In July 2023, the Public Company Accounting Oversight Board (PCAOB) published a report that highlights common areas of audit deficiencies for public companies. Private companies face similar challenges when reporting their financial results. Internal accounting personnel and external auditors can use the PCAOB’s report to identify high-risk areas in financial reporting that may warrant additional attention.

The PCAOB recently inspected portions of financial statement audits for public companies. The findings were published in a new PCAOB Spotlight report, Staff Update and Preview of 2022 Inspection Observations.

Many of the deficiencies found in 2022 are in inherently complex areas that have greater risks of material misstatement. The top seven financial statement deficiency areas were:

Auditors may find this information useful as they plan and perform their audits. Likewise, managers and in-house accounting personnel may benefit from a review of these findings to help improve financial reporting, minimize audit adjustments and use as a reference point when engaging with external auditors.

The PCAOB report also highlights an emerging area of concern: cryptocurrency transactions. Examples of these transactions include:

The PCAOB notes that companies with material digital asset holdings and/or that engage in significant activity related to digital assets present unique audit risks. This was evidenced by the high-profile collapse of crypto asset trading platform FTX. The risks associated with crypto assets may be elevated due to high levels of volatility, lack of transparency regarding the parties engaging in the transactions and the purpose of such transactions, market manipulation, fraud, theft, and significant legal uncertainties. The PCAOB recommends using specialists and technology-based tools to help audit these transactions in certain situations.

Regardless of whether they’re public or private, companies should take proactive measures to ensure their financial reporting is accurate and transparent. These measures may include providing accounting personnel with additional training and assistance, increasing management review and staff supervision, and beefing up internal audit procedures in relevant high-risk areas.

Also, expect external auditors to focus on these high-risk areas. For your next audit, prepare to provide additional documentation to back up your accounting estimates, reporting procedures and account balances for high-risk items.

© 2023

With the COVID-19 pandemic well into its second year and the start of planning for the upcoming audit season, you may have questions about how to evaluate your company’s going concern status. While some industries appear to have rebounded from the worst of the economic downturn, others continue to struggle with pandemic-related issues, such as rising inflation, along with labor and supply shortages. For some businesses, pre-pandemic conditions may never return, which can make it exceptionally difficult to project future performance.

How auditing standards have changed

Financial statements are generally prepared under the assumption that the entity will remain a going concern. That is, it’s expected to continue to generate a positive return on its assets and meet its obligations in the ordinary course of business.

Under Accounting Standards Codification Topic 205, Presentation of Financial Statements — Going Concern, the continuation of an entity as a going concern is presumed as the basis for reporting unless liquidation becomes imminent. Even if liquidation isn’t imminent, conditions and events may exist that, in the aggregate, raise substantial doubt about the entity’s ability to continue as a going concern. Today, the responsibility for the going concern assessment falls on management, not the company’s external auditors.

In addition, the time period that the assessment must cover has been extended. Previously, the determination of an entity’s ability to continue as a going concern was based on expectations about its performance for a one-year period from the date of the balance sheet. Now, under Accounting Standards Update No. 2014-15, Presentation of Financial Statements — Going Concern: Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern, the assessment is based upon whether it’s probable that the entity won’t be able to meet its obligations as they become due within one year after the date the financial statements are issued — or available to be issued — not the balance sheet date. (The alternate date prevents financial statements from being held for several months after year end to see if the company survives.)

When disclosures are required

In situations where substantial doubt exists, management then must evaluate whether its plans will alleviate substantial doubt. That is, is it probable that the plans will be implemented, and if so, will they be effective at turning around the company’s financial distress?
Disclosures are required indicating that either:
• The plans will mitigate relevant conditions and events that have caused substantial doubt, or
• The plans won’t alleviate substantial doubt about the entity’s ability to continue as a going concern.

Though management is responsible for making this assessment, auditors will request appropriate evidence to support the going concern disclosure. For example, detailed financial statement projections or a written commitment from a lender or affiliated entity to fully cover the entity’s cash flow requirements might help substantiate management’s assessment. If management doesn’t perform a sufficient evaluation, the auditing standards may require the auditor to report a significant deficiency or a material weakness.

We can help

If your business is continuing to struggle during the pandemic, contact us to discuss your going concern assessment for 2021. Our auditors can help you understand how the evaluation will affect your balance sheet and disclosures.

© 2021

An external audit is less stressful and less intrusive if you anticipate your auditor’s document requests. Auditors typically ask clients to provide similar documents year after year. They’ll accept copies or client-prepared schedules for certain items, such as bank reconciliations and fixed asset ledgers. To verify other items, such as leases, invoices and bank statements, they’ll want to see original source documents.

What does change annually is the sample of transactions that auditors randomly select to test your account balances. The element of surprise is important because it keeps bookkeepers honest.

Anticipate questions

Accounting personnel can also prepare for audit inquiries by comparing last year’s financial statements to the current ones. Auditors generally ask about any line items that have changed materially. A “materiality” rule of thumb for small businesses might be an inquiry about items that change by more than, say, 10% or $10,000.

For example, if advertising fees (or sales commissions) increased by 20% in 2021, it may raise a red flag, especially if it didn’t correlate with an increase in revenue. Be ready to explain why the cost went up and provide invoices (or payroll records) for auditors to review.

In addition, auditors may start asking unexpected questions when a new accounting rule is scheduled to go into effect. For example, private companies and nonprofits must implement new rules for reporting long-term lease contracts starting in 2022. So companies that provide comparative financial statements should start gathering additional information about their leases in 2021 to meet the disclosure requirements for next year.

Minimize audit adjustments

Ideally, management should learn from the adjusting journal entries auditors make at the end of audit fieldwork each year. These adjustments correct for accounting errors, unrealistic estimates and omissions. Often internally prepared financial statements need similar adjustments, year after year, to comply with U.S. Generally Accepted Accounting Principles (GAAP).

For example, auditors may need to prompt clients to write off bad debts, evaluate repair and supply accounts for capitalizable items, and record depreciation expense and accruals. Making routine adjustments before the auditor arrives may save time and reduce discrepancies between the preliminary and final financial statements.

You can also reduce audit adjustments by asking your auditor about any major transactions or complicated accounting rules before the start of fieldwork. For instance, you might be uncertain how to account for a recent acquisition or classify a shareholder advance.

Plan ahead

An external audit doesn’t have to be time-consuming or disruptive. The key is to prepare, so that audit fieldwork will run smoothly. Contact us to discuss any concerns as you prepare your preliminary year-end statements.

© 2021

Audit committees faced many challenges in 2021. As the economy continues to navigate a global pandemic, there are new dimensions to the oversight roles and responsibilities of the audit committees. Consider taking the following four steps to fortify your committee’s effectiveness.

1. Focus on fundamentals

Check in with your accounting team and evaluate the planning processes that have been put in place for the first quarter of 2022 to ensure that the financial reporting process will wrap up on time. Take the time to revisit goals and expectations to develop an agenda for 2022 that directs the audit committee’s attention back to the basics. The committee is responsible for oversight of the following key areas:

• Financial reporting,
• Disclosures,
• Internal controls, and
• The company’s audit process.

Each agenda item before the audit committee should ideally relate to one of these areas.

2. Assess the composition of the audit committee

Periodically, it’s appropriate to assess the level of financial expertise that each committee member possesses, especially if the group’s composition has recently changed. If the company anticipates significant changes in the regulatory environment, now may be the time to add suitably qualified members to the audit committee. At least one member of the audit committee should possess in-depth financial expertise. (Publicly traded companies have specific “financial literacy” requirements.)

Today, companies increasingly recognize the value of adding gender and racial diversity to decision-making bodies, including audit committees. These companies believe diversity is a strength that leads to better-informed decisions and fresh perspectives.

3. Get a handle on operational risk

Your company’s risk profile may have changed during the pandemic. For example, you may have temporarily cut staff or deferred capital investments to preserve cash flow during uncertain times.
However, these crisis-driven decisions may adversely affect the company’s long-term financial performance. The audit committee should consider asking management to review significant operational decisions made in the last year to determine if excess risk was created and whether it’s time to change course.

In addition, operational changes and increased financial pressures on accounting staff may expose the company to increased risk of internal and external fraud. And remote working arrangements could lead to cyberattacks and theft of intellectual property. If you haven’t already done so, it’s a good time to request that internal auditors commission a fraud and cyber-risk assessment. Proactively assessing these issues can dramatically reduce the probability of losses occurring.

4. Consider exposure to financial difficulties across the supply chain

The pandemic may have affected certain suppliers and customers, especially those located overseas or in states with COVID-19-restrictions on business operations. The audit committee should evaluate whether management has identified the company’s material relationships and the potential financial and operational impact if any of those businesses close or file for bankruptcy.

Full speed ahead

By taking proactive measures, your audit committee can help improve your company’s performance. Contact us to help position your company to minimize risks and maximize value-added opportunities in 2022 and beyond.

© 2021

How should a public company go about selecting its audit firm? The data show public companies tend to default to one of the Big 4 or National firms. According to a 2020 article by Audit Analytics, the Top 10 firms audited nearly two-thirds of all public companies, with the Big 4 firms auditing approximately half of all public companies. So why do public companies default to using one of only a handful of firms for their audit and helping them with their public company filings? This post is the second in a series exploring the factors that come into play when choosing an audit and assurance services provider.

When a company searches for an outside supplier of service, their size and perceived resources are always a consideration. It’s true – the Top 10 firms are larger and have more resources at their disposal than a regional accounting firm. They serve an undeniable purpose in the marketplace. The Apples, Googles, and Amazons of the world do not – and should not – use a smaller firm. But what if a company’s market cap isn’t $500B, but instead $500M? Are all those additional resources really necessary? And perhaps just as important – will those giant firms serve a small or a medium-sized public company as well and as efficiently as they would serve their giant clients? We frequently meet prospective clients that say their current Top 10 firm is too big to care about their small company and that they feel like they get the Top 10 firm’s “B-team” working on their audit.

An untapped resource to consider for public company audits is a regional firm with a membership in an alliance of accounting firms. Alliances offer a network of resources across the globe, while the individual accounting firm is able to maintain small firm agility, personal attention, and cost structures. For example, the Leading Edge Alliance (“LEA”) is a global alliance of CPA firms that spans over 100 countries, over 450 offices, and more than 16,000 professionals. In other words, if the LEA was one firm, it would be the 5th largest firm in the world based on revenue. Haskell & White has utilized LEA’s global resources to conduct inventory observations or to conduct audits that roll up to the parent organization. Our membership not only provides this boots-on-the-ground presence but a resource for specialized knowledge. If a client has a material unique transaction, Haskell & White can perform the research and then reach out to the affiliate’s special interest groups to ensure other professionals with expertise in that area agree with our conclusions. This is a similar process that the Top 10 firms use with their respective national offices; however, the difference is a regional firm does not have to get approval from a national office to reach a conclusion, which makes for an efficient decision making process and a more cost-effective process for the client. In other words, through its global affiliate, smaller firms have many of the resources of a large firm at their disposal, but using those resources – and ultimately the conclusion reached – is up to the individual engagement team.

Please reach out to us to discuss your current audit needs and learn more about how our global resources can be put to use for you.

Let’s face it: no company wants to pay hundreds of thousands – or even millions of dollars to be audited. For public companies, though, it’s not a choice, it’s an annual requirement. So how should a public company go about selecting a PCAOB registered audit firm? The data show public companies tend to default to one of the Big 4 or National firms. According to a 2020 article by Audit Analytics, the Top 10 firms audited nearly two-thirds of all public companies, with the Big 4 firms auditing approximately half of all public companies. So why do public companies choose from only a handful of firms when regional PCAOB registered firms may be a better fit? This post is the first in a series that will explore the most common factors taken into consideration when choosing a public accounting firm.

Within the industry of public accounting firms, there are reliable measures of audit quality. Two of the best measures are restatement rate (percentage of issued financial statements that resulted in a restatement) and Public Company Accounting Oversight Board (“PCAOB”) inspection results. One of the most common reasons for engaging a Top 10 firm is the assumption that the public company audit quality is better.

One might expect that restatement rates at clients of the Top 10 firms to be negligible, as these companies typically can afford to employ sizable accounting departments. However, according to a Compliance Week article regarding restatement rates for public company filings, the Big 4 had a restatement rate of 0.99%. National firms – firms that round out the Top 10 firms – had a restatement rate of 2.74%. All other firms had a restatement rate of 2.43%. However, the “other firms” category includes restatement filings where the company noted in its 8-K disclosures that they had no audit firm at the time of the filing, either because the firm resigned or was dismissed. Therefore, 2.43% is skewed higher by the Big 4 and National firms who were dismissed after a restatement. Furthermore, the Big 4 and National firm rates are skewed lower for the same reason. How much auditor dismissals skew the data is difficult to determine; however, a research article, Determinants and Market Consequences of Auditor Dismissals after Accounting Restatements by Karen M. Hennes, Andrew J. Leone, and Brian P. Miller notes that auditor turnover occurs 28.8% of the time following a restatement.

The second measure of PCAOB audit quality can be found in PCAOB inspection reports. The inspections are part of the requirement to be a PCAOB registered firm. Periodic inspections ensure the firm performs quality PCAOB audits and has all the appropriate quality control procedures in place. None of the Top 10 firms achieved a “clean” report (i.e., no deficiencies noted) in their most recent PCAOB inspection. Since 2010, the combined deficiency rates of the Top 10 firms ranged from 30% to 42% annually, or approximately one in three audits is deemed to be deficient. While PCAOB average deficiency rates at non-Top 10 firms are not readily available, the point here is that audit quality at the Top 10 firms may not be as high as expected. When looking for your next public accounting firm, you can easily access their history of inspections on the PCAOB website to compare your audit firm candidates.

Please reach out to us to discuss your current audit needs and find out why quality audits matter.

In March 2020, the Securities and Exchange Commission (SEC) voted to adopt amendments to the “accelerated filer” and “large accelerated filer” definitions. These definitions are of critical importance to public companies because they determine whether an auditor attestation of an issuer’s internal control over financial reporting is required and the amount of time an issuer gets to file its quarterly and annual reports. This post outlines the key changes to the distinction between the filers.

The amendments also increase the transition thresholds for accelerated and large accelerated filers becoming non-accelerated filers from $50 million to $60 million, and for exiting large accelerated filer status from $500 million to $560 million.

Certain provisions and requirements have remained unchanged:

It should be noted that the definition of a Smaller Reporting Company (SRC) did not change. Scaled disclosure requirements are available to SRCs, who continue to be defined as issuers with less than $250 million of public float or less than $100 million in annual revenues with public float of less than $700 million or no public float at all. More importantly, a company that meets the definition of an SCR may still be an accelerated filer under the amendments if it has over $100 million in revenues but less than $250 million in public float.

The amendments have been highly anticipated by public companies that do not generate significant revenues due to various factors (such as early infancy in its life cycle), as they will no longer be subjected to the SOX 404(b) auditor ICFR attestation requirements. The SEC estimates that a company would save approximately $210,000 a year, which the SEC viewed as a “meaningful cost savings for many of the affected issuers.” The much-needed cost-saving measures can certainly be allocated elsewhere to allow companies to focus on its core competencies to continue to grow. In addition, the cost reduction could be a positive factor that may encourage more companies to go public.

Given the many challenges that the year 2020 has brought, the SEC’s revised definitions are a welcomed development that will make public company reporting more cost-effective and more straightforward. If you would like to discuss this important topic in more detail, please reach out to a Haskell & White team member or contact us through the website.

The year 2020 has been anything but typical and filled with change. So smaller public companies should be ready to embrace the first substantive changes to the standard auditors’ report in more than 70 years. For years ending after December 15, 2020, for the first time ever, the audit report of smaller public companies will be required to disclose Critical Audit Matters, or CAMs for short. Given that this is a significant change from current practice, and given the inherent sensitivity of certain CAMs, public companies, audit committees and auditors should be preparing for CAM implementation now.

The PCAOB (regulator of public company audit firms) defines a Critical Audit Matter as “any matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements; and (2) involved especially challenging, subjective, or complex auditor judgment.” In simple terms, think about your recent audit committee meetings and the topics and issues discussed. Those will likely be your CAMs and will now be required to be disclosed in the auditors’ report. While the determination of CAMs is based on the facts and circumstances of each audit, the PCAOB has stated that “it is expected that, in most audits to which the CAM requirements apply, the auditor will determine at least one CAM.”

When a CAM is identified, what exactly is required to be disclosed in the auditors’ report? Once again, the PCAOB has provided specific requirements to satisfy. For each CAM communicated in the auditors’ report, the auditor must:

As you might imagine, providing this information in the auditors’ report about an issuer’s revenue recognition practices, income tax reporting, or asset impairment assessments will likely result in some spirited conversations between issuers and their auditing and assurance services firm.

Issuers that are categorized under the SEC’s rules as Large Accelerated Filers (generally those public companies with more than $700 million in non-affiliated market capitalization) and their audit firms have already adopted the CAM reporting requirements. A recent study by data firm Audit Analytics examined 333 CAMs from the audit reports of 193 Large Accelerated Filers, with an average of 1.7 CAMs per audit report. The top five topics most commonly identified as Critical Audit Matters thus far have been Business Combinations, Goodwill, Revenue Recognition, Income Taxes, and Contingencies.

Issuers that satisfy the SEC’s requirements as an Emerging Growth Company (EGC) are not required to disclose CAMs in their audit reports. However, auditors may early adopt CAM requirements or apply them voluntarily to audits for which they are not required. Last year, law firm Cooley LLP reported that 39% of surveyed EGCs responded that they plan to apply the CAM requirements voluntarily, while 39% are undecided and 22% will definitely not apply them voluntarily.

With most small public company’s Q3 reporting season still weeks away, the time to prepare your company for CAM implementation is now. Your first step should be to educate and inform key stakeholders, such as financial management, audit committee members, and even key investors. Next, request a dry run or a sample audit report from your auditing and assurance services firm to facilitate an open and honest discussion about your company’s likely CAMs. Taken now, these simple steps will help ensure a seamless transition to CAM reporting so that your business can focus on some of 2020’s many other challenges.

If you would like to learn more about Haskell & White’s experience assisting public companies with new requirements, contact us today to speak to our team.