Category: Audit and Review

Transaction Approval

~ C.O.R.E. Beliefs ~ Leave a comment

Typically, anything I write that deals with HOA’s and Condo audits are written on C.O.R.E. Beliefs.  But, I already wrote a nice little article about reserve funds there and also today’s issue, while stemming from a condo audit, is applicable to every type of business entity out there.

We are currently struggling with a condo audit.  The association has been around for about 20 years and every 5 years or so the board decides to spend money on an audit.  Like all good auditors, we are performing some tests of transactions in the non-audited years to ensure that the money has been accounted for correctly.  Specifically, our concern is the reserve fund.

The first thing we noticed was board meetings did not often have quorum.  Quorum is a fancy Latin term for “who decides”.  It is the minimum number of selected representatives who have to participate in meetings in order for votes to have affect.  So, why is this a concern?

In many associations – and non-profits need to be concerned here too, quorum is typically defined as a “majority of the board members”.  In this particular case, there were 5 board members so a quorum would be 50% plus 1.  Three in this case.  At several meetings only two board members were in attendance.

The board then conducted business.  It discussed contracts for reserve fund expenditures and approved them.  Bad form.  And bad business.

The whole point of quorum is to ensure that the meetings are adequately represented.  You want to make sure that there is robust debate where called for and a full airing of the concerns when necessary to ensure that funds are spent wisely.  When debate doesn’t happen you get decisions that can be challenged.  Which is where we are today.

The problem for us is that we are auditing the records.  They approved a siding project, which was funded from reserves, and did not document how much it was approved for.  There was no indication that there were three (3) competitive bids submitted or even requested.

The initial invoice, prepared on a percentage of completion basis, indicated that the base contract was $98,000.  The total paid to the contractor was $129,000.  We can’t find any reference that the change orders were request or approved by the board.  And it happened when there were 5 different board members.  The five current members were not even involved in that particular project.

Getting proper approvals is an important aspect of taking care of business.  It could be that you, the owner of your company, wants to approve every transaction at time of payment by signing a check.  Or it could be you are the executive director of a non-profit which has a policy that commitments over $5,000 must be reviewed and approved by the finance committee.  Regardless of the process, it is the fact that there is a check and balance that makes it work and when someone overrides that part, you get all sorts of troubles.

Ideally, the board minutes would have documented the issue – siding replacement – and the names and amounts of the competitive bids submitted.  There would be debate about the relative merits of the quotes and then a final approval of the winning bid.  All completed at a properly called board meeting with quorum.  Ideally, there would be another meeting where changes to the scope of the original work order were discussed and approved.  We don’t have that.

We are struggling with a way to remain in the audit and issue an opinion.  We think the owners deserve to know what is going on and a properly worded Disclaimer of Opinion could help them understand and maybe even want to participate as board members.  But, our options are rather limited and we may be forced to withdraw, which doesn’t really help anyone.

What can you do if you are either a board director or are thinking of becoming one?  Make sure that you follow your by-laws and/or state law when it comes to how meetings are carried out.  Know the number required for quorum and make sure you have sufficient notes in the minutes that someone can follow the work and see how the decision was made.  You will save yourself a lot of grief, and an expensive “non-opinion” audit report.

Have a great day and if you are looking for a proposal for audit or review services for the upcoming year, please consider C.O.R.E. Services.  You can find out more about us on our website.  We look forward to the opportunity to be of service to you.

Fraud and Auditor Negligence

~ C.O.R.E. Beliefs ~ Leave a comment

I received an interesting Google alert yesterday.  The Supreme Court of Canada ruled that Deloitte should be held responsible for damages related to its audit work performed almost 20 years earlier.

The case centered on whether an auditor is responsible for catching fraud – and what happens when it is missed.  In this case Deloitte was engaged to audit the financial statements of a theater production company.  The audit was required by both its lending arrangement and because it had sufficient investors who demanded it.  The financial statements understated certain expenses (see yesterday’s blog) and recording certain pre-sales as revenue – debt recorded as income.

There are two questions in these situations – the significance of the fraud and reliance upon the statements.  In some trials it was proven that there was significant fraud but no one relied upon the financial statements.  Without reliance, the auditor is not really responsible – after all, the purpose of the audit is to provide relevant information to stakeholders and if they choose to ignore it, that is their choice.

In this particular case there was substantial fraud.  Deloitte’s procedures did not identify the activity, or if it did, the fraud was not brought to the attention of the appropriate level of management.  Now, this case is interesting because the chairman and vice chairmen were the perpetrators of the fraud so really, who would have been the appropriate level of management?  Technically the auditor should withdraw at that stage – which surprisingly was one of Deloitte’s defenses – that they were being punished for not withdrawing as the auditor.

But I digress as the court did not find that Deloitte discovered the fraudulent activity. Which, by the way, went on for 5 years.

Needless to say, the lenders and investors were decidedly unhappy to know their money disappeared with no likelihood of recovery.  The Company, Livent, filed for bankruptcy and it was the bankruptcy trustee that sued.  Their position is that the auditors’ failure to identify and report the fraud led to the 5 years of borrowing and additional investor funding which essentially went straight to the two chairmen charged with fraud.

The Supreme Court agreed that the auditor was responsible for not identifying the fraudulent activity and taking steps to correct it earlier.

As an auditor, this is one of those rulings that give us pause.  If we perform the audit and gather, what we believe to be sufficient, audit evidence to support the conclusion, then there really shouldn’t be an audit failure.  But actually, even if we gather lots of evidence, the reality is we ask questions of management.  Sometimes, management lies.  Or in this case, were probably instructed by their senior leadership to provide certain answers which proved to be incorrect in the end.

Or, in other words, the audit partner meets with the president and CEO.  She has a list of questions that have filtered up from the audit team through various levels of audit management.  One of those questions was probably, “We discovered certain transactions that were authorized by you, are you comfortable with how those transactions are recorded?”  The answer was no doubt yes.

The auditors may have felt uncomfortable but what can they do?  This type of activity probably doesn’t lead to issuing a qualified, adverse, or disclaimed opinion.  The auditor’s only option is to withdraw because the reporting of fraud is not something you will find in the auditors’ report.  Why? you may ask.  Because fraud is a legal claim that would have to be adjudicated and proven and what the auditor discovers might be evidence of such activity but it hasn’t been proven in a court of law.

It is a terrible position for the auditor.  It is also the risk of performing audits.  I would like to tell you that, in that situation, we would resign.  But because we have withdrawn from engagement before doesn’t mean that the evidence in every case is sufficient to draw that conclusion.  Honestly, there were engagements that we completed that made us uncomfortable but that discomfort never rose to the level of us wanting to withdraw.  This is ultimately what audit leadership is required to made the decision upon.  It isn’t easy and sometimes auditors are wrong.  But if we withdrew from every engagement that caused us to be nervous there would never be another audit performed.

An interesting story that I will still be thinking about for a few days.

Have an awesome day.

Using accounting to deceive

~ C.O.R.E. Beliefs ~ 1 Comment

I have received a few google alerts recently about companies that are being accused of using their accounting and financial statements to deceive readers.   It is sadly a far too common occurrence.  For readers of financial statements – like those who are owners in a homeowners or condominium association – knowing what to look for can help you determine if the information could be incorrect and maybe even fictitious.

First up on the balance sheet is cash.  While it is difficult to determine if the amount of cash is bogus there are things to look for, especially in associations.  If the financial statements show lots of cash but you are receiving messages from the board saying that they are worried about having to increase assessments – ask how that can possibly be.   There could be a logical explanation but every once in a while something is just flat our wrong.

Accounts receivable is one of the places where potential problems may really lurk.  Accounts receivable are sales that have not been collected – i.e. an IOU from the buyer.  For most businesses, one month’s sales in receivable would be expected, but watch out.  I once worked on an engagement for a hotel chain where the accounts receivable kept increasing and was approaching almost 10 days of revenue.  The a/r was used to hide the theft of cash sales and the controller didn’t catch it.  Ask yourself, if you owned a business like that, would you let someone promise to pay you later?

Inventory is another big area where accounting irregularities can show up.  Ask yourself, does the inventory seem excessive?  An easy way to tell is to divide the cost of goods sold by 12 and then compare that number to the amount reported as inventory.  Is it close to or less than 1:1?  That would mean that inventory is turning every 30 days.  If it is over 1.5:1, or more than 45 days, be careful.  Inventory goes obsolete quickly these days so lots of inventory may mean lots of write-offs coming soon.

Fixed assets, or property, plant and equipment can be gimmicked as well.  WorldCom tried to pull off this method of lying to their investors.  This is one of those areas that is harder to tell if something is wrong but the best thing to do is look at how fast the investment in fixed assets grow.  If sales have grown on average 3% over the last 5 years and fixed assets grew 12% this year, it may be worth questioning.  It is definitely worth looking at when fixed assets grows consistently at 12% year over year and sales isn’t going anywhere.  That is a sign of trouble.  We performed a review this past year where we required management to write down their asset value because we felt that the fixed assets were overstated.

Keep in mind that most entities that want to fool you will want you to focus on their profits – which means that revenues exceed expenses.  The easiest way to do that is to move expenses to the balance sheet; the receivables, the inventory, the fixed assets.  Look at expense trends and if you see an expense, like cost of goods sold, drop as a percentage, and then check if inventory went down that same percentage.  If it went up, it could be a sign something is wrong.

The vast majority of financial statement issuers are above board and honest.  To help keep them that way, remember to read the statement critically and be willing to ask questions, especially if you have a financial interest in the issuer.

Have a great day.

It’s Official

~ C.O.R.E. Beliefs ~ Leave a comment

In today’s newsletter from Currie & McLain, they told their clients that they are officially becoming part of Integrated Tax Services (ITS) effective January 1, 2018.  It has been a pleasure to work with the team at Currie & McLain and I know that ITS will be able to offer the same excellent tax service clients came to appreciate from Currie & McLain.

Doug and I purchased the HOA and condo client base of Currie & McLain in September so that there was a firm ready to handle the audit and review services for homeowner associations and condo properties.  C.O.R.E. Services does not do taxes, we refer that out to ITS and other firms who demonstrate superior client service.  But we do offer the review services that are often required of businesses with bank loans and financial statement loan covenants.

So what does this mean for clients?

ITS will be able to do all your tax work and I would strongly encourage you to continue your relationship.  With the integration of the preparation teams, there will actually be more qualified staff to work with clients.

For businesses who need attest work on their financial statements, C.O.R.E. would like the opportunity to work with you.  Because we only focus on audits and review engagements we dedicate our resources to completing these engagements timely and effectively.  We encourage you to have ITS prepare your business tax return while we do the procedures to be able to issue an opinion or conclusion on your financial statements.

C.O.R.E. emphasizes audits and reviews of common property associations – HOA’s, condominium associations and co-operatives.  Doug and I have many years of experience in both the technical aspect of audits and reviews as well as many years of focus on these types of associations.

If you are on a condo or HOA board and are looking for a quote for an audit or review and are interested in working with a firm that dedicates itself to performing the right procedures to ensure that your management’s accounting is accurate, feel free to reach out to C.O.R.E. Services.  If you would a referral for your taxes, either personal or business, we would be happy to give you the right referral based on your needs.

Have a great weekend.  And congratulations to Leslie, Linda and Doug for taking such excellent care of their clients.