Wednesday, August 20, 2008
A key part of the program is the quarterly all day sessions. Yesterday was my second session since joining. Both have been moderated by Jim Ryerson of Sales Octane, and he is outstanding. Yesterday's session was "Money Day" and focused on helping entrepreneurs better understand their financial statements, what to look at, what to track, etc. Being a CPA I was kind of familiar with the material, but I did get to share my expertise with the group.
Anyway, time was spent on the importance of the current ratio. It was also suggested that you track it over time.
Readers of this blog know my feelings on the current ratio. And then my additional feelings on it. I was biting my tongue the whole time, as I didn't want to mess with the curriculum.
So I will say this: The current ratio is easily manipulated. If you aren't going to manipulate it, and you do things on a consistent basis from month to month, it can be a good yardstick to measure how you are doing.
But I still don't like the current ratio.
Tuesday, August 12, 2008
Converging is defined by them as to tend to meet in a point or line; incline toward each other, as lines that are not parallel.
And that is what is going on with accounting standards.
The world keeps getting smaller and that is making it more difficult for investors to compare financial results from companies in different countries. As a result, their is a major push towards converging US accounting standards with international accounting standards. Adopting International Financial Reporting Standards ("IFRS") will represent a significant change for not just accountants like me, but the entire US economy. Nearly 100 countries currently require or allow the use of IFRS for financial reporting by publicly held companies. Canada will require IFRS by 2011, as will Japan. The US probably won't be far behind.
I'll try and write about this more in the coming months. In the meantime, there is plenty of information on a new AICPA sponsored website: http://www.ifrs.com/index.html
Friday, August 8, 2008
I enjoy reading case studies on fraud - what methods were used, how long it lasted, and how the fraud was detected. You often will see a quote in the case studies that goes something like this "Suzanne was the last person we expected to commit a fraud. She was so loyal - she worked here for seven years and never took a day off." Sadly, the entity by then has learned why Suzanne never took any time off.
I'm continuing to read the ACFE's 2008 Report To The Nation on Occupational Fraud & Abuse and was reminded of this while reading Chapter 4 on Victim Organizations. Mandatory vacation policies (and job rotation) were in place in 12.3% of the fraud cases covered by the report. The median loss when this policy was in place was $64,000. The median loss when this policy was not in place was $164,000.
If you do not have mandatory vacation policies, you should strongly consider implementing this policy.
Friday, August 1, 2008
If they had reviewed the bank statement they wouldn't have lost $125,000 to her over 5 years. And it isn't like it happened evenly over the 5 years. Like many frauds, she started small, and built up as she knew she could get away with it.
The naysayer in the crowd will point out how many banks won't send cancelled checks back. That's true. But copies are still available, often online, which will serve the same purpose.
And if you want to take things one level further - have the bank statements sent to the owner's house. That way they can't be altered by the fraudster.
The simple things can make all the difference.
Wednesday, July 30, 2008
Pretend you are a company that has a current ratio covenant and you expect to be out of compliance. You are going to try and bring yourself into compliance by using some of the cash you have on hand to pay off current debt.
Result: You bring yourself into compliance with your current ratio covenant. And you've decreased your cash at the same time. That doesn't make me feel better.
On the other hand, say you attack this by trying to accelerate collections on outstanding receivables. Done right, that can be a good thing. Done wrong, and it can be a nightmare. If you attack it by reducing inventories, that means (hopefully) that you are going to sell it. Which means more receivables.
Really, the only quick way to attack it is to use up cash. And your working capital is unchanged. Why is this better??
Friday, July 25, 2008
In fact, 2:1 is generally considered a good sign; that's what they teach you in the textbooks as well.
The writers of many bank loan agreements have also drunk the current ratio Kool-Aid. Not all loan agreements have financial covenants in them, but we do see them quite often. Quite often you will see one requiring the borrower to maintain a current ratio of at least 2:1.
The problem is that this ratio is easily manipulated.
Say it is December 15, and Acme Company is approaching its December 31 year-end. It has a loan agreement that requires it to maintain a current ratio of 2:1. Uh oh - Acme has current assets of $250,000 and current liabilities of $150,000. Its current ratio is currently (pun kind of intended) 1.67:1. If it maintains that ratio through the end of the year, it will violate its covenant with the bank, which at its worst could result in a default on the loan, and the bank wants to repaid right away.
So what can Acme do about this? Pay off $50,000 of current liabilities. It now has $200,000 of current assets (they used cash after all) and $100,000 of current liabilities. Its current ratio becomes 2:1.
Even better - pay off $75,000 of current liabilities. Now the current ratio becomes 2.33:1. Or pay off $100,000 of current liabilities to get a current ratio of 3:1.
This is just nonsense. Working capital (current assets less current liabilities) in all cases is $100,000. All Acme has done is game the system a little (presuming of course it has sufficient cash) to be in compliance.
Wouldn't just focusing on working capital make more sense? That requires the company to focus in improving its revenues and reduce its costs. And wouldn't that make the bank feel more secure?
Issue Alert - Sarabnes-Oxley Act (SOX) Will Fall - Federal Appellate Court Action Expected Soon.
There is litigation in the US Court of Appeals for the District of Columbia Circuit styled Free Enterprise Fund, et al. v. PCAOB. SOX states that the Public Company Accounting Board (PCAOB) is a private-sector entity, not a governmental body. The litigation challenges the constitutionality itself of the PCAOB. If the Appeals Court finds for the plaintiff, the PCAOB will be put out of business. Even more importantly, SOX in its entirety will fall because there is no severability clause preserving portion of the Act that are not deemed unconstitutional.
The writer of the UBS alert expects the Appeals Court to find for the plaintiff. That would undoubtedly result in an appeal to the US Supreme Court. The writer expects the Supreme Court would hear the case and rule by June 2009.
Let's say the UBS alert writer is correct - the PCAOB is found unconstitutional, and then with it goes all of SOX. What would happen next? In all likelihood, Congress would come up with some kind of a replacement, and quickly. Congress is expected to stay in Democratic hands, and it is unlikely in the current economic condition that would come up with something even more difficult to deal with than what we have. More likely - they would likely ease up on some of the more onerous parts of SOX as it is today.
Let's remember that SOX was a reaction to the spectacular frauds of the first part of this decade (if anyone knows what this decade is called please let me know) - Enron and Worldcom especially. And Congress was in Republican control at the time; there is an irony to all that. Many years later, we are not going to see all of this go away, but we might find ourselves with something that is easier to live with.
Thursday, July 24, 2008
It's been almost a year now since I went for training on these standards, and I've done many audits under the new standards. I also discuss them with colleagues at other firms from time to time. This is what I think about them:
- Overall, the intention behind them is good.
- Practically speaking, it can be overkill on very small companies. I have a franchisor client who as of the most recent financial statement had sold 2 franchises. She issues maybe 5 checks a month, and makes maybe 3, at the most, deposits a month. I can examine/audit every transaction in less than an hour. Yet I am supposed to, amongst other things, have a detailed discussion on fraud risks with her (ok that was SAS 99 which is more than 2 years old), examine all of her systems and controls (it's just her - she doesn't have or need any), link financial statement assertions to various risks and more. It is just overkill.
- It can be very confusing.
At the end of the day, my concern is whether the financial statements are fairly presented in accordance with generally accepted accounting principles. I, as an auditor, need some leeway in determining how I get to that opinion. I'm hoping the Auditing Standards Board realizes this sometime soon.
Thursday, July 17, 2008
I don't know the reception yet on the draft I will submit after lunch, but it is bound to be interesting.
Thursday, July 10, 2008
- Appendix C: Sample Fraud Policy - This appendix is about 4 pages long and can be used as the starting point for a business fraud policy.
- Appendix D: Fraud Risk Assessment Framework Example - the example focuses on potential revenue recognition risks for a business. What I like about it is you often read that you should do something like this, but finding a good example of one is hard to find.
- Appendix E: Fraud Risk Exposures - the material notes it is a sample from an anonymous entity and isn't necessarily complete. It is though a solid listing of potential fraud risks.
- Appendix F: Fraud Prevention Scorecard and Appendix G: Fraud Detection Scorecard - concise tests a business can take to see how they are doing on prevention and detection.
80 pages is a lot of material. If you are serious about reducing your fraud risks, this is a good place to start.
Thursday, July 3, 2008
- Pressure - the fraudster has a financial need or pressure, generally in the form of a perceived nonsharable financial need;
- Opportunity - there is a perceived opportunity in the organization to commit the fraud; and
- Rationalization - the fraudster is able to rationalize their actions.
Generally speaking, most employees are honest. But the new ACFE Report to the Nation reveals that nearly 88 percent of employee fraudster who get caught have no criminal record.
Goldmann makes the case that the triangle of causes may become a diamond - the fourth corner being the "widespread sense of alienation and disenfranchisement, driven largely by the 'layoff culture'...and further fueled by the accelerated disappearance of health care, pension and other benefits...foreign outsourcing of both hourly and salaried jobs...and increasing stressful workloads."
That is frightening.
Goldmann states that historically, employees who survive a mass layoff (defined as more than 50 employees in an individual private-sector employer) generally took it well. They felt bad for their former coworkers, but felt that management was doing what it needed to do to protect the business. However, in the last 10 years or so, researchers are now seeing a change of heart in the surviving employees. There is now a heightened fear that themselves are disposable. When that happens, they lose "all sense of camaraderie and 'belonging' to the community and instead start to focus on 'looking out for number one.' "
Fortunately, not all employees are going to have this reaction to the effects of a culture of layoffs. But to again quote Goldmann, "why risk alienating workers and encouraging them to steal from us if we don't have to?"
One possible solution is tone at the top. Tone at the top is a key context especially in Sarbanes-Oxley compliance, and setting a positive one, one that shares information clearly and consistently, can help combat this.
Wednesday, July 2, 2008
Every other year, Certified Fraud Examiners submit to the ACFE information on frauds they have investigated. The new report is based on 959 cases that were investigated between January 2006 - February 2008.
- Survey participants estimate that U.S. organizations lose 7% of their annual revenues to fraud.
- The median loss caused by the frauds in the study was $175,000. More than one quarter of the frauds involved losses of at least $1 million.
- The typical fraud in the study lasted two years from the time it began until the time it was discovered. (I think it was 18 months in the 2006 Report).
- 27% of cases involved corruptions, and 24% involved fraudulent billing.
- Financial statement fraud was the most costly category with a median loss of $2 million.
- Despite increased focus on anti-fraud controls, occupational frauds are much more likely to be detected by a tip than by audits, controls or other means. 46% of the cases were detected by tips from employees, customers, vendors, and other sources.
- The implementation of anti-fraud controls appears to have a measurable impact on an organization's exposure to fraud. Organizations that conduct surprise audits had a median loss of $70,000, while those that did not had a median loss of $207,000.
- Small businesses are especially vulnerable to occupational fraud. The median loss suffered by organizations with fewer than 100 employees was $200,000. This was higher than the median loss in any other category, including the largest organizations.
- Lack of adequate internal controls was most commonly cited as the factor that allowed fraud to occur.
- Occupational frauds were most often committed by the accounting department or upper management.
- Occupational fraudsters are generally first-time offenders. Only 7% had prior convictions and only 12% had been previously terminated by an employer for fraud-related conduct.
- Fraud perpetrators often display behavioral traits that serve as indicators of possible illegal behavior. The most commonly cited behavioral red flags were perpetrators living beyond their apparent means (39% of cases) or experiencing financial difficulties at the time of the frauds (34%).
Bottom line: Fraud continues to be a major drag on the economy (if 7% of revenues are lost to fraud, that is nearly $1 trillion dollars of the United States Gross Domestic Product). Worse yet, many organizations still do not have appropriate fraud defenses in place.
More from the Report in the future.
Monday, April 28, 2008
Depreciation calculations and recordkeeping used to be tedious and difficult. That was before software. Once you know how to properly use the software, it isn’t that bad anymore.
Why I bring this up is that too often I’m seeing companies having no differences between their book (GAAP) depreciation and their tax depreciation. This gets to be a big problem when there have been substantial Section 179 deductions take in recent years.
Section 179 is a part of the Internal Revenue Code that allows a business to immediately expense, subject to limitations, certain property and equipment purchases. The alternative would be to depreciate these items over time. For 2007, the maximum deduction was $125,000.
The problem is that you can’t take a Section 179 deduction in a GAAP basis financial statement. GAAP requires you to expense long-lived assets over their estimated useful life and using an acceptable depreciation method (such as straight-line or double declining balance). Immediately expensing property and equipment purchases means you are overstating expenses and understating assets.
The tendency to assign the same depreciation method and useful life for tax and GAAP has greatly contributed to this problem. Tax depreciation methods, commonly referred to as MACRS depreciation, are often reasonable for GAAP. For example, MACRS depreciates equipment usually over a 7 year life on a 200% double declining balance method. This is generally a reasonable estimate for GAAP too.
What happens is people just automatically copy over the tax depreciation treatment for the GAAP treatment. And they start taking Section 179 for book and tax.
This becomes a problem when the business wants a CPA to issue an audit, review or compilation report on its financial statements. This often occurs when a company wants to borrow money from a bank and for many other reasons. If the financial statements are to be on a GAAP basis, the CPA will have to disclose the departure from GAAP, or fix it. Fixing it costs money. The alternative is issuing what we call an OCBOA (Other Comprehensive Basis of Accounting) statement – this means you are producing financial statements but they aren’t GAAP. Many companies do this, but I advise against it if possible.
Frankly, the technology is there. Take the 10 extra seconds when you enter an asset into the fixed asset software and give it an intelligent depreciation method that reflects what you expect to occur in your business. And don’t take a Section 179 deduction for book.
Like I said at the beginning, there are 2 ways to do things. The hard way here is to take shortcuts. It will cause you problems in the end. Invest 10 more seconds (or whatever it takes) and do it right up front.
Friday, April 25, 2008
Earlier this month the State of Michigan passed a new law permitting an additional exemption, under certain circumstances. If you bought a new home and are having trouble selling the old one, then you might be able to claim a homestead exemption for both houses. You can claim the second homestead on the old house if that property is not occupied, is for sale, is not leased or available for lease, and is not used for any business or commercial purposes. To claim this second exemption, you have to file a conditional rescission form with the local assessor, and verify annually, on or before December 31, that the property is still eligible for the special exemption. The form, Treasury Form 4640, Conditional Rescission of Principal Residence Exemption, is available at the Michigan Department of Treasury website. To qualify for 2008 tax relief, you must file this new form before May 1, 2008.
Gregg notes that "this letter is intended to be a summary of new law, and not legal advice." He's right. I'm not an attorney either, so ditto from me.
Thursday, April 24, 2008
And just told me that they don't like auditing. Sadness for me.
But I'm going to look at this as an opportunity. I think most firms would say tough this is what you have to do. That's not me. And it doesn't help out this team member. Because if this team member is miserable, then they will look for a firm elsewhere that will meet this person's needs.
Now I have to see if I can rise to the occassion.
Wednesday, April 23, 2008
I'm almost through Chapter 3, and overall am very impressed with the book. Rabbi Lapin is an Orthodox Rabbi (I'm more of an observant Conservative Jew which is a bit more to the center) and his politics are definitely to the right of mine, but he makes some very good points.
Chapter 1 is called The Dignity and Morality of Business. At the end of the chapter, he suggests writing an article on the subject for the local newspaper. I'm going to do it as a blog entry instead.
We constantly see business portrayed as evil. Think of the 1987 movie Wall Street and Michael Douglas' character saying "Greed is good." Think of all of the different TV shows where the business owner is portrayed as being evil. I still remember an episode of The Six Million Dollar Man where a defense contractor made a product at the exact bottom end of the specifications, so as to maximize profit, and of course the product didn't work and Steve Austin had to save the world. There are countless examples of this.
Then there are the headlines: GM lays off 10,000, Delta lays off 8,000 (I made those up). The TV news show all of the employees on TV and they don't know what they are going to do and so on.
But what isn't always reported is while GM may be laying off 10,000 there might have been a greater number of new jobs created elsewhere. Furthermore, does it make more sense for GM to keep these people and risk destroying its own business. Seems to me that would be even worse.
In 2007, Pfizer closed a major facility in nearby Ann Arbor, Michigan (home of my alma mater the University of Michigan). I think over 2,400 people lost their jobs. But you know what is happening? Ann Arbor has become much more entrepreneurial. New businesses are appearing. Ann Arbor Spark, a business incubator, is booming.
People also bemoan the death of the Main Street merchant. "We don't Wal Mart in our town." But what has Wal Mart done wrong? They are offering good products at good prices - they are providing something people need and want and are willing to pay for. Is it unfortunate the old line Main Street merchant loses his business? Absolutely. But those are the risks you take going into business.
I have learned that my job as a CPA and consultant is to help my customers make more money. Sometimes kind of hard to see how performing an audit of a financial statement can do that. But it can. I have one customer who bought out a minority partner and having the history of audited statements helped make the transaction occur. The bank often will require an audit, so the business may think they are buying an audit with a gun to their head. But what would the loan cost without the audit? Probably more than the cost of the audit.
I am very much looking forward to seeing what else I pick up out of this book.
Tuesday, April 15, 2008
Monday, April 14, 2008
1040 clients especially like to complain about the bill.
I have one new 1040 client that has been, frankly, just a pain in the side. I don't think it is intentional on his part. His wife died suddenly last fall, and she took care of the finances. She had also just retired, so there wasn't as much withholding. When I told him he owed money on the return he basically freaked.
Turns out this gentleman had always gone to H & R Block in the past. I looked at the 2006 return - beyond aggressive bordering on tax evasion was the approach taken on Schedule C and possibly on Form 2106. They also missed a $150 credit on the Michigan return; I'll file an amended return for him after April 15 for that.
Let's get back on track: what am I worth to my customers. H & R Block charged him $409. And it was wrong. Another return I saw that was prepared by Jackson Hewitt charged about the same amount for a very simple return.
I am rapidly moving away from billing based on hours. I don't believe in it. If I were to do that for return described above, I would be billing this guy at least $1,500. Unbelievable number of phone calls. But $1,500 isn't a fair value on the return.
Shouldn't I get a good deal more though than H & R Block. My CPA certificate is dated 1986.
I'm raising ALL of my 1040 prices next year. I'm worth more than H & R Block.
Wednesday, March 26, 2008
One interesting thing about the book is that they tell you who is writing. The following is by Ron Baker, on page 5:
No one enters the profession in order to bill the most hours.
I know I didn't. I entered the profession because I enjoyed the subject matter. I now find I get great satisfaction from helping the businesses and people we work with.
I think this statement by Ron Baker is going to have a deep impact on me.
Thursday, January 24, 2008
PARIS - French bank Societe Generale said Thursday it has uncovered a $7.14 billion fraud — one of history’s biggest — by a single futures trader whose scheme of fictitious transactions was discovered as stock markets began to stumble in recent days.
Read the rest here. Scary.
Especially telling - this is the second paragraph from the end:
“In hindsight, it was this guy’s superior knowledge of the control system of every aspect of trading at the bank that allowed him to build up fraudulent positions and hide them.”