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Management Letters: Have You Implemented Any Changes?

boost business concept, process from idea to result

Audited financial statements come with a special bonus: a “management letter” that recommends ways to improve your business. That’s free advice from financial pros who’ve seen hundreds of businesses at their best (and worst) and who know which strategies work (and which don’t). If you haven’t already implemented changes based on last year’s management letter, there’s no time like the present to improve your business operations.

Reporting deficiencies

Auditing standards require auditors to communicate in writing about “material weaknesses or significant deficiencies” that are discovered during audit fieldwork.

The AICPA defines material weakness as “a deficiency, or combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented, or detected and corrected on a timely basis.” Likewise, a significant deficiency is defined as “a deficiency, or a combination of deficiencies, in internal control that is … important enough to merit attention by those charged with governance.”

Auditors may unearth less-severe weaknesses and operating inefficiencies during the course of an audit. Reporting these items is optional, but they’re often included in the management letter.

Looking beyond internal controls

Auditors may observe a wide range of issues during audit fieldwork. An obvious example is internal control shortfalls. But other issues covered in a management letter may relate to:

  • Cash management,
  • Operating workflow,
  • Control of production schedules,
  • Capacity,
  • Defects and waste,
  • Employee benefits,
  • Safety,
  • Website management,
  • Technology improvements, and
  • Energy consumption.

Management letters are usually organized by functional area: production, warehouse, sales and marketing, accounting, human resources, shipping/receiving and so forth. The write-up for each deficiency includes an observation (including a cause, if observed), financial and qualitative impacts, and a recommended course of action.

Striving for continuous improvement

Too often, management letters are filed away with the financial statements — and the same issues are reported in the management letter year after year. But proactive business owners and management recognize the valuable insight contained in these letters and take corrective action soon after they’re received. Contact us to help get the ball rolling before the start of next year’s audit.

© 2019

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Budgeting is Key to a Successful Start-Up

More than half of recent college graduates plan to start a business someday, according to the results of a survey published in August by the American Institute of Certified Public Accountants (AICPA). Unfortunately, the AICPA estimates that only half of new businesses survive the five-year mark, and only about one in three reach the 10-year mark.

What can you do to improve your start-up’s odds of success? Comprehensive, realistic budgets can help entrepreneurs navigate the challenges that lie ahead.

3 financial statements

Many businesses base their budgets on the prior year’s financial results. But start-ups lack historical financial statements, which can make budgeting difficult.

In your first year of operation, it’s helpful to create an annual budget that forecasts all three financial statements on a monthly basis:

1. The income statement. Start your annual budget by estimating how much you expect to sell each month. Then estimate direct costs (such as materials, labor, sales tax and shipping) based on that sales volume. Many operating costs, such as rent, salaries and insurance, will be fixed over the short run.

Once you spread overhead costs over your sales, it’s unlikely that you’ll report a net profit in your first year of operation. Profitability takes time and hard work! Once you turn a profit, however, remember to save room in your budget for income taxes.

2. The balance sheet. To start generating revenue, you’ll also need equipment and marketing materials (including a website). Other operating assets (like accounts receivable and inventory) typically move in tandem with revenue. How will you finance these assets? Entrepreneurs may invest personal funds, receive money from other investors or take out loans. These items fall under liabilities and equity on the balance sheet.

3. The statement of cash flows. This report tracks sources and uses of cash from operating, investing and financing activities. Essentially, it shows how your business will make ends meet each month. In addition to acquiring assets, start-ups need cash to cover fixed expenses each month.

By forecasting these statements on a monthly basis, you can identify when cash shortfalls, as well as seasonal peaks and troughs, are likely to occur.

Reality check

Budgeting isn’t a static process. Each month, entrepreneurs must compare actual results to the budget — and then adjust the budget based on what they’ve learned. For instance, you may have underbudgeted or overbudgeted on some items and, thus, spent more or less than you anticipated.

Some variances may be the result of macroeconomic forces. For example, increased government regulation, new competition or an economic downturn can adversely affect your budget. Although these items may be outside of an entrepreneur’s control, it’s important to identify them early and develop a contingency plan before variances spiral out of control.

Outside input

An accounting professional can help your start-up put together a realistic budget based on industry benchmarks and demand for your products and services in the marketplace. A CPA-prepared budget can serve as more than just a management tool — it also can be presented to lenders and investors who want to know more about your start-up’s operations.

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Auditing Grant Compliance

A business situation.

Has your organization received any public or private grants to fund its growth? Grants sometimes require an independent audit by a qualified accounting firm. Here’s what grant recipients should know to help facilitate matters and ensure compliance at all levels.

Federal compliance

Federal awards require compliance with the Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (also known as 2 CFR Part 200). This guidance requires any entity that expends $750,000 or more of federal assistance received for its operations to undergo a “single audit,” which is a rigorous, organizationwide examination.

To provide grant recipients with the latest guidance on compliance, the Office of Management and Budget (OMB) releases an annual compliance supplement. It covers compliance requirements for a dozen areas when performing a single audit:

  1. Activities allowed or unallowed,
  2. Allowable costs/cost principles,
  3. Cash management,
  4. Eligibility,
  5. Equipment and real property management,
  6. Matching, level of effort and earmarking,
  7. Period of performance,
  8. Procurement, suspension and debarment,
  9. Program income,
  10. Reporting,
  11. Subrecipient monitoring, and
  12. Special tests and provisions.

The supplement also includes sections dedicated to agency program requirements, including clusters of programs that share common compliance requirements.

Your auditor will assess whether your organization has sufficient internal controls in each of the 12 areas. To help ensure compliance, your organization should clearly document decisions and processes, as well as provide a clear audit trail of activity.

Other levels of compliance

The requirements for state, local and private sector grants vary significantly. But compliance generally hinges on the following, regardless of the source providing the funding:

  • A detailed understanding of the grant’s compliance and reporting requirements,
  • A mapping of requirements to individual controls and processes,
  • A documented set of grant management policies and procedures that your organization publicizes and follows,
  • A robust set of internal controls and mechanisms to prevent fraud, waste, and abuse,
  • Training programs designed to promote grant compliance,
  • Frequent risk assessments to map your organization’s policies and procedures against evolving requirements for each grant, and
  • Periodic auditing in compliance with relevant guidance and statutes.

In addition, your auditor will evaluate whether your organization is willing to adapt to regulatory changes. For example, has it adopted new grant controls to accommodate best practices or legislative changes?

We can help

If juggling multiple levels of grant compliance seems overwhelming, contact us to learn how to streamline your approach. We can help your organization improve its ability to satisfy grant requirements at multiple levels.

© 2019

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Corporate Governance in the 21st Century

Colleagues discussing with recycling sign on white board in the office

What’s the purpose of a corporation? For the last 50 years, the answer was “to maximize shareholder value.” But, on August 19, CEOs of 181 leading U.S. businesses, including Amazon, Apple, General Motors and Walmart, pledged to broaden the scope.

Beyond shareholder value

Putting shareholders first was the doctrine of University of Chicago economist Milton Friedman. In 1970, he famously wrote that “the social responsibility of business is to increase its profits.” While this mindset has enriched large shareholders, it’s also had negative consequences, including pay disparities between executives and frontline workers, layoffs and pollution.

Last year, Chairman of the Business Roundtable Jamie Dimon launched a project to update its principles. The new version of its Principles of Corporate Governance looks beyond delivering value to shareholders. It also recognizes the importance of:

  • Investing in employees through training and education, as well as providing fair compensation and benefits,
  • Fostering diversity, inclusion, dignity and respect in the workplace,
  • Dealing fairly and ethically with suppliers,
  • Supporting local communities,
  • Protecting the environment through sustainable business practices, and
  • Providing transparent and effective communications with shareholders and lenders.

For many business leaders who signed the new statement of purpose, these objectives represent a fundamental change in longstanding business principles. “Major employers are investing in their workers and communities because they know it is the only way to be successful over the long term. These modernized principles reflect the business community’s unwavering commitment to continue to push for an economy that serves all Americans,” said Chairman Dimon.

What you can do

Translating the statement’s lofty principles into concrete business practices will be challenging, especially if the changes cause earnings to fall over the short run. The key will be getting investor and lender buy-in by effectively communicating the link between adopting so-called “sustainable” business practices and building long-term shareholder value.

For example, identifying and successfully navigating sustainability issues can add value by building trust with stakeholders, providing improved access to capital and reduced borrowing costs, and enhancing customer and employee loyalty. Tracking sustainability also helps companies identify ways to reduce their energy consumption, streamline their supply chains, eliminate waste and operate more efficiently.

Conversely, aggressive tax strategies and regulatory violations can lead to fines, remedial costs and reputational damage. And the sale of toxic or unsafe products can result in product liability lawsuits, recalls and boycotts.

Disclosing the changes

Do your company’s financial statements include sustainability disclosures? Though they’re currently voluntary under U.S. Generally Accepted Accounting Principles (GAAP) and the financial reporting rules of the Securities and Exchange Commission (SEC), they can be worthwhile. These disclosures provide insight into various nonfinancial issues, such as:

  • Pollution and carbon emissions,
  • Union relations,
  • Political spending,
  • Tax strategies,
  • Training and diversity practices,
  • Health and safety matters, and
  • Human rights policies.

Our auditors can help you draft disclosures that explain your sustainability efforts to stakeholders in a clear, objective manner and establish links to financial performance. Contact us for more information.

© 2019

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The Untouchables: Getting a Handle on Intangibles

Businesswoman hands opened creating a space for product or text placement.

The average company’s balance sheet understates its value by 80%, according to Sarah Tomolonius, co-founder of the Sustainability Investment Leadership Council. Why? Intangible assets aren’t recorded on the balance sheet under U.S. Generally Accepted Accounting Principles (GAAP), unless they’re acquired from a third party.

Instead, GAAP generally calls for the costs associated with creating and maintaining these valuable assets to be expensed as they’re incurred — even though they provide future economic benefits.

Eye on intangibles

Many companies rely on intangible assets to generate revenue, and they often contribute significant value to the companies that own them. Examples of identifiable intangibles include:

  • Patents,
  • Brands and trademarks,
  • Customer lists,
  • Proprietary software, and
  • A trained and knowledgeable workforce.

In a business combination, acquired intangible assets are reported at fair value. When a company is purchased, any excess purchase price that isn’t allocated to identifiable tangible and intangible assets and liabilities is allocated to goodwill.

Acquired goodwill and other indefinite-lived intangibles are tested at least annually for impairment under GAAP. But private companies may elect to amortize them over a period not to exceed 10 years. Impairment testing also may be required when a triggering event happens, such as the loss of a major customer or introduction of new technology that makes the company’s offerings obsolete.

Inquiring minds want to know

Investors are interested in the fair value of acquired goodwill because it enables them to see how a business combination fared in the long run. But what about intangibles that are developed in-house?

At a sustainability conference earlier in May, Tomolonius said that businesses are more sustainable when they’re guided by a complete understanding of their assets, both tangible and intangible. Assigning values to internally generated intangibles can be useful in various decision-making scenarios, including obtaining financing, entering into licensing and joint venture arrangements, negotiating mergers and acquisitions, and settling shareholder disputes.

Calls for change

For more than a decade, there have been calls for accounting reforms related to intangible assets, with claims that internally generated intangibles are the new drivers of economic activity and should be reflected in balance sheets. Proponents of changing the rules argue that keeping these assets off the balance sheet forces investors to rely more on nonfinancial tools to assess a company’s value and sustainability.

It’s unlikely that the accounting rules for reporting internally generated intangibles will change anytime soon, however. In a quarterly report released in August, Financial Accounting Standards Board (FASB) member Gary Buesser pointed to challenges the issue would pose, including the difficulty of recognizing and measuring the assets, costs to companies, and limited usefulness of the resulting information to investors. Buesser explained that “the information would be highly subjective, require forward looking estimates, and would probably not be comparable across companies.”

Want to learn more about your “untouchable” intangible assets? We can help you identify them and estimate their value, using objective, market-based appraisal techniques. Contact us for more information.

© 2019

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What to Expect During a Franchise Audit

It’s important for franchisors to periodically audit individual franchisees. These routine “check-ups” are especially valuable in a store’s early years of operations or if performance starts to deteriorate. They can be used to detect symptoms of unhealthy performance and treat problems before they spiral out of control.

Focus on royalty payments

Royalties are a franchisor’s primary source of income. Because royalties are typically based on a percentage of revenue, auditors pay close attention to the franchisee’s revenue reporting process.

To test whether revenue has been accurately reported, auditors trace transactions from the point-of-sale to:

  • The franchisee’s financial records,
  • Revenue reported to the franchisor, and
  • Tax returns submitted to the state and federal government.

If the revenue trail doesn’t hold up, further investigation may be required. In addition to vouching a representative sample of randomly selected sales transactions, auditors use analytical techniques to compare key metrics for an individual franchisee against benchmarks for franchises of a similar size and others in your franchise system. Any discrepancies from these benchmarks raise a red flag that the franchisee may have underreported revenue to minimize royalty payments.

Standard operating procedures

Beyond testing revenue, auditors spend extensive time examining whether the franchisee has complied with the franchise agreement. They consider such questions as:

  • Is the franchisee spending the required amount on advertising?
  • Does its signage comply with brand standards?
  • Is the franchisee purchasing materials and supplies from approved vendors?
  • Is the HR manager conducting appropriate employee background checks?

Failure to comply with such terms compromises future revenue and the reputation of your brand. So, areas of noncompliance should be identified during the audit — and corrected as soon as possible.

Site visits

Analyzing a franchisee’s books and records can only reveal so much. There’s no substitute for meeting face-to-face with the owner-operator.

Site visits give the auditor an opportunity to assess business operations from the customer’s perspective, evaluate the condition of equipment and the morale of workers, and interview the management team. These inquiries help the auditor understand how the business operates and investigate any anomalies unearthed during testing and analytical procedures.

Need help?

Hiring an outside auditor to enforce the audit provisions of your franchise agreement brings objectivity and financial expertise to the process. In addition to auditing a franchisee’s financial statements, our team can follow up on any compliance issues unearthed by the audit. Contact us for more information.

© 2019  

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Reporting Discontinued Operations

Old Way or New Way

Financial reporting generally focuses on the results of continuing operations. But sometimes businesses sell (or retire) a product line, asset group or another component. In certain situations, such a disposal should be reported as a discontinued operation under U.S. Generally Accepted Accounting Principles (GAAP). Starting in 2015, the rules changed, limiting the scope of transactions that must comply with the complex rules for discontinued operations.

Narrowed scope

A component comprises operations and cash flows that can be clearly distinguished, both operationally and for financial reporting purposes, from the rest of the company. It can be a reportable segment or an operating segment, a reporting unit, a subsidiary or an asset group. Under previous guidance, three requirements were needed for a transaction to be classified as discontinued operations:

  1. The component had been disposed of or was classified as “held for sale.”
  2. The operations and cash flows of the component had been (or would have been) eliminated from the ongoing operations of the entity as a result of the disposal transaction.
  3. The entity didn’t have any significant continuing involvement in the operations of the component after the disposal transaction.

Some stakeholders felt that too many disposals, including routine disposals of small groups of assets, qualified for discontinued operations presentation under the previous guidance. They also found the definition of discontinued operations to be unnecessarily complex and difficult to apply.

So, the Financial Accounting Standards Board updated the rules. Accounting Standards Update No. 2014-08 eliminated the second and third conditions. Instead, disposal of a component (including business activities) must be reported in discontinued operations only if the disposal represents a “strategic shift” that has or will have a major effect on the company’s operations and financial results. Examples of a qualifying strategic major shift include disposal of a major geographic area, a line of business or an equity method investment.

When such a strategic shift occurs, a company must present, for each comparative period, the assets and liabilities of a disposal group that includes a discontinued operation separately in the asset and liability sections of the balance sheet.

Expanded disclosures

Although fewer transactions qualify as discontinued operations than qualified under the previous rules, those that do qualify require expanded disclosures for the periods in which the operating results of the discontinued operation are presented in the income statement. For example, companies must disclose the major classes of line items constituting the pretax profit or loss of the discontinued operation. Examples of major line-item classes include revenue, cost of sales, depreciation and amortization, and interest expense.

In addition, companies must disclose either 1) the total operating and investing cash flows of the discontinued operation, or 2) the depreciation, amortization, capital expenditures, and significant operating and investing noncash items of the discontinued operation. And, if the discontinued operation includes a noncontrolling interest, the company must provide the pretax profit or loss attributable to the parent.

Management also must provide various disclosures and reconciliations of items held for sale for the period in which the discontinued operation is so classified and for all prior periods presented in the statement of financial position. Additional disclosures may be required if the company plans significant continuing involvement with a discontinued operation — or if a disposal doesn’t qualify for discontinued operations reporting.

Need help?

Most companies don’t report discontinued operations every year, so you might not have experience applying the current guidance for reporting these transactions. But we do. Our staff can help determine the appropriate treatment for your disposal and compose the requisite footnote disclosures. Contact us for more information.

© 2019

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FAQs About CAMs

In July, the Public Company Accounting Oversight Board (PCAOB) published two guides to help clarify a new rule that requires auditors of public companies to disclose critical audit matters (CAMs) in their audit reports. The rule represents a major change to the brief pass-fail auditor reports that have been in place for decades.

One PCAOB guide is intended for investors, the other for audit committees. Both provide answers to frequently asked questions about CAMs.

What is a CAM?

CAMs are the sole responsibility of the auditor, not the audit committee or the company’s management. The PCAOB defines CAMs as issues that:

  • Have been communicated to the audit committee,
  • Are related to accounts or disclosures that are material to the financial statements, and
  • Involve especially challenging, subjective or complex judgments from the auditor.

Examples might include complex valuations of indefinite-lived intangible assets, uncertain tax positions and goodwill impairment.

Does reporting a CAM indicate a misstatement or deficiency?

CAMs aren’t intended to reflect negatively on the company or indicate that the auditor found a misstatement or deficiencies in internal control over financial reporting. They don’t alter the auditor’s opinion on the financial statements.

Instead, CAMs provide information to stakeholders about issues that came up during the audit that required especially challenging, subjective or complex auditor judgment. Auditors also must describe how the CAMs were addressed in the audit and identify relevant financial statement accounts or disclosures that relate to the CAM.

CAMs vary depending on the nature and complexity of the audit. Auditors for companies within the same industry may report different CAMs. And auditors may encounter different CAMs for the same company from year to year.

For example, as a company is implementing a new accounting standard, the issue may be reported as a CAM, because it requires complex auditor judgment. This issue may not require the same level of auditor judgment the next year, or it might be a CAM for different reasons than in the year of implementation.

When does the rule go into effect?

Disclosure of CAMs in audit reports will be required for audits of fiscal years ending on or after June 30, 2019, for large accelerated filers, and for fiscal years ending on or after December 15, 2020, for all other companies to which the requirement applies.

The new rule doesn’t apply to audits of emerging growth companies (EGCs), which are companies that have less than $1 billion in revenue and meet certain other requirements. This class of companies gets a host of regulatory breaks for five years after becoming public, under the Jumpstart Our Business Startups (JOBS) Act.

Coming soon

PCAOB Chairman James Doty has promised that CAMs will “breathe life into the audit report and give investors the information they’ve been asking for from auditors.” Contact us for more information about CAMs.

© 2019

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Attention: Accounting Rule Delays In The Works

would delay several landmark accounting rules for certain companies. If finalized, the deferral would apply to new guidance for reporting leases, hedging transactions, credit losses and long-term insurance contracts.

Summary of the changes

The following table summarizes key implementation date changes that the FASB unanimously voted to propose:

The term “smaller reporting companies” refers to those that have either 1) a public float of less than $250 million, or 2) annual revenue of less than $100 million and no public float or a public float of less than $700 million.

Unexpected delays

Private companies and nonprofits often receive an extra year to implement major accounting standards updates, compared to the effective dates that apply to public companies. In a shift in its philosophy for setting reporting dates on major new accounting standards, the FASB wants to give certain entities even longer to implement the changes.

Why are these delays needed? Many entities continue to struggle with implementing the new revenue recognition guidance that went into effect in 2018 for public companies and 2019 for other entities. A possible deferral of other new rules would also allow smaller entities to learn from public companies how to implement the changes — and it would give accounting software providers extra time to update their packages to support the new reporting models.

Proposal is coming soon

The FASB is expected to issue its proposal as soon as possible. Then it will be subject to a 30-day comment period.

These deferrals, if finalized, would be welcome news for many organizations. But they’re not an excuse to procrastinate. Depending on your industry and the nature of your transactions, implementing the changes and educating stakeholders could take significant resources. Contact us before the implementation deadline to come up with a realistic game plan.

© 2019

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Let’s Find A Better Way To Manage Your Receivables


Failure to collect accounts receivable (AR) in a timely manner can lead to myriad financial problems for your company, including poor cash flow and the inability to pay its own bills. Here are five effective ideas to facilitate more timely collections:

1. Create an AR aging report. This report lets you see at a glance the current payment status of all your customers and how much money they owe. Aging reports typically track the payment status of customers by time periods, such as 0–30 days, 31–60 days, 61–90 days and 91+ days past due.

Armed with this information, you’ll have a better idea of where to focus your efforts. For example, you can concentrate on collecting the largest receivables that are the furthest past due. Or you can zero in on collecting receivables that are between 31 and 60 days outstanding before they become any further behind.

2. Assign collection responsibility to a sole accounting employee. Giving one employee the responsibility for AR collections ensures that the “collection buck” stops with someone. Otherwise, the task of collections could fall by the wayside as accounting employees pick up on other tasks that might seem more urgent.

3. Re-examine your invoices. Your customers prefer bills that are clear, accurate and easy to understand. Sending out invoices that are sloppy, vague or inaccurate will slow down the payment process as customers try to contact you for clarification. Essentially you’re inviting your customers to not pay your invoices promptly.

4. Offer customers multiple ways to pay. The more payment options customers have, the easier it is for them to pay your invoices promptly. These include payment by check, Automated Clearing House, credit or debit card, PayPal or even text message.

5. Be proactive in your billing and collection efforts. Many of your customers may have specific procedures that must be followed by vendors for invoice formatting and submission. Learn these procedures and follow them carefully to avoid payment delays. Also, consider contacting customers a couple of days before payment is due (especially for large payments) to make sure everything is on track.

Lax working capital practices can be a costly mistake. Contact us to help implement these and other strategies to improve collections and boost your revenue and cash flow. We can also help you with strategies for dealing with situations where it’s become clear that a past-due customer won’t (or can’t) pay an invoice.

© 2019