It’s worth it

This week, well actually almost this entire month, has been trying to overcome bad advice and management practice which was provided to a client.  I would love nothing more than to share names, opinions, and actions which got this entity into the mess they are in but that won’t solve the problem.  It would make me feel a whole lot better though.

Last night, after spending another 7 hours trying to figure out how to take incorrect balances and make them right, while at the same time trying to write the letter which explains to them why they now owe new balances, I asked myself, “Is it truly worth it?”

And when I almost convince myself to really question what I am doing, I think about the poor accounting clerk at the unnamed management company who, several years ago, no doubt discovered that what was being done, was wrong.  This accountant, filled with the righteous fury of making accounting meaningful, marched up to the unnamed boss at the management company, and laid out the facts.

“We are wrong.” The intrepid accounting person said.

“You are fired.” Said the boss.

Shooting the messenger is so much a part of the game isn’t it?  When things are not going well, it is easier to get rid of the those who question the steps, who report the unpleasantness, than to deal with the problem.  For the people who don’t want to hear it, they get silence and are grateful.  The ones who sounded the warning likely become gun shy and possibly vow to never raise a concern again.  There mantra might become, “It’s just how they do it here.”  Without realizing that by mouthing the phrase, they too become caught in the trap of decay.

Let’s be clear.  I think that when you start to simply accept poor behavior you become part of the problem.  When you see your manager using the company car on weekends, the same week you were involved in a termination of an employee who borrowed a work hammer, and you are silent, you are part of the problem.  Excusing the behavior of the manager simply because she is manager means that the rot won’t end.

Wrong is wrong.  Oh don’t misunderstand, no one will thank you for taking the stand.  Not your boss, not your bosses boss.  If you are lucky, you keep your job but get stuck with the title SNITCH.   But maybe, just maybe, people will start acting a little more ethical, at least in your presence.  And maybe, just maybe, they will act a little more ethically all the time because frankly it is too much work always looking over their shoulder to see if you are watching.

To that accounting clerk who, years ago, noticed that their employer was doing something completely wrong and called them on it, I thank you.  I know you tried and you succeeded.  Perhaps not as quickly as you might have hoped long ago but you are being vindicated.

One journal entry at a time.

Is it worth it?  Yes.  Doing right by people isn’t a zero sum game, it is the easiest way to live.  And like any questing knight, when you see people not wanting to correct a mistake, don’t be afraid to call them out.  Do it for the sake of the game, not because you expect an atta’ boy (or girl).  The greatest rewards in life are from within, when you can lie your head on the pillow and say, “Thank you, me, for a job well done.”

Why GAAP matters

Sadly I am not allowed to say too much about today’s meeting as the board was in executive session but the gist of the other accountant’s opinion is that economic reality doesn’t matter only the legal form of a transaction.

Really?

When pressed about how that could possibly be the case since contractors obviously have earned a certain amount of revenue based upon an economic theory, the reply was, “Well you can’t confuse for profit with non-profit.”

Really?

When asked how, when a contract shows the total amount due or, if you elect you can pay a sum each month over XXX number of months and it includes interest at Y%, this someone does not create a sum certain for accounting purposes,  there is not somehow some understanding that the sum certain is a receivable, the replay was, “The contract says it is revenue only upon the payment of the monthly amount.”

Really?

The board naturally is confused.  Rightly so.  Two professionals, two different opinions, one type of transaction.

Except that one professional has a position backed up by research on the application of GAAP and how the Accounting Standards Codifications call for the transactions to be recorded.  The other is an opinion based upon his 30+ years of experience so he doesn’t need to know GAAP.

Honestly, if I were the board I would fire us both.  Me for yelling at a dumbass accountant who thinks that if he appeases his fired client he will continue to reap referrals and the other accountant for being a dumbass and trying to provide accounting 101 lessons.

I was wrong to lose my temper.  At the end of the day the treatment we selected is appropriate and consistent with GAAP.  But there was almost $2,500 of billing listening to a lecture of how debits are on the left and credits are on the right.  I was infuriated not for myself but the fact that these board members have owned and run businesses, sat on boards and really do understand the basics of accounting theory.  They paid $2,500 to listen to a self-proclaimed expert prattle on how form matters over substance.

Each person in the room understands that Enron happened.  That WorldCom cost them and their friends dearly.  When no matter how you cut it, you can’t incur an expense without the expectation that there exists a pool of resources to pay the attendant liability. And one expects their financial statements to reflect the reality of that situation.

GAAP exists for a reason.  GAAP doesn’t reflect – or rather should not reflect – the mere form of a transaction.  GAAP reflects economic reality.  And it does matter.  Because the next time you go to buy a home and you look at the books and it shows zero receivable from the owners and a bank liability of any amount, please understand, you are likely facing a special assessment only no one wants you to know.  And, had those books been properly kept on GAAP, you would have known the problem exists.  You probably still would have bought but at least you won’t be able to say (with a straight face) that you weren’t warned.  Which is the whole point of a financial statement anyways – to help you make better investing decisions.

So, GAAP is GAAP.  If you are bothered by the fact that your accounting is complex, look to the reality of your transaction as it is likely complex.  The further you get from doing work and billing for it, the more complex you make accounting in addressing your transactions.  Don’t blame the accountants… We are simply the messengers.

What did I say?

I guess I stepped in it today.

On my other blog for CORE, I wrote today about independence, you know that little section of rules which constrain the CPA from essentially reporting on their own work.

  • Yes, I know that it is done;
  • Yes, I know it is done all the time;
  • Yes, it is a literal interpretation;
  • No, I don’t think you should try and paper it over.

Two reports require the CPA to be independent of the client and management: Audit and Review.  No one is forcing the CPA firm to perform an audit or a review.  If you want to be part of management, I say GO FOR IT!  Help management get their act together.  Help them adjust their books and, more importantly, know when they need to debit this and credit that.  Help them, but don’t come back and then claim your independence isn’t impaired.

Impairment of independence isn’t just a factual matter.  Yes, you can create lots of paper which says that Ms. Whatshername, the a/p clerk, understands what you are doing on her behalf and she is ok with you making that journal entry for her.  But when you are brought in to re-enter the entire accounts payable because Ms. Whatshername didn’t enter anything and the controller was fired so there is no one to check your work… don’t push your luck.

The appearance of impairment is even more important for those reviews and audits.  You are dealing with the integrity of the profession when you ignore what some other person might think about your independence, or lack of it.  If it looks to an innocent person that you are doing the work of management, well, guess what?  You are.

To paraphrase a letter which went from an association to the owners of a condominium:

  • Management way back when got it wrong
  • New management starting in 20XX got it even more wrong
  • New management denied their work was wrong consistently from then until now
  • New management denied it was wrong even after being beat over the head with it
  • Board hired independent CPA to redo management’s work
  • Independent CPA recalculated the numbers, resulting in a major change
  • The CPA says their work is correct
  • And, you can rely upon the CPA for this because they are trustworthy

Sorry, but that wonderful letter praising the CPA now means the CPA probably is no longer independent as to the financial statement audit.

Their work was awesome.  Totally correct.  Nailed it to within $0.02 for every owner.  Told the attorney and the board they were right and said so in a letter to the owners.  they were worth every dime they were paid to fix the mess.

But their independence is now impaired.  There is no one, not management, not the board, definitely not the attorney, who is going to take responsibility for the CPA’s work.  The CPA owns it.  They said so.  Under the rules, both of the AICPA and common sense, they are no longer independent of the client.

No independence no audit.

I get it, it is my interpretation.  Well… Not really.  It is 20 odd years of practicing in this area and reading hundreds of ethics interpretations.  It is having to struggle with deciding when we cross a line and are no longer looked at by Tommy Banker or Amanda Bonding Agent as separate from management.  When the question is, “Are you getting paid to help management or to report on them?”; it does become a little more clear.

Attest firms MUST err on the side of caution.  The big 4 don’t, the next 8 don’t.  Their failures don’t give the rest of us license to slide down that wonderful chute into impairment hell.  Take the road less traveled but best for your client.  Have integrity to admit your lack of independence when it exists.

Make the right call.  Help management or report on them.  If you can’t tell the difference, well, you probably shouldn’t be playing this game.

 

Debit This, Credit That, isn’t that Accounting?

Sometimes all you can do is simply stare at a speaker and wonder what is going through his mind.  “Accounting says you have to debit receivables and credit revenues.”

Um, no.

Accounting makes no such claim.  Effective accountants (and auditors) know that often earning revenues is divorced from demands for payment.  Demanding payment is a contract right – your attorney might require a retainer, your roofer wants a deposit, you want to be paid for the feet of pipe laid; but none of these are revenues. Yet.

Accounting is about reporting the economic substance of a transaction.  Accounting has to look for features which support the premise that the efforts necessary have been expended and accepted by the buyer in order to record revenue.  It doesn’t have to be hard, but it does have to be consistently applied.

Take for example, that piping contractor.  Let’s say he has a contract to

  • Dig a 1,000 foot ditch for $20/foot
  • Lay 1,000 of 24″ concrete pipe at $18/foot
  • Backfill and compact the trench for a lump sum of $8,000

The contract requires that the contractor submit a schedule of values (work completed) in order to be paid.

On the first billing, the contractor submits the schedule for the 1,000 feet of ditch dug for $20,000.  The effective accountant does not immediately do this for the invoice:

  • Accounts Receivable       $20,000
  •     Contract Revenues                         $20,000

That is because the rules for recognizing revenues is not based upon something as arbitrary as a schedule of values.  The smart accountant understands that the true measure of the revenue for a contractor is based upon an analysis of costs expended to actual anticipated costs.  So the accountant creates a little spreadsheet:

Anticipated Period Actual
Contract Revenue Costs Gross Profit Costs % Complete Revenue Billings Over/Under CIE BIE
ABCD     46,000   35,000          11,000   6,500 18.57%       8,543   20,000          11,457     –   11,457

The Company incurred only $6,500 of costs in the period.  This represents less than 20% of the total anticipated costs for the project.  The reality is, the contractor front-loaded the bid.  This is perfectly acceptable – provided the owner accepts the schedule of values and is a great way to get project funds in early.  But, GAAP says to recognize the contract’s revenue based on the relationship between actual costs incurred and the estimated total costs to complete.

In this case, only 18.6% of the project costs were incurred so really only 18.56% of the contracts revenues are earned.  The remainder is considered unearned revenues or, in construction accounting parlance, Billings in Excess of Costs and Gross Profits.  The accounting principle is called the percentage of completion method of accounting for long-term construction contracts.  The rule says that the form – the schedule of values – is not the appropriate measurement for recording revenues: The comparison of actual to anticipated costs is the appropriate basis for recording revenues.  Economic substance over the form.  $8,500 not $20,000 for revenues.

Accounting is more than debits and credits.  That is, assuming you need to know what is actually happening economically in an enterprise.  Most non-employee investors in a business should be thinking about the true substance of transactions and how they impact today’s profits and tomorrow’s cash flows.  Revenues and profits generate true cash flow, not the other way around.  The effective accountant knows this is far more important than debits and credits.