Using accounting to deceive

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

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.

Financial Statement Compliance

Doug and I were primarily responsible for audits and reviews and Currie & McLain CPA’s and this has rolled over to our new venture C.O.R.E. Services, LLC .  While we focus our efforts almost exclusively on audits of condo and homeowner associations, we also provide review services for clients of smaller CPA firms in Oregon and Washington who prefer to focus on income taxes. We think it can be a great partnership all the way around.

We conducted many financial statement reviews during 2017.  And, as odd as it sounds, each of them was facing a going concern problem.  While this is not a rehash of the new accounting standards for going concern, we did want to point out what we look for and what management needs to consider.  This can be very important with your year-end possibly approaching and you want the review to be completed early.

For the clients whose financial statements we reviewed this year, the number one driver of the going concern evaluation was non-compliance with bank covenants. For instance, your loan agreement may state that your business must maintain a current ratio of 1.25:1.00.  This means that you must have $1.25 in current assets – cash, a/r, inventory to every dollar of current liabilities – a/p, accrued payroll, current maturities of debt.

Another covenant we typically see is some sort of debt coverage ratio.  This is typically calculated as the current debt obligation divided by earnings before interest, taxes, depreciation and amortization (EBITDA).  if it says you must have a coverage ratio of 1:1, then if you have $1.0 Million of current debt obligations you need to earn $1.0 Million in EBITDA.

The problems arise when one or both of these are missed and missed by a lot or for multiple years.  Most of the financial statements we reviewed reported a second or third year where the current ratio and/or the debt coverage ratio were well below the requirement.  The problem is that, technically, the bank can call the debt, forcing the owners into very painful decisions.

What can management do?  Well, the first step is to admit the problem.  Non-compliance with bank covenants should not be a surprise to management, the owners or the bank.  Typically, the bank will require some sort of plan to address the covenant violation.  This may be as simple as a cash flow projection to a complex plan to sell assets and lease them back to generate cash to pay down a line of credit.  Whatever you do, don’t bury your head in the sand.

The second step is to prepare a disclosure for your financial statement.  Now, I know that typically you expect your accountant to write up the notes but this is one where you may want to be involved.  Your company is on the line and the reader, i.e. the credit officer at the bank, may well decide that your plan can’t deal with the problem and start creating solutions for you.

If you would like some ideas of how to disclose the going concern issue and your plan, let us know  by writing to info@core-acct.com and we will be happy to send you an outline of the disclosure we have clients complete.  The vital thing though is to provide enough detail that the reader can see the issue and understand your plan without investing so many hours that it distracts you from the issue of running the business.

The third step is to get the bank to issue a waiver or forbearance on compliance.  Stay in control here because this can become a circular problem since the bank will want the reviewed financial statement to know where your business is and the accountant will not want to issue the reviewed financial statement without the forbearance.  It requires a good deal of communication to make this work and it is very helpful if you can get them together for a conversation.

A going concern issue is possibly the single biggest financial statement headache you are likely to ever have to address.  Get in front of it early and work closely with your bank on getting approvals in place and with your accountant to draft the plan for inclusion in the notes and it is very likely that you can still meet a respectable turnaround time for producing the financial statements.

Have a great Monday.