Understanding risk

We were asked to propose on a review engagement about 10 days ago.  This is for a commercial business doing about $20 million in revenue.  Their prior accountant got out of doing attest work – it seems the peer review burden and trying to stay in compliance with the standards was more than he wanted to undertake.

We asked for and received copies of their past two year financial statements as well as their interim statements.

  • Significant losses in 2015
  • Significant losses in 2016
  • Significant profits in 2017

We started asking some high level questions of the controller and her response bothered us.  She started by asking if we were accusing her of “cooking the books”.

If you own a business, or are the responsible accounting person, you need to understand how this goes.  It is all about risk and from the independent accountant’s perspective, the risk is based on who reads your financial statement – so our job (in a review) is to make sure that nothing comes to our attention to make us think the financial statements are not correct.

When we see a pattern like this, we are skeptical.  Believe it or not, skepticism is a job requirement.  The code of professional conduct requires us to be skeptical.  But skepticism is not cynicism and automatically assuming the worse, it is thinking that maybe something is overlooked.

Imagine your teen brings home 2 progress reports in a row which say that homework is not being turned in.  You walk into his room while he is playing video games and ask if he completed his homework.  He says “Yeah of course.”

It isn’t that you don’t believe him.  But lets face it, history isn’t kind and he does have a track record of not doing it.  So what do you do?

Ask if you can see it of course.  You are skeptical.  You are not accusing him of not doing it, you are simply verifying that it is complete and ready to be turned in.

If it is done, great!  Pat on the head and maybe even a hint on how to beat the level.  If it isn’t, well I wouldn’t say he lied, I would say that no doubt the game is interfering with his memory and say that perhaps it is better off in your closet.  Until his memory improves and the homework is done.

It’s a silly analogy but true.  As the independent accountant, we are concerned with risk.  Risk to ourselves naturally, but also the risk that might be taken by the reader of the financial statement if it turns out it isn’t accurate.  We are proud of our independence and objectivity.  And this requires us to ask questions which make people uncomfortable.

Keep in mind, most of us who still perform attest services have seen a thing or two, so we know a thing or two. (Sorry Farmers, I owe you two cents) We realize that the bank is probably paying very close attention to your numbers.  We are pretty certain that another year of losses could end up with you in special assets.  We know that some peoples jobs are potentially on the hook if profits don’t improve.

We have seen it before.  But it isn’t cynicism, it is skepticism.  The patterns are there so we have to reduce the risk that the pattern is real.  And we do this by asking questions.  Sometimes painful questions.

We have to learn your business, your processes.  We have to understand the industry you compete in and sometimes the multiple industries you try to make a profit in.  We have to know what others in your industry do when it comes to capitalizing assets and recording liabilities.  We have to understand your motivation and tolerance for risky behavior.

Keep this in mind when your independent accountant starts asking questions.  And, if your accountant isn’t asking questions, maybe it is time for you to get another accountant.

Have a great day.  If you have a need for an audit or review in Washington or Oregon, feel free to learn more about us on our website and contact us for more information.  We are here to be of service to you.

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