Tag: Accounting

Auditing investments

It is always refreshing to see associations which take responsibility for their future replacements by trying to find investments which can actually grow beyond the rate of inflation.  A solid investment plan can help them ease the burden of reserve assessments by using collected funds to grow at an accelerated, but reasonably safe, rate of return.

Auditing these investments is challenging though.

Conceptually, auditing investments is not any harder than auditing cash.  Except that investments carry certain additional disclosure requirements and the treasurer typically has little to no exposure on how to record the transactions let alone report them to be audited.  Which means that our work as the auditor grows significantly.

You see, Generally Accepted Accounting Principles (GAAP) requires that the investments be reported as either trading, available for sale or held to maturity.  How many investment advisors even understand what can be assigned to these categories?  And our role, as auditor, is to make sure that the investments are properly categorized and that the related gains, losses, and earnings is properly reported in the statement of activity; i.e. the profit and loss statement.  To ensure that they are properly recorded in the period, the accounting department has to know the difference between realized and recognized gains and losses, temporary impairment, other than temporary impairment and put those in the right reporting areas.

Which of course leads to another big accounting issue, accumulated other comprehensive income.  This is the series of holding accounts for the unrealized gains.  You have to know how to close out the transaction to recognize the ultimate sale of the investment.

Did I mention that you have to also track bond premiums and discounts and do some accounting work to get the amortization right?  Again, all this has to be tracked correctly to report in accordance with GAAP.

The rub is that treasurers and boards don’t really understand the complexity of this and often don’t really care.  Their issue is the investment and the return, not its reporting.  Which brings us to our dilemma.

Trying to account for, and then audit, investments can add a substantial cost to the engagement.  It is a cost that probably won’t be valuable to the board and owners in the association.  So, do we allow for a GAAP departure on the investments and simply say they are recorded at cost and have associations report gains and losses at the time of sale?

It is a difficult position.  On the one hand we want the statements to fairly represent the financial activity of the association but on the other hand we don’t want to drive up the cost of the engagement to the point where they find another auditor.  One who perhaps will take huge shortcuts on the reporting and auditing side.  Yes, we see that far too often as well.

So, putting your reserve fund to work by investing it strategically and at reasonable risk is a fair approach to managing the money.  But there are other things to consider besides the actual investing and you, as a board, need to be aware of these issues and take a position on how to report this to the owners in your association financial statement.

Have a great day and an awesome weekend.  And, if you are looking for an experienced audit team to help you maintain effective controls over your association’s finances, feel free to contact us anytime.  We look forward to the opportunity to be of service to you.



Topic number 3 today so far.

I am in the process of designing our proposal template.  Actually templates because we will end up with several different ones for each type of work we do.  I was originally going with only having one but doing so required far too many variables.  Take an audit proposal, as an example, we list out several things that could cause the clients costs to increase beyond what was quoted.  We decided to do that because our goal is to provide a high quality and fairly (i.e. low) priced audit.  But when there is a lack of cooperation our time commitment increases and so does the cost.  We wanted to convey this fact to the reader.

For a review engagement we don’t face those same sorts of hurdles.  So the list is not only smaller but vastly different.  It would take a lot of variable programming to make use of a single template which added and subtracted elements.  I dislike the idea of having multiple templates but we want to provide proposals now and we want them to feel right.  So we did a trade-off and I am learning to be ok with that.

Yes, I strive for excellence.  I strive for things working well and with the least amount of effort.  In my mind excellence is an attitude that says I will always try to improve.  Improve me, my relationships, my work experience.

But I am not a perfectionist.  Not by a long shot.  I believe in the concept of materiality; not only as it applies to auditing and accounting but in life in general.  Some things just are not material – they seem important but in reality have little impact on decisions.

For example – I love giving examples – lets talk accounting adjustments.  In my mind, a client’s accounting records, the trial balance they send me, is the Word.  I treat it as true and correct, to the best of the clients knowledge and ability.  Which means that it holds blemishes and inaccuracies.  It has to as it was crafted by a person.

The perfectionist accountant wants everything to “tick and tie”.  They immediate start making $2.00 adjustments to “tie-out” the depreciation schedule to the trial balance.  They go through each line item in hopes of bringing the trial balance to the “right” numbers.  And in the process cost the client thousands of dollars.

We focus on excellence.  Excellence starts with the end product in mind.  Lets say atax return.  An excellent tax return is one that can be filed and then never recalled.  What keeps it from being recalled?  Certainly not the little differences between supporting schedules and the trial balance.  Material differences cause returns to be recalled.

Sometimes materiality is an amount, sometimes it is a concept.  If the taxpayer is an accrual basis corporation then not having any accounts receivable, no matter the amount, is material.  The accounts receivable being overstated by $50,000 might not be; with a client who makes $200 million in sales annually.

Yes, the perfectionist says adjust the books.  I say only adjust if it is going to make a difference.  Yes, the amount doesn’t agree to something but who says that something is actually correct?

In our opinion, the excellent practitioner of his or her art starts with an entirely different premise.  They start by asking, “What is the purpose of this work?”  They frame the end game.  The perfectionist starts by asking, “What is wrong with what I am looking at?”

Which is why I think many people have difficulties choosing professionals to help them.  Lets face it, we choose a tax practitioner based on the claim of the largest refund, i.e. the perfectionist.  Never mind the fact that in order to gain a large refund you first had to pay it in.  We choose lawyers based on the claim they have never lost a case, because they always settle cases where there is the risk of loss.  Perfection.

Focus on excellent, on improvement.  Think about the bigger picture and then surround yourself with those who can support your vision.  You will be a happier person in the end.

Have an awesome day.


GAAP and Projections

I have a new project which I started at the end of last week and which must be ready for discussion by Friday.  I need to pull together a projection for a start-up company, determine its capital requirements, figure out how it should be structured by debt and equity class and then make sure that, given a certain range of possibilities, what the ROI is going to be.

Did I mention this has to be done by Friday?

It is interesting and I have a great model I have developed over the years (in my humble opinion) that helps me focus on the big picture while also making sure I cover the necessary ingredients.  One area I have spent a lot of time updating is the revenue projection side.  First, I am trying to design a revenue model which takes certain assumptions, like lead generation rates through sales close rates and figure out how many sales will happen.  And then from there how many sales support people are needed.  And then…

Sorry, I was going to slide right in and describe why I like modeling this so much but really, today I am writing to discuss how Generally Accepted Accounting Principles (GAAP) are causing a serious headache for me in this projection.

Naturally, my first irritation is the requirement of recognizing stock awards as compensation expense, although I know intuitively that it is something the employees earn.  It is still a challenge because the only “cash” part of this is the amount paid in taxes to gross up the award.  Why am I worried about it?  Because I am thorough and don’t want anyone to say they were “Unaware” that earnings were going to be lower than projected because GAAP treats stock compensation differently than cash models.

The bigger concern is the new GAAP on revenue recognition.  You remember, the one I have blogged about here recognizing that this particular headache was coming.  Well, this projection is impacted by it because, naturally, it is a software company that licenses its program on an annual subscription and offers free, unlimited tech support.  Love it.  Revenue recognition side?  Not so much.

I spent about 6 hours last night after the game (nice to see the Saint’s work hard to try and lose but they managed to survive until next week – not much hope there) updating my assumptions page and working through the model to address control and amortization of revenue.  No, I am still not done but I am getting closer.  What I can tell you is, I don’t like the results.

On a cash basis, this particular start-up should get to positive operating cash flow in about 14 months; right now it takes about 52 months to get to profitability under GAAP.  I am also seeing about $8,000,000 in deferred revenues.  That is, by the way, cash collected from customers that the company cannot claim as revenue.  Yes, it is software and there is no right to refund but still, under the control principles in new GAAP, the revenue is unearned.

How I get there is to make certain assumptions about purchasing patterns and I am making a rather aggressive assumption that most purchases will happen in the first part of the year.  It is more intuition at this stage but my research indicates that this is the likely time when this sort of software is installed – something about New Year resolutions.  So, this is only a few months of overall deferred revenues but it is enough to throw off accounting ROI.

Don’t get me wrong, I think the most important information comes from cash flow.  How quickly cash is burned through, minimum cash levels, marketing expenditures are absolutely essential to figuring out minimum equity positions, acceptable leverage, target interest rates; all that delightful CFO stuff that can make or break a project.   But still, I think that potential investors have a right to know everything about the project they are taking under consideration and GAAP is one of those things – because at the end of the day, if the goal is to go public, then GAAP is the beast to tame.

Like I said, I try to be thorough.

I will keep you updated, probably at the end of the week when I meet with the ownership to review what I have and start changing assumptions and figure out what to add.  They want to start pitching by the end of the month so I have my work cut out for me – because I am doing this on top of everything else I do!

If you are looking for an accountant who might be able to help you get to that next level, either by acting as your controller or CFO (or combination) feel free to contact me and lets schedule a time to talk.  I enjoy being of service to growing entities and risk-takers.ready for discussion

Have a great day.


Financial Statement Compliance

Doug and I were primarily responsible for audits and reviews and Currie & McLain CPA’s and this has rolled over to our new venture C.O.R.E. Services, LLC .  While we focus our efforts almost exclusively on audits of condo and homeowner associations, we also provide review services for clients of smaller CPA firms in Oregon and Washington who prefer to focus on income taxes. We think it can be a great partnership all the way around.

We conducted many financial statement reviews during 2017.  And, as odd as it sounds, each of them was facing a going concern problem.  While this is not a rehash of the new accounting standards for going concern, we did want to point out what we look for and what management needs to consider.  This can be very important with your year-end possibly approaching and you want the review to be completed early.

For the clients whose financial statements we reviewed this year, the number one driver of the going concern evaluation was non-compliance with bank covenants. For instance, your loan agreement may state that your business must maintain a current ratio of 1.25:1.00.  This means that you must have $1.25 in current assets – cash, a/r, inventory to every dollar of current liabilities – a/p, accrued payroll, current maturities of debt.

Another covenant we typically see is some sort of debt coverage ratio.  This is typically calculated as the current debt obligation divided by earnings before interest, taxes, depreciation and amortization (EBITDA).  if it says you must have a coverage ratio of 1:1, then if you have $1.0 Million of current debt obligations you need to earn $1.0 Million in EBITDA.

The problems arise when one or both of these are missed and missed by a lot or for multiple years.  Most of the financial statements we reviewed reported a second or third year where the current ratio and/or the debt coverage ratio were well below the requirement.  The problem is that, technically, the bank can call the debt, forcing the owners into very painful decisions.

What can management do?  Well, the first step is to admit the problem.  Non-compliance with bank covenants should not be a surprise to management, the owners or the bank.  Typically, the bank will require some sort of plan to address the covenant violation.  This may be as simple as a cash flow projection to a complex plan to sell assets and lease them back to generate cash to pay down a line of credit.  Whatever you do, don’t bury your head in the sand.

The second step is to prepare a disclosure for your financial statement.  Now, I know that typically you expect your accountant to write up the notes but this is one where you may want to be involved.  Your company is on the line and the reader, i.e. the credit officer at the bank, may well decide that your plan can’t deal with the problem and start creating solutions for you.

If you would like some ideas of how to disclose the going concern issue and your plan, let us know  by writing to info@core-acct.com and we will be happy to send you an outline of the disclosure we have clients complete.  The vital thing though is to provide enough detail that the reader can see the issue and understand your plan without investing so many hours that it distracts you from the issue of running the business.

The third step is to get the bank to issue a waiver or forbearance on compliance.  Stay in control here because this can become a circular problem since the bank will want the reviewed financial statement to know where your business is and the accountant will not want to issue the reviewed financial statement without the forbearance.  It requires a good deal of communication to make this work and it is very helpful if you can get them together for a conversation.

A going concern issue is possibly the single biggest financial statement headache you are likely to ever have to address.  Get in front of it early and work closely with your bank on getting approvals in place and with your accountant to draft the plan for inclusion in the notes and it is very likely that you can still meet a respectable turnaround time for producing the financial statements.

Have a great Monday.