Financial statements provide a good financial picture of the company’s performance but possibly not the whole story. Sometimes your CPA can identify indicators that are not specifically noted in the financial statement that could be red flags. Here’s how a CPA can help stakeholders identify unrecorded items either through external auditing procedures or by conducting agreed upon procedures (AUPs) that target specific accounts.
Search for undisclosed asset liabilities and risks
Revealing undisclosed liabilities and risks begins with assets. Certain assets include management’s estimate on their collectability and value. For example, accounts receivable may include bad debts, or inventory may include damaged goods. In addition, some fixed assets may be broken or in desperate need of repairs and maintenance. These items may signal financial distress and affect financial ratios just as much as unreported liabilities do. An accountant will assess assets for reasons an account may diminish.
A tour of the company will reveal any facility and equipment short falls. Another strategy is to review the schedules and identify any slow-moving items that may be stored in inventory too long. Benchmarking can also help. For example, if receivables are growing much faster than sales, it could be a sign of aging, uncollectible accounts.
Evaluate liabilities
Next, external accountants can assess liabilities to determine whether the amount reported for each item seems accurate and complete. For example, a company may forget to accrue liabilities for salary or vacation time.
Alternatively, management might underreport payables by holding checks for weeks (or months) to make the company appear healthier than it really is. This ploy preserves the checking account while giving the impression that supplier invoices are being paid. It also mismatches revenues and expenses, understates liabilities and artificially enhances profits. Delayed payments can hurt the company’s reputation and cause suppliers to restrict their credit terms.
What’s not in the financial report
Your CPA can investigate what isn’t showing on the balance sheet. Examples include warranties, pending lawsuits, IRS investigations and an underfunded pension. Such risks appear on the balance sheet only when they’re “reasonably estimable” and “more than likely” to be incurred.
These are subjective standards. In-house accounting personnel may claim that liabilities are too unpredictable or remote to warrant disclosure. Footnotes, when available, may shed additional light on the nature and extent of these contingent liabilities.
Need help?
If the company already has an external audit, some of these considerations will be addressed. Depending on the risks involved and how detailed a look the interested party wants, an Agreed Upon Procedures engagement may prove preferable, as it can target specific high-risk accounts, transactions, or key control processes in more detail than would be covered by an audit . At Ciuni & Panichi, our professionals are experienced in helping assess business transactions to achieve successful outcomes. Contact Herzl Ginsburg, CPA, Audit and Accounting Services Senior Manager, at 216-831-7171 or by email here to learn how we can help you.
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