Adjusting entries
5. Reclassifying entries
6. Closing entries
7. Consolidating entries
8. Proposed audit adjustments

These journal entry types are not mutually exclusive. For example, an accrual entry can be recurring or nonstandard.

1. Recurring Journal Entries

Recurring journal entries are those that are repetitive. Often, these entries are automated with the company’s accounting software.

For instance, if a company will pay $5,000 per month for rent for the next three years, the accountants might set up an automated entry. That way, the company doesn’t have to make this monthly entry manually. Most accounting software packages provide for automated entries. Set it up once and specify the number of periods to make the entry. Then, the software will record an entry such as the following until the rental agreement terminates.

Account	Debit	Credit
Rent	5,000
Accounts payable		5,000
To accrue the monthly rental expense due to Clockworks, Inc.

 

Another example of a recurring journal entry is depreciation. If the company purchases a corporate office for $5,000,000 and plans to depreciate it straight-line over 50 years, it can create an automated entry of $8,333 each month.

Account	Debit	Credit
Depreciation expense	8,333
Accumulated depreciation – buildings		8,333
To record the monthly building depreciation for the corporate office

So, what are nonstandard journal entries?

2. Nonstandard Journal Entries

Nonstandard journal entries are those that are not repetitive. For example, they might be one-time entries or occur twice a year. These entries are usually manually inputted into the company’s accounting software. Examples of nonstandard entries include the following:

• Impairment charges
• Writing off bad debts
• Stock buy-backs
• Legal settlements
• Debt restructuring

Nonstandard journal entries, such as those for mergers with or acquisitions of other companies, can be complex.

Next, I explain what accruals and deferrals are.

3. Accruals and Deferrals

When a company uses the accrual basis of accounting, it accrues and defers revenues and expenses based on when it earns revenues and incurs expenses. The company’s activity—goods or services provided or purchased—drives the accounting.

For example, if you are an attorney, you can recognize revenue as you provide services on a particular day, even though you may not receive the related payment until weeks later. And if you buy office supplies on the first day of a month, you accrue (record) the expense on that day, though you make the related payment thirty-five days later. Accruals are the recognition of revenues and expenses before cash is received or paid.

In contrast, a company using the cash basis of accounting recognizes revenues and expenses as cash is received and paid: the receipt and payment of cash drive the accounting. Companies using the cash basis of accounting do not accrue or defer revenues and expenses.

Accruals

Suppose a company receives an invoice from a CPA for audit services totaling $25,000, but it plans to pay the expense at the end of the month. The company can accrue the expense upon receiving the invoice.

Account	Debit	Credit
Professional services	25,000
Accounts payable		25,000
To accrue audit expenses for the September 12, 20XX Crofts and Seals invoice #1015

Cash Payment

The company would recognize the cash payment when paid.

Account	Debit	Credit
Accounts payable	25,000
Operating checking		25,000
To record the October 2, 20XX payment of the Crofts and Seals invoice #1015

Deferrals

Deferrals postpone the recognition of revenues and expenses until a period after the one in which cash is received or paid.

Suppose a repair company receives $10,000 for services on April 2, 20XX, but performs the work on May 10, 20XX. The company can defer revenue recognition until it provides the repair work. Deferred revenue is a liability account.

Account	Debit	Credit
Cash	10,000
Deferred revenue		10,000
To defer revenue recognition for the April 2, 20XX receipt from Jerry’s, Inc., repair work is to be done in May.

 

The company recognizes the earned revenue when it provides that service on May 10, 20XX.

Account	Debit	Credit
Deferred revenue	10,000
Repair services		10,000
To recognize income earned on May 10, 20XX, repair ticket 1452

Another type of journal entry is an adjusting entry. 

4. Adjusting Entries

Adjusting entries are often made at period-end (e.g., month-end) to correct the company’s financial statements, though they can be made during the period.

For example, if company employees work one week but are not paid by month-end, an accrual can be made to recognize the salary expense incurred. So, the company makes an adjusting entry (in the form of an accrual) at the end of the month.

While adjusting entry is often used synonymously with the word accrual, they are not the same. Adjusting entry is broader than accrual and encompasses all entries made to record a company’s activities. Accruals record revenues and expenses. On the other hand, adjusting entries include non-accrual activities such as depreciation, allocations, and bad debts—and accruals of revenues and expenses.

Here are examples of adjusting entries:

• Accrued expenses
• Accrued revenues
• Prepaid expenses
• Unearned revenues
• Depreciation
• Amortization
• Bad debts

Adjusting entries also encompass prior period adjustments. A prior period adjustment is an entry made to correct a prior period error.

Suppose a company uses GAAP and does not record $45,000 in payables at the end of December 31, 20X3, and records that amount as an expense in January 20X4. Now, the expense appears in the wrong year (assuming the company has a calendar year-end), resulting in an understatement of 20X3 expenses and an overstatement of 20X4 expenses. On July 2, 20X4, the company discovers the error. So, a prior period adjustment is necessary and is recorded in December 20X4.

Now, let’s look at reclassifying entries.

5. Reclassifying Entries

A reclassifying entry is one made to move amounts between different accounts.

For example, if a company has recorded an expense as Miscellaneous Expense that should be Office Expense, a reclassifying entry is made to debit Office Expense and credit Miscellaneous Expense. Doing so moves the expense from Miscellaneous Expense to Office Expense. This entry has no impact on net income. It only reclassifies the expense to the correct account.

Here is the reclassification entry:

Account	Debit	Credit
Office Expense	15,232
Miscellaneous Expense		15,232
To reclassify office expenses to the appropriate account for the Skagg’s invoice #41230

 

Classification of amounts can be critical to accurate reporting. For instance, what if a company defaults on the debt covenants of a $9 million loan? According to GAAP, the debt usually becomes short-term. Why? The loan is callable by the lender, meaning the creditor can demand immediate payment. So, a reclassifying entry is made to move the debt from long-term to short-term. This reclassification entry has no impact on equity, only on the presentation on the balance sheet.

Account	Debit	Credit
Debt – long-term	9,000,000
Debt – short-term		9,000,000
To reclassify the Herald Bank note payable to short-term after default of debt covenants

Next, we explore closing entries. 

6. Closing Entries

Closing entries are journal entries made at the end of an accounting period to transfer balances from temporary accounts (e.g., revenue accounts) to permanent accounts (e.g., equity accounts).

A temporary account is an account that is closed at the end of every accounting period, meaning its balance is $0 on the first day of the next accounting period (usually a year). Temporary accounts include all income statement accounts, such as revenues and expenses.

Permanent accounts are those that are not closed out at period end. Their balances do not reset to $0 on the last day of the period. Permanent accounts include asset, liability, and equity accounts—balance sheet accounts.

Closing Out Revenues

For example, sales revenue is $2,010,099 on December 31, 20X3 (for a calendar year entity), but $0 on January 1, 20X4. The revenue is closed to retained earnings (an equity account) at year-end. Revenue accounts start with a $0 balance at the beginning of the new accounting year. 

Account	Debit	Credit
Sales	2,010,099
Retained earnings		2,010,099
To close out the sales revenue amount at year-end

 

This entry increases retained earnings, which is a permanent account.

Closing Out Expenses

In another example, the salary expense account is $687,098 on December 31, 20X3 (for a calendar year entity), but $0 on January 1, 20X4. At year-end, the expense is closed to retained earnings (an equity account). Expense accounts start with a $0 balance at the beginning of the new accounting year.

Account	Debit	Credit
Retained earnings	687,098
Salaries		687,098
To close out the salary expense amount at year-end

 

This entry decreases retained earnings, which is a permanent account.

Closing entries are normally made automatically by a company’s accounting software.

7. Consolidating Entries

Companies make consolidating entries when two or more entities are combined. Consolidating entries eliminate intercompany transactions.  

In consolidation (or combined) financial statements, the presentation should appear as though the two entities are one. So, revenues recognized in selling from company A to company B are eliminated (when consolidating the two entities). Company B’s expense (for these transactions) is also removed from the consolidated financial statements.

Additionally, companies eliminate intercompany receivables and payables. That is, companies normally offset intercompany receivables and payables against each other.

Consolidating entries are often made in a spreadsheet (e.g., Excel) with the two entities’ account balances side by side and then additional columns to record the eliminating entries. The final columns include the adjusted balances for the financial statement balances.

Some accounting software packages make the consolidating entries for you, and no spreadsheet is necessary.

Finally, we look at proposed audit adjustments. 

8. Proposed Audit Adjustments

External auditors sometimes propose journal entries to adjust a company’s accounts. Auditors create the proposed audit adjustments to correct misstatements. These are provided to the company, and it decides whether it will record the entries; this is why they are called “proposed adjustments.” If the company does not record material proposed audit adjustments, the auditor may need to modify their audit opinion. Companies seldom desire a modified audit opinion.

Types of Journal Entries – Summary

There, you have eight types of accounting journal entries. Now, it will be easier to speak the language of accounting. 

If you’re an auditor, see my article about testing journal entries. 

Journal Entries Book

Want a JE handbook? Check out my new book, Journal Entries Made Easy, an Introduction to Accounting.