Category: GAAP

What to Look for in an Auditor

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

“Why should we engage C.O.R.E.?”, asked the condominium board president.  It is an interesting question which deserves an entertaining answer.  And, even though Kubae says I should never do it, I always answer that question with another question.

“What do you hope to get from your audit?”

If you are looking for an independent CPA firm who believes that it is important to hold management accountable, then you should engage C.O.R.E.  If you want to feel good that the financial information you are using for decision-making is accurate, you should engage C.O.R.E.  If you want to understand how to better protect your neighbor’s hard earned money, then you should engage C.O.R.E.

If you are interviewing audit firms for your association, you may want to think about asking the following questions of the prospective firms:

  • Have you ever had a disagreement with management?  If so, explain the disagreement and how it was handled
  • Who do you believe is responsible for the preparation of the financial statement?
  • What steps do you take to ensure that client money isn’t misappropriated by management?
  • How do you handle GAAP departures when management doesn’t record a transaction correctly?
  • What are the three biggest weaknesses you see in association accounting overall?
  • Who do you believe is your client?
  • Have you ever caught management doing something which showed a significant weakness in the internal control structure?
    • What did you say about it?
    • Did you help management resolve it?
    • Did you help the board understand the weakness and how to address it in the future?

Each of these questions will give you insight into how the auditor might respond to your particular needs when it comes to auditing your association’s financial statements.  It is important to remember that your role, as directors, is oversight, not operations.  You are there to make sure that the management team you hired is presenting accurate information that you can use in making decisions about your association.

You want to make sure your auditor takes their role as independent, objective auditors seriously.  They do not need to go out of their way to find fault with management, but the reality is, they have almost total control over how your money is being spent.  You should want your auditor to focus on their spending of your money to ensure it is done to support your association.

As a director, you want to feel confident that the financial information that management presents is accurate and follows some standard.  How your auditor handles a GAAP departure could be important as the more management does things “their own way” the harder it is for you and your neighbors to follow it.  Make sure your auditor challenges management’s accounting treatment so you get the best information possible.

You want to feel confident that your auditor is looking for risk of material errors.  Your auditor should have a strong idea of what could go wrong and plan the audit for those key risk areas.  Thinks like spending money over the approved budget; paying themselves above their contract without the board reviewing the additional charges; hiring businesses where there is a conflict of interest.  The auditor should be on the look-out for those activities.

Keep in mind that the auditor works for the board.  This means you will want to interview the auditor and approve the audit engagement letter.  The audit is focused on management’s work so you never want to allow management to select the auditor.  Keeping these questions and approach in mind will help you get the maximum value from your audit and auditing professional.

Have a great Monday.

 

Auditor Relationship

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

I have written about this before but it is probably worth repeating.

In a meeting today we were told “management’s expectation”… that we are part of the team.  Somewhere there is a misunderstanding as we are not part of any team.

To be clear:

Auditors are engaged by the board of directors to independently audit management on behalf of the owners or others who contractually require an independent check on the financial reports being issued..

The key term there is independently.  To be effective, auditors must be independent of management.  So, how can an auditor remain independent while also being part of “the team?”  We really can’t and we definitely shouldn’t.

Part of the confusion is no doubt that some auditor’s have billed this as a team effort to provide information to the owners.  I have seen proposals by firms which essentially tout this approach; but it is not quite accurate to say this.  I would argue it is against auditing standards to say that you, as an independent auditor, are going to help management through their tough spots.  The independent auditor is not the clean-up position.  We are not fixers.  Finding the error, correcting the error and then expecting the entity to pay for it, when they have already paid management (and the accounting department) to get it wrong defeats the purpose of auditing the books.

Remember: Boards set policy.  Management implements policy.  Auditor’s verify that the implementation was correct.  If it isn’t, well, that is a problem.  It will obviously need to be cleaned up.  The problem is that when the auditor cleans it up, they are actually stepping into management’s role.  Acting as management impairs independence.  There are numerous ethics rulings on this matter.   The auditor is only as good as their independence by the way.  So why would we do it?

By the way, management has access to lots of consultants and CPA’s who could help them get the information right to begin with.  It isn’t like no one would help them.  But when it is done wrong and you expect the auditor to fix it, you are waiting far too long.  Months, possibly even longer than a year has gone by with the incorrect information being reported over and over.  Every report was inaccurate and somehow my pointing it out during the audit means I am not a team player?  Where is management’s responsibility in this?

Management could even have requested the board to make the auditor available to explain the expectations.  We love to talk (most of us anyway) and help you make sure it is right.  Believe it or not, we often sit around and dream about how awesome it would be to have the perfect audit – where everything balanced, management adjusted for all the issues before we brought it up, every receivable was collected and nothing ever happened after the balance sheet date.  We would be happy with just 10% of that truth be told.

Truthfully, we can’t be on your team.  We might like you, hell, you could be the greatest thing since sliced bread and we are going to be envious of your stock options and bonuses; but we can’t support you.  Our job, remember, is to make sure your stock option and bonus isn’t clouding your judgement when you decided to record a transaction.  Our responsibility is to ensure that you didn’t record only one part of the transaction to ensure you hit your target to keep your cushy job.  It isn’t that we don’t trust you but… oh who am I kidding, it is precisely that we don’t trust you.  You are management after all.

So, record the transactions.  Document compliance with policy.  Keep your financial statements in accordance with GAAP.  Or don’t.  But don’t blame the auditor when we find the work lacking.  We are doing our job of keeping “the team” honest and we make no apologies for it.

When Assessments become loans

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We had an interesting one come up last week.  A 100 unit condo Association passed the following in a resolution:

  • Monthly payments of $200 per month
  • Term of the assessment is for 10 years
  • The assessment is transferred to the buyer at time of sale unless the buyer demands it to be paid in full at time of sale

This passed in February of 2016.  The association waived the 2016 audit (not wise) and then contacted us for a 2017 audit.  The dilemma?  How should this transaction be recorded?

The board and management argued that it is a monthly, on-going assessment.  But we are not so certain that is the correct way to handle it.  As we dug deeper we discovered:

  • Bank loan with a principal balance of about $1.8 Million dollars at 4.0% interest
  • Monthly payments on the loan of $20,000
  • Can pay any amount of principal after year 3 of the loan

We believed their assertion was incorrect and requested they capitalize the full receivable as a loan.  Our reasoning?

  • The present value of the payment stream could be calculated using the interest rate provided by the bank as the minimum interest charged
  • The assessment was directly tied to the repayment of the bank loan
  • The assessment was assumable but only if the buyer accepted it, otherwise it had to be paid in full at time of settlement

It is important because most state laws require disclosure of outstanding balances due from owners.  There is a huge difference between stating that the amount in arrears on an assessment is $0 and there is a $20,000 special assessment balance outstanding.  In some instances, the amount disclosed on the resale certificate is the maximum amount of liability that the buyer can assume at closing.  Management disclosed the seller’s maximum amount due on the disclosure.

Finally, since the buyer could assume, but didn’t have to, all the available evidence indicated that it should be treated as a loan to the owners.

Now there is a 10 year receivable to record.  There is interest to charge to the owner which splits their payment into two parts – principal and interest.  And because they didn’t adjust it correctly for 2016, the Association’s cost for the financial statement is going to almost double to correct for the prior year.

All of this could be avoided by consulting with a CPA firm which specializes in association (CIRA) accounting and auditing.  If you are a board that is looking at doing something that hadn’t been done before, it will be well worth the few hundred dollars you will be charged to get an idea of the complexity involved in accounting for the activity.  Can your management handle this type of transaction?  Will their software perform the calculations correctly?  How will our reports change?  All of this is as important as making sure you legally dot your “I’s” and cross your “T’s”.  Otherwise, don’t be surprised when your auditor says, “No, sorry it can’t work that way.”

Ask your accountant or feel free to reach out to us.  We are happy to assist you in any way we can as a little work up front can stop a landslide later.

At C.O.R.E. Services, we focus on being a strong independent check on management and their assertions. Which is why we enjoy working with Property Owner Associations. The boards are dedicated but typically outsource the management who record the transactions and prepare financial statements for the board to review. Our audits are designed to help the board and owners rely upon those statements. You can find more information about us on our website.

Complexity

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The past 10 days has seen us dealing with a lot of challenges which come about through complex entities trying to be simple.  Most of the challenges come from participants claiming they don’t understand but in reality it is they don’t want to pay the underlying cost of their organization structure.

The condominium association where the board didn’t want to address the interest charges to owners for financing a special assessment over 10 years.  Their stated argument was that they were trying to keep it simple.  The real issue was that they didn’t want to pay a manager or accountant money to track the owner accounts.  Eight years later, they need to perform a new special assessment to come up with the shortfall that is owed the bank.  This is going to be complex.

The investment partnership which wants to shift income between partners.  They crafted a simple partnership agreement and right from the beginning started doing this.  In the beginning they had lots of equity so the tax preparer was not worried about the unequal distributions.  Five years later six of eight members have negative capital accounts and it needs to be fixed.  They created a complex structure and thought a simple partnership agreement would allow them to do what they wanted.  They didn’t understand.   The truth is they didn’t want to pay someone to manage the complex modeling of the cash flow reallocation to ensure it was done correctly.  It is their profit after all.

The Corporation who borrows money from the bank and then retires their majority shareholder.  They write an agreement which says that the Company will repurchase 1/10th of the shares every year for the next 10 years.  At a stated price.  And then they fire the accountant who tells them they need to record a $5.0 Million debt – which of course puts them out of compliance with the bank.  They find a more accommodating CPA to prepare the financial statement.  Bank still finds out and calls the bank loans.  They didn’t understand GAAP.  No, the didn’t want to pay for effective advice.

Complexity has a price.  If you don’t want to pay higher prices, keep it simple.  There are no rules which say that profit can’t be distributed equally amongst all partners.  Shockingly  simple.  There is no rule which says you can’t buy back the owners shares.  But you should probably discuss that with the bank before you borrow money.  And then talk with someone who knows what GAAP might have to say about that kind of transaction.

The old adage is very true: Pay me now or pay me more later.  Alright I confess I added the more but it should have always been there.  It is never cheaper to fix the problem later.  NEVER.

There is another old saying: Accountants have the magic wand and attorneys have the way back machine.  Notice though that you have to go to the true wizards of Oz to fix the problem.  Accountant’s to create the numbers to correct the problem you created and the attorney to create the right paperwork at the right time.  In hindsight.

Today is about clichés apparently.  I believe it was Einstein who said, “A problem can never be solved by the same intellect which created it.” or something to that effect.  What this means, in my world, is that the client goes to one accountant and lawyer to “be simple” and then fires them to find someone to fix the “complexity”.  That means coming up to speed, understanding what you originally did, and then trying brainstorming for hours trying to come up with a plausible solution.

Yes, there is a better way.  Plan for complexity.  Accept that some modes of transacting business require new, or at least different, processes.  Maybe new software; perhaps a new department; perhaps a new legal structure.

The entities above each spent under $2,500 to create the original simple way they wanted.  Each has to be in excess of $20,000 to fix the problem.  I don’t think planning to deal with complexity right up front would have cost anywhere near the cost to fix it.

Complexity.  You will pay for it.  The smarter play is to accept it upfront and make it a cost of being in business.  Or don’t.  You simply pay more to fix it.

Have a great weekend.