Monthly Archives: April 2018

Auditing work in progress

Category : Blog , sccm

Financial statement auditors spend a lot of time evaluating how their clients report work in progress (WIP) inventory. Here’s why this account warrants special attention and how auditors evaluate whether WIP estimates seem reasonable.

Accounting for inventory

Companies must report the value of raw materials, WIP and finished goods on their balance sheets. WIP — which includes partially finished products at various stages of completion — relies on the use of estimates. As a general rule, the more raw materials, labor and overhead invested in WIP, the higher its value.

Most experienced managers use realistic estimates, but inexperienced or dishonest managers may inflate WIP values. This can make a company appear healthier than it really is by overstating the value of inventory at the end of the period and understating cost of goods sold during the current accounting period.

Accounting for costs

Companies assign manufacturing costs depending on the type of product they produce. When a company produces large volumes of the same product, they allocate costs as they complete each phase of the production process. This is known as standard costing. For example, if a production process involves six steps, at the completion of step three the company might allocate 50% of their costs to the product.

On the other hand, when a company produces unique products — such as the construction of an office building or made-to-order parts — they typically use the job costing system to allocate materials, labor and overhead costs as incurred.

Analyzing WIP

Auditors focus substantial effort on analyzing how companies quantify and allocate their costs. Under standard costing, the WIP balance grows based on the number of steps completed in the manufacturing process. Therefore, auditors analyze the methods used to quantify a product’s standard costs, as well as how the company allocates the costs corresponding to each phase of the production process.

With job costing, auditors analyze the process to allocate materials, labor and overhead to each job. In particular, auditors test to ensure that costs assigned to a particular product or project correspond to that job.

Recognizing revenue

Auditors perform additional audit procedures to ensure that a company’s recognition of revenue complies with their accounting policies. Under standard costing, companies typically record inventory (including WIP) at cost, and then recognize revenue once they sell the product. For job costing, revenue recognition typically happens based on the percentage-of-completion or completed-contract method.

Sorting through the details

Under both the standard and job costing methods, accounting for WIP affects the balance sheet and the income statement. Companies with long-term contracts must follow new rules for recognizing revenue starting in 2018 for public companies and a year later for private ones. As you update your company’s reporting systems and procedures to comply with the changes, expect auditors to modify their auditing procedures for WIP to accommodate the new measurement and disclosure guidance.

Contact us if you need help applying the new revenue recognition standard or reporting WIP in general. We can help you make reliable estimates based on your company’s specific production process.

© 2018


New Budget Deficit

Category : Blog , sccm


Report: Budget deficit is expected to soar. A new Congressional Budget Office report says the deficit will rise sharply over the next few years, mainly because of deep tax cuts in the Tax Cuts and Jobs Act. The report states the deficit will grow to $804 billion in fiscal year 2018, $242 billion larger than what was projected in 2017. Accounting for most of the difference is a $194 billion reduction in projected revenues, mainly because the law is expected to reduce collection of individual and corporate income taxes. To read the report: https://bit.ly/2GKR1kH


Internal control testing: What role does sampling play?

Category : Blog , sccm

Auditors must test the effectiveness of internal controls before signing off on your financial statements. But it’s impossible to analyze every transaction that’s posted to the general ledger, due to time and budget constraints. Instead, auditors select and analyze a representative sample of transactions to make assertions about the entire population. Here’s more on how sampling works — along with the pros and cons of using it during internal control testing.

Picking a sample

Auditors may use statistical techniques to develop a sample of transactions to test. For example, an auditor might select enough transactions to represent a specific percentage of 1) the total transactions in an account, or 2) the company’s total assets or revenue. Alternatively, a sample of transactions may be pulled randomly using statistical sampling software.

Auditors also can use nonstatistical sampling techniques based on a dollar threshold or professional judgment. These techniques tend to be more effective when the CPA has many years of audit experience to ensure that the sample chosen is representative of the population of transactions.

Unexpected outcomes

Before analyzing a sample, your auditor has expectations about the number of “exceptions” (such as errors and omissions) that will appear in the sample. If the actual exceptions exceed the auditor’s expectation, he or she may need to perform additional procedures. For instance, your auditor might expand the sample and conduct more testing to assess the degree of noncompliance.

Ultimately, your auditor might conclude that your internal controls are ineffective. If so, he or she will perform more work to estimate the magnitude of the control failure.

Pros vs. cons

Sampling helps keep audit costs down by streamlining the internal control testing process. It also reduces disruptions to business operations during audit fieldwork. When applied correctly, the results of sampling are theoretically as accurate as if the audit team had analyzed every transaction posted to the general ledger. But, in practice, sampling can sometimes cause problems during internal controls testing.

For example, sampling presumes that controls function consistently across the whole population of transactions. If an exception doesn’t appear in the sample — because the sample was too small or otherwise unrepresentative of the entire population — your audit team could reach the wrong conclusion about the effectiveness of your internal controls.

There’s also a risk that your audit team could rely too heavily on nonstatistical sampling. Relying more on judgment than statistical methods could result in errors, especially if an auditor lacks professional experience.

A collaborative process

You can help maximize the benefits of sampling by providing the audit team with document requests in a timely manner and following up on your auditor’s management points at the end of each year’s audit. It’s frustrating to both auditors and business owners when internal control weaknesses recur year after year. Our auditors have extensive experience testing internal controls, and we’d be happy to answer any questions you have on testing and sampling techniques.

© 2018


Self-Employment Tax

Category : Blog , sccm





The U.S. Tax Court ruled that Mary Kay Inc. retirement plan payments are subject to self-employment tax. It stated that payments made by the company’s postretirement deferred compensation plan to a former sales executive were subject to the tax. The payments were calculated based on preretirement commissions the taxpayer had earned. She’d reported the payments as “other income” and paid no self-employment tax on it. The IRS audited her returns and disagreed with that treatment. The court made the same ruling in 2013 for another taxpayer. (TC Summary Op. 2018-15)


Reporting Through Rose-Colored Lenses

Category : Blog , sccm


Management wants to paint the rosiest possible picture of a company’s financial performance. But aggressive earnings management, or “spin,” can mislead investors and lenders. Here are some ways U.S. Generally Accepted Accounting Principles (GAAP) can be manipulated to obscure the truth.

Creative accounting vs. cooking the books

Earnings management usually starts out small, but it can become increasingly aggressive and eventually cross the line into fraud if it goes unchecked. An external audit may help detect the red flags of earnings management, including:

Premature revenue recognition. Some companies recognize revenue early to make the income statement temporarily appear more attractive. This ploy is common when a company is applying for bank financing or up for sale.

Miscellaneous “cookie jar” reserves. Management can create a hidden reserve of funds during good times. Then the reserves can be tapped into to nourish earnings in lean times.

“Big bath” restructuring changes. Some companies overstate the costs associated with restructuring. This enables them to clean up their balance sheets and create reserves for a rainy day.

Immediate acquisition write-offs. Acquired companies may classify a portion of the purchase price as “in process research and development,” which they immediately write off. This reduces the amortization of the purchase price to future earnings.

Overreliance on EBITDA. Earnings before interest, taxes, depreciation and amortization (EBITDA) and other non-GAAP metrics have become popular ways to evaluate a company’s performance. But they aren’t usually audited, and they may be calculated differently from company to company.

EBITDA is generally intended to resemble cash flow. But this metric can obscure problems for start-up companies with major debt. Although their EBITDAs give these start-ups appeal, their debt service may mean they won’t be profitable for many years.

Too good to be true?

Pay attention when reviewing financial statements and corporate press releases — the opportunity and pressure to spin earnings is everywhere. Contact us for more information on how to identify when a business may have engaged in “creative” accounting practices to improve their financial picture.

© 2018