Current Accounting Issues Red Flags of Credit Analysis

Transcription

1 Current Accounting Issues Red Flags of Credit Analysis Presented by: Dennis M. Schleper, Principal

2 Objectives Understand the current accounting issues and pronouncements that impact lenders. Identify potential red flag issues in financial statements. Identify potential red flag issues regarding management, ethics, and compliance. Be better prepared to assess the potential loan and ongoing monitoring of loans. 2

3 Outline Changes Caused by Sarbanes-Oxley Act SAS 99 Requirements - Fraud Standards Update Checklist of Current Issues Revenue Recognition Inventory and Receivable Schemes Where to hide the debit Related Party Transactions Stockholder Loans Impairment of Assets Goodwill Valuation Capitalization Guidelines - Construction in Progress FASB Interpretation No Guarantees or Indemnification agreements Independence Issues 3

4 The Sarbanes-Oxley Act An Act To Protect Investors By Improving The Accuracy and Reliability of Corporate Disclosures Made Pursuant To The Securities Laws, And For Other Purposes 4

5 Sarbanes-Oxley Act of 2002 Unlawful for firms to provide non-audit services: Bookkeeping Information system design and implementation Appraisal and valuation services Actuarial services Internal audit outsourcing 5

6 Sarbanes-Oxley Act of 2002 Unlawful for firms to provide non-audit services (cont.): Management functions or HR resources Broker/ investment advisor Legal or expert services not related to the audit Any other service the Board determines is impermissible 6

7 Sarbanes-Oxley Act of 2002 CEO and CFO must certify financial statements If a restatement, CEO and CFO must pay back any bonuses during twelve months from report date Unlawful for company to loan money to any Board member or executive 7

8 Sarbanes-Oxley Act of 2002 State regulators to determine which of the standards to adopt for small and mid-size nonregistered firms 8

9 SAS 99 Requirements - Fraud Standards Financial Reporting Misappropriation of Assets 9

10 SAS 99 What has changed? The required documentation has changed. The new standard does not technically increase auditor responsibility. However, because of the publicity of the new standard, it increases client perception of the auditors responsibility. 10

11 SAS 99 What has changed? New Assumptions: There is the potential for revenue to be misstated. Management override of controls is a risk area for fraud. The standard does not intend to increase our risk. The standard intends to mitigate our risk. 11

12 The Fraud Triangle Incentive/Pressure (Reason to commit fraud) Fraudulent Financial Reporting Misappropriation of Assets Perceived Opportunity (Absence of controls, ability to override) Rationalization or Justification (Character trait or set of ethical values allowing individual to commit fraud) 12

13 Fraud Consideration Planning Stages of the Audit Evaluating how the entity responds to risks Brainstorming sessions Risk assessment and planning forms Understanding of internal control Inquiries of management Preliminary analytical review Throughout the audit Interactions with client personnel Information we come across Substantive analytical procedures 13

14 Evaluating How the Entity Responds to Fraud Risks 14

15 How the Entity Responds to Fraud Risks Management should be in the best position to know where fraud vulnerabilities are: Find out what management has done to: assess fraud risk mitigate fraud risk Auditor s risk assessment is affected by the evaluation of how well management has assessed and responded to fraud risk. 15

16 Considerations for Brainstorming Sessions Attitude Matters Healthy professional skepticism can compensate for poor procedures Complete Distrust Neutral Complete Trust 16

17 Considerations for Brainstorming Sessions Attitude Matters However, good procedures cannot make up for a lack of skepticism Complete Distrust Neutral Complete Trust 17

18 Warning Signs Cash flows from operations that bear little relationship to reported earnings. Prolonged periods of success. Receivables growing faster than sales. Unusual changes in profit margin. Ratios and benchmarks differ significantly from industry averages. Difficulty explaining how the company actually makes money. Ineffective audit committees and board governance. Accounting policies that rely heavily on management s judgment or seem too aggressive. Transactions lack economic purpose Improper revenue recognition continues to be the primary cause of financial statement restatements and a prevalent theme in accounting scandals. 18

19 Checklist of Current Issues Read disclosures or ask questions related to: Revenue Recognition Inventory and Receivable Variances Related Party Transactions Stockholder Loans Impairment of Assets Goodwill Valuation Capitalization Guidelines - Construction in Progress FASB Interpretation No Guarantees or Indemnification Agreements Consolidation of Related Entities Change of Auditor should be inquired and understood! 19

20 SFAS No Impairment of Assets Effective for years beginning after December 15, 2001 Supersedes SFAS No. 121 Supersedes accounting and reporting provisions of APB Opinion No

21 SFAS No. 144 (cont.) Establishes a single accounting model for the disposal of long-lived assets Recognize an impairment loss only if the carrying amount of a long-lived asset exceeds undiscounted cash flows The amount is the difference between the carrying amount and fair value 21

22 SFAS No. 144 (cont.) Goodwill is not in the scope of SFAS No. 144 Requires the depreciable life of longlived asset to be abandoned be revised Broadens the presentation of discontinued operations to include more disposal transactions 22

23 SFAS No Goodwill Apply beginning 12/15/01 Changes from an amortization method to an impairment-only approach Upon adoption, amortization of goodwill, including that recorded in past business combinations, will cease New basis of goodwill to be measured for impairment will equal the net book value of goodwill on date of adoption 23

24 SFAS No. 142 (cont.) Other intangible assets will still be amortized over their useful lives and reviewed for impairment in accordance with SFAS 121 (superceded by SFAS #144) Intangible assets (other than goodwill) with indefinite lives should not be amortized but reviewed for impairment similar to goodwill 24

25 Consolidation Accounting for Consolidation of SPE s The proposed interpretation will apply to any business enterprise (except Not-For-Profits) that has an ownership interest or any business relationship with an SPE. Explains how to identify an SPE that is not subject to control through voting ownership interests and would require each enterprise involved with such an SPE to determine whether it provides financial support to the SPE through a variable interest. The primary beneficiary of such an SPE would be required to include the assets, liabilities, and results of operations of the SPE in it s consolidated financial statements. 25

26 Guarantees Guarantor s Accounting and Disclosure Requirements for Guarantees Would help clarify the different interpretations of required disclosures under FASB 5 and would elaborate on disclosures to be made by Guarantors in their financial statements for obligations they have undertaken. Would require Guarantor to to recognize at inception of the Guarantee, the fair value to the obligation it has undertaken. Guarantor would be required to disclose: Nature of the guarantee Maximum potential amount of future payments Carrying amount of the obligation Nature of any recourse provision that would allow the guarantor to recover any amounts paid. 26

27 Current FASB Projects Reporting Financial Instruments and Certain Related Assets and Liabilities at Fair Value (Preliminary Views) Financial Instruments are: cash ownership interests in an entity contractual rights and obligations for deliveries of financial instruments contractual rights and obligations for exchanges of financial instruments 27

28 Current FASB Projects (cont.) Requirement for fair value measurement would apply to all financial instruments except investments accounted for using the equity method, minority interests in consolidated subs, a reporting entities own equity instruments, and obligations for post-retirement and post-employment benefits. 28

29 Current FASB Projects (cont.) Consolidated Financial Statements: Purpose and Policy This statement would establish standards that specify when entities should be included in consolidated financial statements. It would apply to business enterprises and not-forprofit organizations that control other entities regardless of the legal form of the controlling and controlled entities. 29

30 Current FASB Projects (cont.) Consolidated Financial Statements: Purpose and Policy The controlling entity (parent) would be required to consolidate all entities that it controls (subsidiaries) unless control is temporary at the time the entity becomes a subsidiary. 30