Anderson ZurMuehlen Blog

5 Common Sources of Substantive Audit Evidence

Do you understand how auditors verify account balances and transactions? This knowledge can minimize disruptions when the audit team visits your facilities and maximize the effectiveness of your audit. Here’s a list of five common sources of “substantive evidence” that auditors gather to help them form an opinion regarding your financial statements.

1. Confirmation letters. Auditors send letters to third parties, such as customers or vendors, asking them to verify amounts recorded in the company’s books. There are two types of confirmations: A positive confirmation requests that the recipient complete a form confirming account balances (for example, how much a customer owes the company). A negative confirmation requests that the recipient respond only if the balance is inaccurate.

2. Original source documents. Auditors can verify an account balance or record by vouching (or comparing) it to third-party documentation. For example, an auditor might verify the existence of a vehicle on your fixed asset list by reviewing the invoice from the seller. Vouching enables an auditor to evaluate the accuracy of the amount claimed by the company and whether the company recorded the transaction correctly in its accounting system.

3. Physical observations. Seeing is believing. So, auditors sometimes verify the existence of assets through physical observations and inspections. For example, inventory audit procedures typically include observing or conducting a physical inventory count, inspecting the process to record incoming and outgoing inventory, and analyzing the inventory obsolescence process.

4. Comparisons to external market data. For assets actively traded on the open market, auditors may confirm the amounts claimed on the company’s financial statements by researching pricing data. For example, if the company invests in marketable securities that it plans to sell within one year, an auditor could analyze the prevailing market price to confirm their book value. Likewise, a random sample of parts inventory could be compared to online pricing sheets to confirm that items are reported at the lower of cost or market value.

5. Recalculations. Auditors may verify in-house schedules and records by re-creating them. If the auditor’s work matches the client’s work, it confirms that the underlying accounts appear reasonable. Auditors often rely on this procedure for such items as bank reconciliations and schedules of payroll-related expenses (for example, overtime, benefits and tax payments).

Let’s work together

An effective audit requires coordination between auditors and their clients. Before audit season starts, let’s discuss the types of substantive evidence we expect to gather for each major financial statement category. We can help you anticipate document requests and inquiries, thereby facilitating audit fieldwork.

© 2017

 

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Not Necessarily a Luxury: Outsourcing

For many years, owners of small and midsize businesses looked at outsourcing much like some homeowners viewed hiring a cleaning person. That is, they saw it as a luxury. But no more — in today’s increasingly specialized economy, outsourcing has become a common way to cut costs and obtain expert assistance.

Why would you?

Outsourcing certain tasks that your company has been handling all along offers many benefits. Let’s begin with cost savings. Outsourcing a function effectively could save you a substantial percentage of in-house management expenses by reducing overhead, staffing and training costs. And thanks to the abundant number of independent contractors and providers of outsourced services, you may be able to bargain for competitive pricing.

Outsourcing also allows you to leave administration and support tasks to someone else, freeing up staff members to focus on your company’s core purpose. Plus, the firms that perform these functions are specialists, offering much higher service quality and greater innovations and efficiencies than you could likely muster.

Last, think about accountability — in many cases, vendors will be much more familiar with the laws, regulations and processes behind their specialties and therefore be in a better position to help ensure tasks are done in compliance with any applicable laws and regulations.

What’s the catch?

Of course, potential disadvantages exist as well. Outsourcing a business function obviously means surrendering some control of your personal management style in that area. Some business owners and executives have a tough time with this.

Another issue: integration. Every provider may not mesh with your company’s culture. A bad fit may lead to communication breakdowns and other problems.

Also, in rare cases, you may risk negative publicity from a vendor’s actions. There have been many stories over the years of companies suffering PR damage because of poor working conditions or employment practices at an outsourced facility. You’ve got to research any potential vendor thoroughly to ensure its actions won’t reflect poorly on your business.

To further protect yourself, stipulate your needs carefully in the contract. Pinpoint milestones you can use to ensure deliverables produced up to that point are complete, correct, on time and within budget. And don’t hesitate to tie partial payments to these milestones and assess penalties or even reserve the right to terminate if service falls below a specified level.

Last, build in clauses giving you intellectual property rights to any software or other items a provider develops. After all, you paid for it.

Need more time?

Outsourcing may not be the right solution every time. But it could help your business find more time to flourish and grow. We can help you assess the costs, benefits and risks.

© 2018

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Find Time for Strategic Planning

As a business owner, you know that it’s easy to spend nearly every working hour on the multitude of day-to-day tasks and crises that never seem to end. It’s essential to your company’s survival, however, to find time for strategic planning.

Lost in the weeds

Business owners put off strategic planning for many reasons. New initiatives, for example, usually don’t begin to show tangible results for some time, which can prove frustrating. But perhaps the most significant hurdle is the view that strategic planning is a time-sucking luxury that takes one’s focus off of the challenges directly in front of you.

Although operational activities are obviously essential to keeping your company running, they’re not enough to keep it moving forward and evolving. Accomplishing the latter requires strategic planning. Without it, you can get lost in the weeds, working constantly yet blindly, only to look up one day to find your business teetering on the edge of a cliff — whether because of a tough new competitor, imminent product or service obsolescence, or some other development that you didn’t see coming.

Quality vs. quantity

So how much time should you and your management team devote to strategic planning? There’s no universal answer. Some experts say a CEO should spend only 50% of his or her time on daily operations, with the other half going to strategy — a breakdown that could be unrealistic for some.

The emphasis is better put on quality rather than quantity. However many hours you decide to spend on strategic planning, use that time solely for plotting the future of your company. Block off your schedule, choose a designated and private place (such as a conference room), and give it your undivided attention. Make time for strategic planning just as you would for tending to an important customer relationship.

Time well spent

Effective strategic planning calls for not only identifying the right business-growing initiatives, but also regularly re-evaluating and adjusting them as circumstances change. Thus, strategizing should be part of your weekly or monthly routine — not just a “once in a while, as is convenient” activity. You may need to delegate some of your current operational tasks to make that happen but, in the long run, it will be time well spent. Please let us know how we can help.

© 2017

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2018 Q1 Tax Calendar: Key Deadlines for Businesses and Other Employers

 

Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2018. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

January 31

  • File 2017 Forms W-2, “Wage and Tax Statement,” with the Social Security Administration and provide copies to your employees.
  • Provide copies of 2017 Forms 1099-MISC, “Miscellaneous Income,” to recipients of income from your business where required.
  • File 2017 Forms 1099-MISC reporting nonemployee compensation payments in Box 7 with the IRS.
  • File Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return,” for 2017. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it’s more than $500, you must deposit it. However, if you deposited the tax for the year in full and on time, you have until February 12 to file the return.
  • File Form 941, “Employer’s Quarterly Federal Tax Return,” to report Medicare, Social Security and income taxes withheld in the fourth quarter of 2017. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until February 12 to file the return. (Employers that have an estimated annual employment tax liability of $1,000 or less may be eligible to file Form 944,“Employer’s Annual Federal Tax Return.”)
  • File Form 945, “Annual Return of Withheld Federal Income Tax,” for 2017 to report income tax withheld on all nonpayroll items, including backup withholding and withholding on accounts such as pensions, annuities and IRAs. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the year in full and on time, you have until February 12 to file the return.

February 28

  • File 2017 Forms 1099-MISC with the IRS if 1) they’re not required to be filed earlier and 2) you’re filing paper copies. (Otherwise, the filing deadline is April 2.)
  • March 15
  • If a calendar-year partnership or S corporation, file or extend your 2017 tax return and pay any tax due. If the return isn’t extended, this is also the last day to make 2017 contributions to pension and profit-sharing plans.

Contact us with questions.

© 2017

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Prepayment of Certain 2018 Expenses by Cash Basis Taxpayers May Yield Deduction Benefit in 2017 Due to Potential Tax Reform

As the Tax Cuts and Jobs Act makes its way through the House and Senate Conference Committee and put up for vote in both houses of Congress this week, cash basis taxpayers may be considering prepaying certain expenses in order to obtain relief from some of the Act’s provisions that eliminate or place limitations on tax deductions for taxable years beginning after December 31, 2017. For federal income tax purposes, cash basis taxpayers generally can take into account amounts representing allowable deductions in the taxable year in which paid. However, prepaying a 2018 liability or expense in 2017 without an obligation to do so is not a valid deduction, even for a cash basis taxpayer. Based on case law, the prepayment of the liability or expense could be challenged by the Internal Revenue Service because the payment lacks business purpose or fails to clearly reflect income. Further, if the benefit period or useful life associated with the prepaid expense exceeds 12 months, the payment is required to be capitalized and amortized. That said, to the extent that the taxpayer has an invoice in hand by year-end or the consideration to which the liability relates has been provided by year-end, and the benefit period does not exceed 12 months, cash basis taxpayers that prepay expenses in 2017 for 2018 expenses can claim a deduction in 2017.

Details

Tax Reform

On December 15, 2017, the House-Senate Conference Committee members working on the House and Senate tax reform bills signed off on a revised bill. Issued that evening, the full language of the Tax Cuts and Jobs Act (H.R. 1) encompasses over 1,000 pages, including a 570-page joint explanatory statement describing key differences, if any, between the House and Senate tax reform bill, and a summary of the resolution of such differences in the revised bill. The revised bill will be sent to both houses of Congress during the week beginning December 18, 2017, for a vote and could set the stage for the bill to be signed by the President prior to the end of 2017.

Among the many provisions affecting individuals and businesses, this alert specifically discusses the (1) modification of deduction for taxes not paid or accrued in a trade or business; (2) repeal of certain miscellaneous itemized deductions subject to the two-percent floor; and (3) entertainment expenses.

Modification of deduction for taxes not paid or accrued in a trade or business (section 164 of the Code). Under the revised bill, individuals generally can deduct State, local, and foreign property taxes and State and local sales taxes only when paid or accrued in carrying on a trade or business, or an activity described in section 212 (relating to expenses for the production of income). Accordingly, the provision allows only those deductions for State, local, and foreign property taxes, and sales taxes, which are presently deductible in computing income on an individual’s Schedule C, Schedule E, or Schedule F on such individual’s tax return. For example, in the case of property taxes, an individual may deduct such items only if these taxes were imposed on business assets (such as residential rental property).

Under the provision, in the case of an individual, State and local income, war profits, and excess profits, taxes are not allowable as a deduction.

The provision contains an exception to the above-stated rule. Under the provision, a taxpayer may claim an itemized deduction of up to $10,000 ($5,000 for married taxpayer filing a separate return) for the aggregate of (i) State and local property taxes not paid or accrued in carrying on a trade or business, or an activity described in section 212, and (ii) State and local income, war profits, and excess profits taxes (or sales taxes in lieu of income, etc. taxes) paid or accrued in the taxable year. Foreign real property taxes may not be deducted under this exception.

The above rules apply to taxable years beginning after December 31, 2017, and beginning before January 1, 2026.

The conference agreement also provides that, in the case of an amount paid in a taxable year beginning before January 1, 2018, with respect to a State or local income tax imposed for a taxable year beginning after December 31, 2017, the payment shall be treated as paid on the last day of the taxable year for which such tax is so imposed for purposes of applying the provision limiting the dollar amount of the deduction.

Observation: An individual may not claim an itemized deduction in 2017 on a pre-payment of state or local income tax for a future taxable year in order to avoid the dollar limitation applicable for taxable years beginning after 2017. The prepayment in 2017 would have no direct link to taxable income for the 2018 tax year; therefore, a payment made to a state or local government in 2017 to apply against the taxpayer’s 2018 tax liability is merely a deposit for which no tax deduction is permitted. However, if the taxpayer has an estimated income tax payment due in April of 2018 based on 2017 taxable income, prepaying the tax in 2017 rather than 2018 would yield a proper deduction in 2017 and possibly generate the benefit of time value of money if tax rates fall in 2018.

Repeal of Certain Miscellaneous Itemized Deductions Subject to the Two-Percent Floor (Sections 62, 67, and 212 of the Code)

The conference agreement temporarily suspends all miscellaneous itemized deductions that are subject to the two-percent floor under present law. Miscellaneous itemized deductions include, for example, fees to collect interest and dividends, investment fees and expenses, tax preparation expenses, and unreimbursed business expenses incurred by an employee. Thus, under the provision, taxpayers may not claim items as itemized deductions for the taxable year beginning after December 31, 2017, and before January 1, 2026.

Observation: To the extent that the taxpayer has an invoice in hand by year-end or the consideration to which the liability has been provided by year-end, thereby establishing an obligation to pay on the taxpayer’s part, a cash basis taxpayer prepaying the expense in 2017 rather than in 2018 could reasonably claim a deduction in the earlier year, so long as the prepaid benefit period does not exceed 12 months.

Entertainment, etc. expenses (Section 274 of the Code)

Under the conference agreement, no deduction is allowed with respect to (1) an activity generally considered to be entertainment, amusement or recreation, (2) membership dues with respect to any club organized for business, pleasure, recreation or other social purposes, or (3) a facility or portion thereof used in connection with any of the above items. As a result, the provision repeals the present-law exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to (or, in certain cases, associated with) the active conduct of the taxpayer’s trade or business (and the related rule applying a 50 percent limit to such deductions).

In addition, the provision disallows a deduction for expenses associated with providing any qualified transportation fringe to employees of the taxpayer, and except as necessary for ensuring the safety of an employee, any expense incurred for providing transportation (or any payment or reimbursement) for commuting between the employee’s residence and place of employment.

Taxpayers may still generally deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel). For amounts incurred and paid after December 31, 2017, and until December 31, 2025, the provision expands this 50-percent limitation to expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer.

The provision generally applies to amounts paid or incurred after December 31, 2017. However, for expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer, amounts paid or incurred after December 31, 2025, are not deductible.

Observation: A cash basis taxpayer should take action to immediately pay any entertainment expense invoices and expense reports during 2017. If commitments exist for the 2018 year which are budgeted for (e.g., 2018 season tickets), the taxpayer is advised to request an invoice from the seller before year-end so that the amount can be prepaid in 2017.

Other Types of Expenses

There are a number of expenses that cash basis taxpayers may wish to consider prepaying in order to obtain a tax benefit in 2017. The federal tax treatment below assumes that the benefit period associated with the prepaid expense does not exceed 12 months.

MOVING EXPENSES

The conference agreement generally suspends the deduction for moving expenses for taxable years 2018 through 2025. However, during that suspension period, the provision retains the deduction for moving expenses and the rules providing for exclusions of amounts attributable to in-kind moving and storage expenses (and reimbursements or allowances for these expenses) for members of the Armed Forces (or their spouse or dependents) on active duty that move pursuant to a military order and incident to a permanent change of station. Taxpayers outside of the Armed Forces exception may wish to prepay an invoice in 2017 for 2018 moving expenses in order to take advantage of the moving expenses deduction before suspension.

HOME MORTGAGE INDEBTEDNESS

The conference agreement suspends the deduction for interest on home equity indebtedness. Thus, for taxable years beginning after December 31, 2017, a taxpayer may not claim a deduction for interest on home equity indebtedness. The suspension ends for taxable years beginning after December 31, 2025. In this regard, cash basis taxpayers should consider prepaying “points” charged in 2017 in order to take advantage of the home equity indebtedness deduction before the suspension period. Although a taxpayer must capitalize interest that is properly allocable to a period that extends beyond the close of the taxable year and amortize it over the period to which it applies, section 461(g)(2) provides an exception for points paid in respect of any indebtedness incurred in connection with the purchase or improvement of, and secured by, the taxpayer’s principal residence to the extent that such payment of points is an established business practice in the area in which such indebtedness is incurred and the amount of such payment does not exceed the amount generally charged in such area. Points paid in refinancings may not meet the exception.

PREPAID RENT

Accelerating a deduction from 2018 to 2017 can provide time value of money benefits to the extent that the tax rates drop in 2018. Generally speaking, prepaid rent can be deducted by a cash basis taxpayer in the year of payment so long as the lease agreement calls for rent to be prepaid prior to the beginning of the month to which the rent payment relates. Cash basis taxpayers must also be aware that the prepaid benefit period cannot exceed 12 months. Thus, for example, if the lease agreement requires January 2018 rent to be paid by the end of December, the lessee can claim an accelerated deduction by prepaying for the next month. On the contrary, if the lease agreement calls for January 2018 rent to be due on the first day of that month, prepaying in 2017 would not result in an earlier deduction.

© 2017

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Cutting Costs When You’ve Gone Over Budget

Year end can’t get here soon enough for some business owners — especially those whose companies have exceeded their annual budgets. If you find yourself in this unenviable position, you can still cut costs to either improve this year’s financial picture or put yourself in a better position for next year.

Tackle staffing issues

It’s easy to put off tough staffing decisions, but those issues may represent an unnecessary drain on your finances. If you have employees who don’t have enough work to keep busy, think about restructuring jobs so everyone’s productive. You might let go of extra staff, or, alternatively, offer mostly idle workers unpaid time off during slow periods.

You also need to face the hard facts about underperforming workers. Few business owners enjoy firing anyone, but it makes little sense to continue to pay poor performers.

Take control of purchasing

Are you getting the most out of your company’s combined purchasing power? You may have different departments independently buying the same supplies or services (for example, paper, computers, photocopying). By consolidating such purchases, you might be able to negotiate reduced prices.

To strengthen your bargaining power with suppliers when seeking discounts, pay your bills promptly. Even if it doesn’t help you land reduced prices, you’ll avoid late payment fees and credit card interest charges.

But don’t just continue to pay bills mindlessly. Review all of your service invoices — especially those that are automatically deducted from your bank accounts or charged to credit cards — to confirm you’re actually using the services. Consider canceling any services you haven’t used in 90 days.

Redirect your marketing efforts

Advertising costs can take a significant bite out of your budget, and the priciest efforts often have the lowest returns on investment. Cut programs and initiatives that haven’t clearly paid off, and move your marketing to social media and other more cost-efficient avenues — at least temporarily. A single, positively received tweet may reach exponentially more people than a costly directory listing, print ad or trade show booth.

A caveat

Resist the urge to solve your budget shortfalls with one dramatic cut — the risks are simply too high. The better approach is to execute a combination of incremental actions that will add up to savings. Contact us for a full assessment of your company’s budget.

© 2017

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Are You a US Shareholder Who Owns 10% or More of a Foreign Corporation? If So, This Bill’s Aimed at You…

You may or may not be following the US tax reform legislation that has dramatically worked its way through the House and the Senate.  A primary reason for the tax reform is to make the US a more tax-friendly environment for corporations.  Many provisions are geared toward this end, and much has been touted about changing corporate taxation.  The provision we are talking about here changes the US taxation of earnings in foreign subsidiaries.  Currently, US shareholders invested in foreign operating corporations are taxed on dividends their foreign corporations pay them (even though their foreign subsidiaries are probably already paying tax in the foreign country of incorporation).  The new provisions would reduce or eliminate the US tax on dividends those foreign subsidiaries pay their US shareholder(s).

As usual, the means to accomplish this end are complicated.  In order to transition between the two systems, the proposed legislation triggers tax on foreign earnings that have not been previously taxed by the US.  The tax on these foreign earnings would be at a special reduced rate (as yet to be determined, but probably somewhere between 7% and 15%).  The deadline to pay the tax is also to be determined, but it’s likely there will be an election available to spread the payments out over several years (the current draft is proposing 8 years).

This is all pretty wonky…so what does it mean?

Let’s talk in examples.  Say, for example, that you are a US citizen who has been living in Canada since you were 18 months old.  You grew up in Canada, got married in Canada, and your home is in Canada.  You own a plumbing business, which you have incorporated in Canada.  The customers you serve are only in Canada, the income your business generates is Canadian only, and your corporation pays Canadian income tax.

You and your Canadian spouse each own 50% of the company.  You are a US citizen so you have been diligently filing your US returns and reporting your foreign assets as is required.  Your US returns include extensive information about your corporation, but you don’t have to pay US tax on any of the corporation’s earnings unless the corporation pays you dividends.  The corporation doesn’t pay out all of its earnings as dividends each year because it’s growing and reinvesting in itself.  All is hunky dory.

But….

Along comes this new provision that says that the US wants to reduce the tax you pay on the dividends that your corporation pays you.  Great right?  However, to get you to that point, the US needs a clean slate on the undistributed earnings that have accumulated in your corporation.  To do that, the US is going to tax those earnings that haven’t already been paid out in dividends.  It doesn’t matter if those earnings haven’t been paid to you….. the US is going to tax them.  Period.

Why?

Well, the US wants to pull cash back into its borders.  It’s trying to trigger growth and jobs and other things that require cash funding.  So, the theory is if US shareholders are going to be taxed on the earnings anyway….. hopefully they’ll pull dividends out of their foreign companies and bring that cash back to the US.  Makes sense when you’re thinking about Apple or Google or another big multinational company headquartered in the US.  Doesn’t make as much sense when you’re thinking about a US citizen living and working abroad with minimal ties to the US.

Unfortunately, the details are still to be determined and we won’t know what they are until the House and Senate reconcile the two bills that have passed.  They’ve announced that they will start the reconciliation process on Wednesday the 13.  President Trump wants a bill on his desk by Christmas, so they are pushing hard to do that.  Will they?  It’s hard to say –but it’s likely a final bill will be ready for House and Senate vote soon.

So, what can you do?

Well…. unfortunately, probably not much.  In the proposed legislation, the testing date for undistributed earnings is as of a date earlier in 2017.  So you may already caught in the web.  The critical factor will be calculating your company’s Earnings & Profits, which is a US tax concept and it is what the tax will be based upon.

We are here to help you with this calculation and with the filings in general.  As we learn more about it, we’ll share that information with you.

They say in the long run it will reduce US taxation of foreign company earnings from operations, so there is that silver lining.

Contributed by Dana Cade, senior manager and Erin Stockwell, shareholder

© 2017

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7 Last-Minute Tax-Saving Tips

The year is quickly drawing to a close, but there’s still time to take steps to reduce your 2017 tax liability — you just must act by December 31:

  1. Pay your 2017 property tax bill that’s due in early 2018.
  2. Make your January 1 mortgage payment.
  3. Incur deductible medical expenses (if your deductible medical expenses for the year already exceed the 10% of adjusted gross income floor).
  4. Pay tuition for academic periods that will begin in January, February or March of 2018 (if it will make you eligible for a tax credit on your 2017 return).
  5. Donate to your favorite charities.
  6. Sell investments at a loss to offset capital gains you’ve recognized this year.
  7. Ask your employer if your bonus can be deferred until January.

Many of these strategies could be particularly beneficial if tax reform is signed into law this year that reduces tax rates and limits or eliminates certain deductions (such as property tax, mortgage interest and medical expense deductions) beginning in 2018.

Keep in mind, however, that in certain situations these strategies might not make sense. For example, if you’ll be subject to the alternative minimum tax this year or be in a higher tax bracket next year, taking some of these steps could have undesirable results. (Even with tax reform legislation, some taxpayers might find themselves in higher brackets next year.)

If you’re unsure whether these steps are right for you, consult us before taking action.

 

© 2017

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Demystifying the Audit Process

 

Independent auditors provide many benefits to business owners and management: They can help uncover errors in your financials, identify material weaknesses in your internal controls, and increase the level of confidence lenders and other stakeholders have in your financial reporting.

But many companies are unclear about what to expect during a financial statement audit. Here’s an overview of the five-step process.

1. Accepting the engagement

Once your company has selected an audit firm, you must sign an engagement letter. Then your auditor will assemble your audit team, develop a timeline, and explain the scope of the audit inquiries and onsite “fieldwork.”

2. Assessing risk

The primary goal of an audit is to determine whether a company’s financial statements are free from “material misstatement.” Management, along with third-party stakeholders that rely on your financial statements, count on them to be accurate and conform to U.S. Generally Accepted Accounting Principles (GAAP) or another accepted standard.

Auditing rules require auditors to assess general business risks, as well as industry- and company-specific risks. The assessment helps auditors 1) determine the accounts to focus audit procedures on, and 2) develop audit procedures to minimize potential risks.

3. Planning

Based on the risk assessment, the audit firm develops a detailed audit plan to test the internal control environment and investigate the accuracy of specific line items within the financial statements. The audit partner then assigns audit team members to work on each element of the plan.

4. Gathering evidence

During fieldwork, auditors test and analyze internal controls. For example, they may trace individual transactions to original source documents, such as sales contracts, bank statements or purchase orders. Or they may test a random sample of items reported on the financial statements, such as the prices or number of units listed for a randomly selected sample of inventory items. Auditors also may contact third parties — such as your company’s suppliers or customers — to confirm specific transactions or account balances.

5. Communicating the findings

At the end of the audit process, your auditor develops an “opinion” regarding the accuracy and integrity of your company’s financial statements. In order to do so, they rely on quantitative data such as the results of their testing, as well as qualitative data, including statements provided by the company’s employees and executives. The audit firm then issues a report on whether the financial statements 1) present a fair and accurate representation of the company’s financial performance, and 2) comply with applicable financial reporting standards.

Reasonable expectations

Understanding the audit process can help you facilitate it. If your company doesn’t issue audited financials, this understanding can be used to evaluate whether your current level of assurance is adequate — or whether it’s time to upgrade. Contact us for additional information.

© 2017

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Valuing and Reporting Gifts in Kind and Donated Services

 

Not-for-profit organizations don’t receive only cash donations. Your support also likely comes in the form of gifts in kind and donated services. But even when such gifts are welcome, it can be challenging to determine how to recognize and assign value to them for financial reporting purposes.

Recording gifts in kind

Gifts in kind generally are pieces of tangible property or property rights. They may take many forms, including:

• Free or discounted use of facilities,
• Free advertising,
• Collections, such as artwork to display, and
• Property, such as office furniture or supplies.

To record gifts in kind, determine whether the item can be used to carry out your mission or sold to fund operations. In other words, does it have a value to your nonprofit? If so, it should be recorded as a donation and a related receivable once it’s unconditionally pledged to your organization.

To value the gift, assess its fair value — or what your organization would pay to buy it from an unrelated third party. In many cases it’s easy to assign a fair value to property, but when the gift is a collection or something that doesn’t otherwise have a readily determinable market value, its fair value is more difficult to assign. For smaller gifts, you may need to rely on a good faith estimate from the donor. But if the value is more than $5,000, the donor must obtain an independent appraisal for tax purposes, which will give you documentation for your records.

Recognizing donated services

The fair value of a donated service should be recognized if it meets one of two criteria:

1. The service creates or enhances a nonfinancial asset. Such services are capitalized at fair value on the date of the donation. These types of services either create a nonfinancial asset (in other words, a tangible asset) or add value to an asset that already exists.

2. The service requires specialized skills, is provided by persons with those skills and would have been purchased if it hadn’t been donated. These services are accounted for by recording contribution income for the fair value of the service provided. You also must record it as a related expense, in the same amount, for the professional service provided.

Beyond the basics

These are only basic guidelines to recognizing and valuing gifts in kind and donated services. For more comprehensive information about handling these gifts, contact us.

© 2017

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