Friday, December 21, 2007
Frankly, there are some parts of it I really like, and some parts of it that really annoy me.
The good: The new auditing standards require the auditor to get a much better understanding of the risks faced by the company being audited. I think this is going to help me better work with these companies. The more I understand these companies the better job I can do and the better advisor I can be.
The bad: There doesn't seem to be a lot of wiggle room. The smallest company I audit is a very small franchisor. This company has maybe two deposits a month and writes maybe three checks a month. I can audit close to 100% of the transactions in 30 minutes. The risks are pretty darn clear. But to have to complete page after page of checklists just seems ridiculous.
Calling it the way I see it.
Thursday, December 20, 2007
Friday, November 2, 2007
On October 1, 2007 Governor Jennifer Granholm signed into law Public Act 93 of 2007, extending the Use Tax to include select services in an effort to increase much needed state revenue. The service providers affected will be required to submit the 6% Use Tax similar to the way that Sales Tax is collected.
To clarify and define which service providers will be affected, the Act references codes published by the Federal government. These industry definitions, the North American Industry Classification System (NAICS) of 2002, are to be used by service providers to identify if they are required to submit the tax. It is important to note that a service is subject to the new tax based on the description of that service in the applicable NAICS code, and not on the classification of the establishment providing the service (You can find the complete NAICS classification system here)
In late November, the Michigan Department of Treasury added a section to its web site designed to help businesses determine if they are subject to this tax. The Department says they will be updating it frequently as more information becomes available.
New wrinkle: Oakland County Executive L. Brooks Patterson is leading a massive campaign to overturn this new tax, as are some business coalitions. Certain members of state government are also saying that this is leading to unintended consequences.
Bottom line: There is a lot of uncertainty here, and I will be using this blog to try to keep people up to date on it. For now, this is what I can say:
- This tax may be overturned. But since it isn't a certainty, you need to determine if you will need to collect it.
- The start date of this tax may be delayed until January 1. But since that isn't a certainty, you should be ready for December 1.
- Look at the state web site on the use tax and it will give you an idea if it affects you.
Please contact me if you need more assistance.
the services that your business performs are subject to this new Use Tax, please contact our office at (248) 203-0080.
Very truly yours,
Maddox Ungar Silberstein, PLLC.
Thursday, October 25, 2007
Tuesday: Construction incident about a mile from my office and we lose power for several hours. Interestingly, a building right by the incident only lost power for a minute. We lost it for several hours. So I join one of my partners for a while as he interviews possible interns for tax season. Then I came back and got the network up. Went home because I didn't feel well. No post.
Wendesday: Stayed home sick. Watching TV all day because you don't feel good is really boring. Although I did get to watch Jerry Springer. No post.
Thursday: I'm getting ready to go home and realized uh oh no post.
Wednesday, October 17, 2007
I had the pleasure to meet today with an area company that is currently with another CPA firm. The office manager and I worked together in the past, so it was wonderful to see her after several years.
The State of Michigan needs money, so they are sending out self-audit forms on Use Tax. Use Tax is what you pay on something that you would have paid Sales Tax on. For example, you buy a book from Amazon. If you live in Michigan, Amazon doesn't charge you sales tax because they don't have a physical presence here. But if I bought the same book at Borders or Barnes & Noble, they'd charge me sales tax. So you are supposed to pay use tax. Voluntarily.
Anyway, the office manager asked for help from the current CPA firm. They seem highly uninterested in helping. That alone boils my blood.
So I started looking at what this current firm does for the entity. Among other things, they are issuing a quarterly compiled balance sheet and income statement. Why? Why?? The bank isn't asking for it. The office manager with a small amount of additional training can do this herself using QuickBooks.
I sat with her and the owner and said I see no reason for them to do quarterly statements with a CPA report on them. I recommend they do an annual statement, but the quarterly is a waste of money.
This all reminds me of the famous story of Henry Ford and the Model T - you can get it in any color you want as long as it is black. This CPA firm seems to take all clients and fit them into one standard mold of how things get done.
And that just isn't right. And I try not to do things that way.
Monday, October 15, 2007
There are only two seasons. Hockey season, and the rest of the year.
I'm remembering that because there are, in my life, only two seasons: Tax season, and the rest of the year. Tax season for all intents and purposes really does end on April 15. We then get to breathe pretty easy for the spring and summer.
Once you get past October 15, you start to think in earnest about the next tax season.
So, a new tax season starts tomorrow.
Why don't I remember the rest of the year?
- Separate requirement paragraphs from the application text, so auditors can identify the requirements more easily;
- Include an objective within each standard to help auditors understand what the standard is meant to accomplish; and
- Set the same effective date for all “clarified” standards. The date will be far enough in the future to allow firms sufficient time to update their methodologies and training programs.
Harold Monk, ASB Chair, also indicated that this is part of the project to bring greater harmony between US and International auditing standards. I heard him speak recently at a conference on changes in auditing standards and was very impressed by him.
Sadly, they aren't going to make the standards any easier.
Wednesday, October 10, 2007
We're seeing a lot more of them. Generally we aren't seeing significant, if any, adjustments coming from them. We like to think that is because we are doing our job well.
One thing we are especially noticing is that S Corporations that use an employee leasing company (also known as a Professional Employer Organization) seem to be getting audited at a higher rate (this is an unscientific observation).
If you are using employee leasing, then you technically don't have wages to report on the officer's compensation and wages paid to employees lines. That's because you don't have employees - everyone is the employee of the leasing company. Instead you report that cost on the other deductions line.
Please keep this in mind - there is absolutely nothing wrong with using an employee leasing company. We ourselves use one, as do many of the companies we work with. They make sense in many situations. It just seems that is piquing the interest of the IRS.
The real end is October 15th. That is the final due date for individuals, partnerships and limited liability companies.
What happens is things are nuts until about April 10th. By then you know what will get issued and what will be extended.
And then a lot of them just sit, because six months is a long time. Which goes by real quickly. I've got one left to go out. I already sent a draft out and now I'm just waiting for their ok.
So if one tax season is ending, I guess that means another one isn't far behind.
The NephCure Foundation is the only organization solely committed to seeking a cause and cure for two potentially devastating kidney conditions, Nephrotic Syndrome and Focal Segmental Glomerulosclerosis (FSGS). NephCure is made up of patients, their families and friends, researchers, physicians and other healthcare professionals joining forces to create awareness and generate funding for research.
The disease generally strikes young children. Not all children respond to existing treatment, and those that do respond often have sever side effects. NephCure is seeking to discover the cause to these horrible diseases, and then find a cure.
I have had the privilege of being associated on a professional basis with NephCure over the last few years.
Monday, October 8, 2007
Friday, October 5, 2007
A big issue that came out of SAS No. 112 related to preparation of an entity's financial statements. Historically, an entity's CPA firm would assist in drafting the financial statements, including the notes to the financial statements. Let's be realistic - most small businesses do not have the in house capability to do this themselves, or even if they do would prefer that the auditor, who has a lot of experience in this area, do it.
SAS No. 112 though makes it clear that an entity has the responsibility to do draft its financial statements, including the notes. If the auditor does it, then the entity has essentially included the auditor in its internal control structure. And SAS No. 112 says you can't include the auditor in your internal control structure.
This is a problem for many companies. If they keep the status quo, then the auditor has to issue a letter stating that the entity has a significant deficiency in internal control in this area. This can lead to problems in some instances.
- Demonstrate the capability to supervise the work done by the auditor. If possible, then there should be no significant weakness.
- Don't make a change. Many entities are fine with getting this as a significant weakness.
- Bring in a second accounting firm to specifically prepare the financial statements and notes prior to the auditors coming in.
The auditing theorists really like that 3rd idea, and think it will happen a lot as time goes forward. In theory it makes sense, but I'm sure there are CPAs out there who are afraid the second accounting firm will try to take over the entire account.
For my part, I'm doing audits where a second firm is involved. In both cases, I got brought in by the second firm. We've arrived at a situation where we respect what the other is doing and work well with each other to service the client. Which is what it is all about anyway.
Wednesday, October 3, 2007
It reminded me of when my friend Bill and I went to Europe for six weeks after we graduated from Michigan - we did the whole tour Europe deal and it was hard work. One mistake we made was we went to Venice. Ok, Venice was interesting to see, but it is a city made for lovers. What, were Bill and I going to go on a gondola ride together?
So there I was in Las Vegas by myself. I wound up getting a piece of pizza for dinner on Monday at a place at New York New York. What was I going to do - sit in the ESPN Zone by myself?
The water show in front of Bellagio was cool though.
The vast majority of audits I have performed over the last 12 years or so have been primarily substantive in nature. That means you do a tremendous amount of testing of details - agree account balances to vendor invoices, confirm accounts receivable, etc. And it has meant placing little or no reliance on the entity's internal control structure. Frankly, this was usually the most efficient approach. Why would I want to spend say 8 hours testing controls if it would only save me 2 hours of audit testing time.
This primarily substantive approach is still possible under the risk assessment standards, but now instead of just saying "control risk at maximum" you have to document how you came to that conclusion.
Instead, we will be working on getting an even better understanding of the business, and then ask "what could go wrong?" Perhaps the business is a construction contractor that uses the percentage of completion method - that is a complicated calculation and it "could go wrong." Once you have identified these risks, you determine how you are going to respond.
Result: auditors should be more focused on the risk areas and should do a better audit.
Tuesday, September 25, 2007
The IRS has a 20 question test they will use to determine if an individual is an independent contractor or an employee. Key questions include:
- Does the individual set their own hours?
- Does the individual provide their own equipment or is it provided by the business?
- Does the individual supervise themselves or are they supervised by the business?
- Does the individual perform these services for other entities?
Generally speaking, the IRS will decide someone is an employee.
I've dealt with this issue several times over the years, and it just came up again this morning. We have a client that is going to get a large capital investment from an investment fund. The investment fund's attorneys asked this morning if the people performing service for the company are really independent contractors or employees. The issue here was the investment fund wants to make sure they are aware of all liabilities as of the date of investment. If the IRS was to come in and retroactively decide the independent contractors were actually employees, there would be back payroll taxes, workers compensation and sundry other liabilities. Fortunately, our client was in the clear on this.
Post investment, we expect this client to really ramp up operations and hire full time employees. And put them on payroll.
Monday, September 24, 2007
The IRS unveiled a special new section on IRS.gov for people who have lost their homes due to foreclosure. The IRS also reassured homeowners that, although mortgage workouts and foreclosures can have tax consequences, special relief provisions can often reduce or eliminate the tax bite for financially strapped borrowers who lose their homes. The question and answer page on IRS.gov has a variety of information, including a worksheet designed to help borrowers determine whether any of the foreclosure-related relief provisions apply to them.
This is a very interesting notion, and one that I haven't encountered, or, for that matter, ever even thought of.
An entity's financial statements are supposed to disclose various contingencies, as required by Statement of Financial Accounting Standards, No. 5, Accounting for Contingencies. Other accounting standards require disclosing various risks faced by the entity. For example, an entity should disclose the existence of customer's that comprise more than 10% of revenue. The thinking - the reader of the financial statement should be aware of that and the risks associated with it. Say a business has one customer that comprises 69% of revenues. The entity would likely be in trouble if it lost that customer.
Same thing goes for economic risks. Assume the entity is a bar that is located right across the street from a factory. If the factory goes, the bar probably does too. The reader of the financial statements would want to know that.
Which is why I am intrigued by this petition. Assume you are reading the financial statements of an entity that is located right on the water. Because of global warming, the entity might literally be under water in 10 years. I think that is something that the reader of the financial statements would want to know.
This is an interesting topic and one I am going to try to continue to follow.
Thursday, September 20, 2007
- Understand an entity’s present and past financial position
- Understand the past operating, financing, and other activities that caused an entity’s financial position to change and the components of those changes
- Use that financial statement information (along with information from other sources) to assess the amounts, timing, and uncertainty of an entity’s future cash flows.
What does this mean? Essentially, this is a part of the project to bring US accounting standards and international accounting standards together. This really is an important project, as in theory it make it easier for investors to understand financial information.
But what caught my eye was an announcement that the IASB revised their standards on financial statement presentation to be in conformity with FASB Statement 130, Reporting Comprehensive Income. Statement 130 introduced the concept of other comprehensive income. Items reported as comprehensive income under 130 includes changes in fair value of certain investments, changes in value in certain derivatives such as interest rate swaps, and other specific items. The standard writers didn't think these items should be reported as part of net income, but thought there should be a way to report this.
So they came up with other comprehensive income. I was hoping that concept would go away, not spread internationally.
The concept behind it all makes sense. But I had a client do an interest rate swap last year which resulted in having to make all sorts of changes to the statements and I had to explain to them why we needed to have a new financial statement reporting other comprehensive income.
Here is to hoping the next aspect of this project makes things easier for people to understand.
Tuesday, September 18, 2007
The guidance applies to the internal control objectives over financial reporting, as well as the objectives related to effective operations and compliance. In addition, it includes the principles of effective internal control over financial reporting developed by COSO in 2006, and reiterates the importance of those principles to all organizations, regardless of size.
Topics covered by the guidance include:
- monitoring as a component of internal control systems;
- the fundamentals of monitoring;
- the nature of information used in monitoring;
- designing effective monitoring;
- communicating and addressing the results of monitoring;
- the scalability of monitoring; and
- the principles of effective internal control over financial reporting.
Through an online feedback portal, COSO is asking specific questions about the clarity and applicability of the guidance. The comment period will end on October 31, 2007. Input from respondents will be used in developing an exposure draft, to be released later this year, including tools, case studies, and implementation guidance. The final full publication is scheduled for release during the first quarter of 2008.
In case you don't know, the COSO principles are kind of best of breed when it comes to considering internal control systems, and the Public Company Accounting Oversight Board especially likes it.
Tuesday, September 11, 2007
From my casual following of the case, the verdict is the correct one.
But the city, not Kilpatrick, is on the hook for $6.5 million. That doesn't seem quite right.
Senate Bill 687, introduced in late August, proposes a technical fix to the new Michigan Business Tax as it relates to FAS 109. Due to the mechanics of the accounting rules under GAAP, many companies in Michigan are facing an adverse earnings impact in the current calendar quarter from the implementation of the MBT. GAAP requires that a tax expense be recognized for book purposes when book income exceeds income reports on a tax return. Many people doing business in Michigan that have recorded such “deferred tax” liability in prior years are now facing the requirement of adjusting their liability for the MBT by recording a one-time increase in their tax expense that will have the effect of lowering their earnings in 2007. Senate Bill 687, which met successful passage in the State Senate on August 30, would prevent calendar-year companies from recording a charge to earnings in their current calendar quarter. As long as this proposal is enacted by the end of September, companies will not be forced to adjust their liability.
So what does this mean? The current Michigan Single Business Tax (SBT) is not an income tax. Therefore, the expense from it does not get reported in the line item "Provision for income taxes" that would show up just before "Net Income." Instead, it is reported as a component of selling, general and administrative expenses.
However, the new MBT, unlike SBT, is partially based on income. When you have taxes based on income, you become subject to FAS 109, Accounting for Income Taxes. FAS 109 is what explains how to calculate deferred tax assets and liabilities for temporary differences between financial and tax income. The common deferred tax item is accelerated depreciation for tax purposes.
Here is the big problem as I see it: Assuming that S Corporation and LLCs are going to have to pay this tax, they will, if material, have to start reporting deferred tax assets and liabilities for the income tax portion of the MBT, and the income tax portion of the MBT will be reported in the provision line in the income statement.
I'm not excited about this.
Thursday, September 6, 2007
Tuesday, September 4, 2007
“When was the last time you asked your client what they need instead of telling them what services you can offer them?”
The question was asked by Allan Boress, a fellow CPA and CFE who helps professionals grow their practices.
What a simple question. I wish I had thought of it myself. I'm going to start asking it.
Friday, August 31, 2007
I've been a licensed CPA in the state of Michigan for almost 21 years now. I had to read this three times to even get an understanding.
So here goes: The FASB is best known for issuing difficult to understand and difficult to implement accounting standards. But it also does research, which in theory at least is a good thing. One long standing project has been to get a better understanding of what are the objectives of financial reporting.
Let's hope that when they figure that out they can communicate it in a way that is not difficult to understand or difficult to implement.
Thursday, August 30, 2007
WASHINGTON — The Army will examine as many as 18,000 contracts awarded over the past four years to support U.S. forces in Iraq to determine how many are tainted by waste, fraud and abuse, service officials said Wednesday.
Overall, the contracts are worth close to $3 billion and represent every transaction made between 2003 and 2007 by a contracting office in Kuwait, which the Army has identified as a significant trouble spot.
In a separate probe, a high-level team led by Pentagon Inspector General Claude Kicklighter will travel to Iraq next week to investigate how U.S. weapons intended for Iraqi security forces ended up being used for murders and other violent crimes in Turkey.
Among the contracts to be reviewed by the Army are awards to former Halliburton subsidiary KBR, which has received billions of dollars since 2001 to be a major provider of food and shelter services to U.S. forces in Iraq and Afghanistan.Democrats in Congress have claimed that KBR, formerly known as Kellogg, Brown and Root, benefited from ties to Vice President Dick Cheney, who once led Halliburton Co., the Houston-based oil services conglomerate, and congressional Republicans.
The officials did not specify which KBR contracts would be examined or their value.
The announcement, made by Army Secretary Pete Geren, comes as the number of criminal cases related to the acquisition of weapons and other supplies for forces in Iraq and Afghanistan has grown to 76. So far, 20 military and civilian Army employees have been indicted on charges of contract fraud.
"There have been reported cases of fraud, waste and abuse of contracting operations, with many of the worst cases originating out of Kuwait," Geren said.
Geren said the Army has been auditing the contracting operation in Kuwait for more than a year. He acknowledged the expanding list of criminal investigations was a factor in appointing a special task force headed by a three-star Army general.
"There is fraud," Geren said. "We have seen more cases lately and that's cause for concern."
Lt. Gen. N. Ross Thompson has been empowered to take whatever corrective actions he determines are necessary "to prevent any further abuse, fraud or waste," Geren said.
Thompson, the military deputy to the Army's top civilian acquisition official, said his task force will "make sure that we've identified anything that needs to be looked at that hasn't been already been picked up by an ongoing investigation."
By Sept. 30, Thompson plans to boost the number of personnel in the Kuwait office by 35, giving it a staff of 90.
"We already know from our internal looks over the last few months in Kuwait that the experience level of some of the people - not all of the people that we had in Kuwait - wasn't up to the challenge or the complexity of the contracts," Thompson said.
By Jan. 1, contracts worth more than $1 million will be handled by the Army Materiel Command at Fort Belvoir, Va., which has more staff able to deal with larger, more complex procurements, Thompson said.
In late 2005, the Army began audits and its Criminal Investigation Command accelerated its inquiries into contract fraud in Kuwait, according to an Army news release. The command first established an Iraq Fraud Detachment and then a Kuwait Fraud Office, both staffed with specially trained agents.
By early 2007, the Army had reorganized the Kuwait office, provided ethics training for employees and added a legal team.
Geren has also formed a special commission to examine long-term solutions to improve the Army's weapons and supply contracting process. That team will be headed by Jacques Gansler, a former under secretary of defense for acquisition, and its report is due in 45 days.
The investigation into U.S. weapons in Turkey was sparked in May when Pentagon officials learned that the Turks were concerned about American-issued weapons being involved in crimes in their country, Pentagon spokesman Geoff Morrell said.
Last month, Defense Secretary Robert Gates sent the Pentagon's top lawyer, William Haynes, to Turkey to meet with Turkish officials, Morrell said. The officials told Haynes that American-supplied weapons were ending up in the wrong hands, possibly including Kurdish militants, a group known as the PKK that the Turkish military has been fighting on the Iraq border.
The situation has raised tensions between Ankara and Washington, and left open the possibility Turkey may conduct military operations in northern Iraq if the situation continue.
"We don't deal with terrorists, Morrell said. "We don't deal with the PKK. And we certainly don't arm the PKK. So if American-issued weapons have ended up in the hands of criminals in Turkey or terrorists in Turkey, that is not based upon the policy of this department or this government."
Tuesday, August 28, 2007
As a dues paying member of the AICPA, the New York State and Louisiana societies of CPAs, I am writing to express my total disgust with the “Feed the Pig” program for retirement planning (“Inside AICPA,” May 07, page 102). I have never found it to be appropriate, and after yesterday that has become completely clear.
Imagine my horror while watching TV with my wife and the following commercial came on. It showed a man in a suit with a pig head, seeming to shake down small businesses and individuals for money.
How in anyone’s imagination could an ad such as this ever have been approved by the Board of Trustees of the AICPA. The last time I saw a character with a pig head was on a recent “Dr. Who” episode. What does this ad do for the image of the AICPA?
The ad, along with the program, should be immediately withdrawn from promotion by the AICPA. It would seem that an organization such as ours could find a more appropriate mascot for the program.
In considering a replacement for “Feed the Pig,” perhaps a frog turning into a prince with a tag line: “You can create a princely sum by saving toward your retirement on a monthly basis.” It might become as popular as the GEICO ads and be a whole lot more appropriate for our organization.
I believe it is time for the AICPA to consider its true purpose.
What was more incredible was the AICPA's defense. It was about 4 times as long as the above letter. You can see it here.
I'm with the writer of this letter. What a horrible name for a campaign.
Thursday, August 23, 2007
I recently saw a column that said GAAP - Generally Accepted Accounting Principles - should really be thought of as POOP - Pitifully Old and Obsolete Principles. The column makes a good point.
Consider the age of the following standards:
- Long-term contracts - ARB 45 - 1955
- Inventory and cost of goods sold - ARB 29 - 1947
- Treasury stock - ARB 1 - 1939
- Research and development - SFAS 2 - 1974
Think about the changes in the business world since just 1974. The PC revolution and the Internet have dramatically changed business processes. All sorts of technologies have emerged and changed the ways of business.
But many accounting principles are stuck in another age.
The Financial Accounting Standards Board is aware of this. Whether or not movement in improving financial reporting actually occurs is another story.
Wednesday, August 22, 2007
Issued on the heels of the Enron, Worldcom and other frauds, Sarbanes-Oxley was intended to restore investor confidence in the financial reporting. Many believe it has done that, and it has done a lot more.
For one thing, the largest accounting firms are busier and bigger than ever. When I started at the Detroit office of what was then Deloitte Haskins + Sells in September 1984, there were of course large multinationals like General Motors. But there also was an entire department focused on serving "small" businesses - $5 million to $100 million. I was the senior on the audit of a publicly held company that did about $100 million in revenue.
Now, businesses like that are too small for the "Final 4" accounting firms. Those businesses have been snapped up by the second tier of firms - Grant Thornton, BDO Seidman and others. The second tier have moved up the chain, and what used to be their bread and butter, the "small" business has been left behind.
That has been good for our firm, of course.
Back in my Deloitte days, we used to joke that the 1986 Tax Reform Act was an "Accountants Full Employment Act." It may or may not have been, but Sarbanes-Oxley is definitely The Accountants Full Employment Act. There is greater demand for accountants and, especially, auditors, than ever before.
I go back and forth on this. As someone who has done and still does a lot of financial statement auditing, it is nice to have what I do be in demand. But it bothers me that it took catastrophic audit failures and the collapse of Arthur Andersen to make this happen.
Like I said in the title, I think this is an unintended consequence of SOX.
Tuesday, August 21, 2007
Anyway, I was reading the comics with breakfast this morning, and saw today's Pearls Before Swine. The background is that the crocodile is suing his neighbors the zebras because the zebras won't allow the crocodile to make a meal out of them. Crocodile is represented by the rat, and crocodile doesn't like the fee.
Makes a pretty good argument.
Monday, August 20, 2007
Why is this an issue? These networks are growing and having a bigger impact on the marketplace. We at Maddox Ungar Silberstein, PLLC have taken note of that and are proud members of msi, a London based network of legal and accounting firms.
On the surface, this ethics guidance sounds like a good idea. I reserve the right to study this one further.
Sunday, August 19, 2007
Thursday, August 16, 2007
I am the lucky beneficiary of some friends of are partners in another Detroit area firm. They found themselves "not independent" on one of their audit clients and asked me to do the audit. The audit right now is in process and the people are nice.
A bonus of this situation is that the staff person from my friend's firm is someone I worked with at a previous firm. We were comparing notes about how much audits have changed.
I remember the first time I wrote an audit planning memo - it was 1 1/2 pages long. The next year it was 4 pages. And this was on a $100 million revenue publicly traded company. I bet that when I count the pages related to planning this new audit, which is a considerably smaller company, that it is in excess of 50 - checklists, forms, processing descriptions.
In early October, I will be going to a two-day conference in Las Vegas for training on the a series of new auditing standards that dramatically changes the planning and performance of an audit. I'm betting that if I do this same audit again next year, that the planning section will be even longer.
Wednesday, August 15, 2007
Accounting can also be summarized while standing on one foot:
"The left side of the balance sheet shows what the company owns, and the right hand side shows who has a claim on it. All the rest is commentary."
Sunday, August 12, 2007
I recently developed a new found respect for the statement of cash flows. Perhaps it was a client telling me it was a meaningless statement that didn't accurately portray their cash flows. But it did, and I learned a thing or two in the process.
First, some background. Cash flow statements are pretty easy to do (despite what young staff accountants think). Say cash was $250,000 last year, and this year it is $150,000. Cash decreased $100,000. Since this statement is driven by the balance sheet, if cash decreased $100,000, all other accounts have increased by $100,000. That is what keeps everything in balance. Figure out the change in each other line item in the balance sheet, and you can explain how your cash decreased by $100,000.
Cash flow statements are divided into three sections:
- Cash flows from operating activities
- Cash flows from investing activities
- Cash flows from financing activities
SFAS No. 95 specifically defines what items go into investing and financing activities. Investing activities are from the asset side of the balance sheet, and generally involve cash flows from property and equipment, investments, and loans. Cash flows from financing activities involve liabilities and equity, and generally involve cash flows from debt borrowings and repayments, equity investment by owners and distributions to owners. That's it. Everything else goes in operating activities.
Practically speaking, cash flows from investing and financing activities are very quickly determined - there are only a few things that get reported there.
So, let's return to our earlier example where cash decreased $100,000. We have further determined that cash flows from investing activities was a negative $30,000 - as in the Company spent $30,000 to buy more property and equipment. Cash flows from financing activities are a positive $50,000 - the Company borrowed $90,000 on a bank note and repaid $40,000.
We now know what cash flows from operating activities must be: -$100,000 (our total negative cash flow) = x (operating cash flow) - $30,000 (investing) + $50,000 (financing). Solve for x and you see that cash flow from operating activities was a negative $20,000. A whole bunch of items make up cash flow from operating activities, but they add to a negative $20,000.
I started by saying that I have a new found respect for the statement of cash flows. In this situation, the reporting company felt there were expense items that belong in a prior year, and as a result their current year would look better. I disagreed. I also realized that even if a prior year adjustment was right, the subtotals would still be the same - cash flows from financing activities wouldn't change, cash flows from investing activities wouldn't change, and for that matter neither would beginning or ending cash. All the adjustment would do was change the makeup of the items that you added together to get operating cash.
In this case, the cash flows statement showed a true story - the company was not generating cash from operations. This was not something that could be fixed by pushing what I believed where current year expenses into a prior year.
Moral of the story: Cash is king, and the statement of cash flows can actually tell you a story about the king.