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The Untouchables: Getting a Handle on Intangibles

Businesswoman hands opened creating a space for product or text placement.

The average company’s balance sheet understates its value by 80%, according to Sarah Tomolonius, co-founder of the Sustainability Investment Leadership Council. Why? Intangible assets aren’t recorded on the balance sheet under U.S. Generally Accepted Accounting Principles (GAAP), unless they’re acquired from a third party.

Instead, GAAP generally calls for the costs associated with creating and maintaining these valuable assets to be expensed as they’re incurred — even though they provide future economic benefits.

Eye on intangibles

Many companies rely on intangible assets to generate revenue, and they often contribute significant value to the companies that own them. Examples of identifiable intangibles include:

  • Patents,
  • Brands and trademarks,
  • Customer lists,
  • Proprietary software, and
  • A trained and knowledgeable workforce.

In a business combination, acquired intangible assets are reported at fair value. When a company is purchased, any excess purchase price that isn’t allocated to identifiable tangible and intangible assets and liabilities is allocated to goodwill.

Acquired goodwill and other indefinite-lived intangibles are tested at least annually for impairment under GAAP. But private companies may elect to amortize them over a period not to exceed 10 years. Impairment testing also may be required when a triggering event happens, such as the loss of a major customer or introduction of new technology that makes the company’s offerings obsolete.

Inquiring minds want to know

Investors are interested in the fair value of acquired goodwill because it enables them to see how a business combination fared in the long run. But what about intangibles that are developed in-house?

At a sustainability conference earlier in May, Tomolonius said that businesses are more sustainable when they’re guided by a complete understanding of their assets, both tangible and intangible. Assigning values to internally generated intangibles can be useful in various decision-making scenarios, including obtaining financing, entering into licensing and joint venture arrangements, negotiating mergers and acquisitions, and settling shareholder disputes.

Calls for change

For more than a decade, there have been calls for accounting reforms related to intangible assets, with claims that internally generated intangibles are the new drivers of economic activity and should be reflected in balance sheets. Proponents of changing the rules argue that keeping these assets off the balance sheet forces investors to rely more on nonfinancial tools to assess a company’s value and sustainability.

It’s unlikely that the accounting rules for reporting internally generated intangibles will change anytime soon, however. In a quarterly report released in August, Financial Accounting Standards Board (FASB) member Gary Buesser pointed to challenges the issue would pose, including the difficulty of recognizing and measuring the assets, costs to companies, and limited usefulness of the resulting information to investors. Buesser explained that “the information would be highly subjective, require forward looking estimates, and would probably not be comparable across companies.”

Want to learn more about your “untouchable” intangible assets? We can help you identify them and estimate their value, using objective, market-based appraisal techniques. Contact us for more information.

© 2019

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What to Expect During a Franchise Audit

It’s important for franchisors to periodically audit individual franchisees. These routine “check-ups” are especially valuable in a store’s early years of operations or if performance starts to deteriorate. They can be used to detect symptoms of unhealthy performance and treat problems before they spiral out of control.

Focus on royalty payments

Royalties are a franchisor’s primary source of income. Because royalties are typically based on a percentage of revenue, auditors pay close attention to the franchisee’s revenue reporting process.

To test whether revenue has been accurately reported, auditors trace transactions from the point-of-sale to:

  • The franchisee’s financial records,
  • Revenue reported to the franchisor, and
  • Tax returns submitted to the state and federal government.

If the revenue trail doesn’t hold up, further investigation may be required. In addition to vouching a representative sample of randomly selected sales transactions, auditors use analytical techniques to compare key metrics for an individual franchisee against benchmarks for franchises of a similar size and others in your franchise system. Any discrepancies from these benchmarks raise a red flag that the franchisee may have underreported revenue to minimize royalty payments.

Standard operating procedures

Beyond testing revenue, auditors spend extensive time examining whether the franchisee has complied with the franchise agreement. They consider such questions as:

  • Is the franchisee spending the required amount on advertising?
  • Does its signage comply with brand standards?
  • Is the franchisee purchasing materials and supplies from approved vendors?
  • Is the HR manager conducting appropriate employee background checks?

Failure to comply with such terms compromises future revenue and the reputation of your brand. So, areas of noncompliance should be identified during the audit — and corrected as soon as possible.

Site visits

Analyzing a franchisee’s books and records can only reveal so much. There’s no substitute for meeting face-to-face with the owner-operator.

Site visits give the auditor an opportunity to assess business operations from the customer’s perspective, evaluate the condition of equipment and the morale of workers, and interview the management team. These inquiries help the auditor understand how the business operates and investigate any anomalies unearthed during testing and analytical procedures.

Need help?

Hiring an outside auditor to enforce the audit provisions of your franchise agreement brings objectivity and financial expertise to the process. In addition to auditing a franchisee’s financial statements, our team can follow up on any compliance issues unearthed by the audit. Contact us for more information.

© 2019  

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Reporting Discontinued Operations

Old Way or New Way

Financial reporting generally focuses on the results of continuing operations. But sometimes businesses sell (or retire) a product line, asset group or another component. In certain situations, such a disposal should be reported as a discontinued operation under U.S. Generally Accepted Accounting Principles (GAAP). Starting in 2015, the rules changed, limiting the scope of transactions that must comply with the complex rules for discontinued operations.

Narrowed scope

A component comprises operations and cash flows that can be clearly distinguished, both operationally and for financial reporting purposes, from the rest of the company. It can be a reportable segment or an operating segment, a reporting unit, a subsidiary or an asset group. Under previous guidance, three requirements were needed for a transaction to be classified as discontinued operations:

  1. The component had been disposed of or was classified as “held for sale.”
  2. The operations and cash flows of the component had been (or would have been) eliminated from the ongoing operations of the entity as a result of the disposal transaction.
  3. The entity didn’t have any significant continuing involvement in the operations of the component after the disposal transaction.

Some stakeholders felt that too many disposals, including routine disposals of small groups of assets, qualified for discontinued operations presentation under the previous guidance. They also found the definition of discontinued operations to be unnecessarily complex and difficult to apply.

So, the Financial Accounting Standards Board updated the rules. Accounting Standards Update No. 2014-08 eliminated the second and third conditions. Instead, disposal of a component (including business activities) must be reported in discontinued operations only if the disposal represents a “strategic shift” that has or will have a major effect on the company’s operations and financial results. Examples of a qualifying strategic major shift include disposal of a major geographic area, a line of business or an equity method investment.

When such a strategic shift occurs, a company must present, for each comparative period, the assets and liabilities of a disposal group that includes a discontinued operation separately in the asset and liability sections of the balance sheet.

Expanded disclosures

Although fewer transactions qualify as discontinued operations than qualified under the previous rules, those that do qualify require expanded disclosures for the periods in which the operating results of the discontinued operation are presented in the income statement. For example, companies must disclose the major classes of line items constituting the pretax profit or loss of the discontinued operation. Examples of major line-item classes include revenue, cost of sales, depreciation and amortization, and interest expense.

In addition, companies must disclose either 1) the total operating and investing cash flows of the discontinued operation, or 2) the depreciation, amortization, capital expenditures, and significant operating and investing noncash items of the discontinued operation. And, if the discontinued operation includes a noncontrolling interest, the company must provide the pretax profit or loss attributable to the parent.

Management also must provide various disclosures and reconciliations of items held for sale for the period in which the discontinued operation is so classified and for all prior periods presented in the statement of financial position. Additional disclosures may be required if the company plans significant continuing involvement with a discontinued operation — or if a disposal doesn’t qualify for discontinued operations reporting.

Need help?

Most companies don’t report discontinued operations every year, so you might not have experience applying the current guidance for reporting these transactions. But we do. Our staff can help determine the appropriate treatment for your disposal and compose the requisite footnote disclosures. Contact us for more information.

© 2019

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FAQs About CAMs

In July, the Public Company Accounting Oversight Board (PCAOB) published two guides to help clarify a new rule that requires auditors of public companies to disclose critical audit matters (CAMs) in their audit reports. The rule represents a major change to the brief pass-fail auditor reports that have been in place for decades.

One PCAOB guide is intended for investors, the other for audit committees. Both provide answers to frequently asked questions about CAMs.

What is a CAM?

CAMs are the sole responsibility of the auditor, not the audit committee or the company’s management. The PCAOB defines CAMs as issues that:

  • Have been communicated to the audit committee,
  • Are related to accounts or disclosures that are material to the financial statements, and
  • Involve especially challenging, subjective or complex judgments from the auditor.

Examples might include complex valuations of indefinite-lived intangible assets, uncertain tax positions and goodwill impairment.

Does reporting a CAM indicate a misstatement or deficiency?

CAMs aren’t intended to reflect negatively on the company or indicate that the auditor found a misstatement or deficiencies in internal control over financial reporting. They don’t alter the auditor’s opinion on the financial statements.

Instead, CAMs provide information to stakeholders about issues that came up during the audit that required especially challenging, subjective or complex auditor judgment. Auditors also must describe how the CAMs were addressed in the audit and identify relevant financial statement accounts or disclosures that relate to the CAM.

CAMs vary depending on the nature and complexity of the audit. Auditors for companies within the same industry may report different CAMs. And auditors may encounter different CAMs for the same company from year to year.

For example, as a company is implementing a new accounting standard, the issue may be reported as a CAM, because it requires complex auditor judgment. This issue may not require the same level of auditor judgment the next year, or it might be a CAM for different reasons than in the year of implementation.

When does the rule go into effect?

Disclosure of CAMs in audit reports will be required for audits of fiscal years ending on or after June 30, 2019, for large accelerated filers, and for fiscal years ending on or after December 15, 2020, for all other companies to which the requirement applies.

The new rule doesn’t apply to audits of emerging growth companies (EGCs), which are companies that have less than $1 billion in revenue and meet certain other requirements. This class of companies gets a host of regulatory breaks for five years after becoming public, under the Jumpstart Our Business Startups (JOBS) Act.

Coming soon

PCAOB Chairman James Doty has promised that CAMs will “breathe life into the audit report and give investors the information they’ve been asking for from auditors.” Contact us for more information about CAMs.

© 2019

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Let’s Find A Better Way To Manage Your Receivables


Failure to collect accounts receivable (AR) in a timely manner can lead to myriad financial problems for your company, including poor cash flow and the inability to pay its own bills. Here are five effective ideas to facilitate more timely collections:

1. Create an AR aging report. This report lets you see at a glance the current payment status of all your customers and how much money they owe. Aging reports typically track the payment status of customers by time periods, such as 0–30 days, 31–60 days, 61–90 days and 91+ days past due.

Armed with this information, you’ll have a better idea of where to focus your efforts. For example, you can concentrate on collecting the largest receivables that are the furthest past due. Or you can zero in on collecting receivables that are between 31 and 60 days outstanding before they become any further behind.

2. Assign collection responsibility to a sole accounting employee. Giving one employee the responsibility for AR collections ensures that the “collection buck” stops with someone. Otherwise, the task of collections could fall by the wayside as accounting employees pick up on other tasks that might seem more urgent.

3. Re-examine your invoices. Your customers prefer bills that are clear, accurate and easy to understand. Sending out invoices that are sloppy, vague or inaccurate will slow down the payment process as customers try to contact you for clarification. Essentially you’re inviting your customers to not pay your invoices promptly.

4. Offer customers multiple ways to pay. The more payment options customers have, the easier it is for them to pay your invoices promptly. These include payment by check, Automated Clearing House, credit or debit card, PayPal or even text message.

5. Be proactive in your billing and collection efforts. Many of your customers may have specific procedures that must be followed by vendors for invoice formatting and submission. Learn these procedures and follow them carefully to avoid payment delays. Also, consider contacting customers a couple of days before payment is due (especially for large payments) to make sure everything is on track.

Lax working capital practices can be a costly mistake. Contact us to help implement these and other strategies to improve collections and boost your revenue and cash flow. We can also help you with strategies for dealing with situations where it’s become clear that a past-due customer won’t (or can’t) pay an invoice.

© 2019

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Why Do Companies Restate Financial Results?

Every year, research firm Audit Analytics publishes a study about financial restatement trends. In 2018, the number of public companies that amended their annual reports increased by 18%.

Many of these amendments were due to minor technical issues, however. Of the 400 public companies that amended their returns in 2018, only 30 amended 10-Ks (or 8%) were due to financial restatements. But this was up from 13 amended 10-Ks (or 4%) in 2017. Any time a company restates its financial results, it raises a red flag and prompts stakeholders to dig deeper.

Reasons for restatement

The Financial Accounting Standards Board (FASB) defines a restatement as a revision of a previously issued financial statement to correct an error. Whether they’re publicly traded or privately held, businesses may reissue their financial statements for several “mundane” reasons. Management might have misinterpreted the accounting standards, requiring the company’s external accountant to adjust the numbers. Or they simply may have made minor mistakes and need to correct them.

Leading causes for restatements include:

  • Recognition errors (for example, when accounting for leases or reporting compensation expense from backdated stock options),
  • Income statement and balance sheet misclassifications (for instance, a company may need to shift cash flows between investing, financing and operating on the statement of cash flows),
  • Mistakes reporting equity transactions (such as improper accounting for business combinations and convertible securities),
  • Valuation errors related to common stock issuances,
  • Preferred stock errors, and
  • The complex rules related to acquisitions, investments, revenue recognition and tax accounting.

Often, restatements happen when the company’s financial statements are subjected to a higher level of scrutiny. For example, restatements may occur when a private company converts from compiled financial statements to audited financial statements or decides to file for an initial public offering. They also may be needed when the owner brings in additional internal (or external) accounting expertise, such as a new controller or audit firm.

Audit Analytics reports that “material restatements often go hand-in-hand with material weakness in internal controls over financial reporting.” In rare cases, a financial restatement also can be a sign of incompetence — or even fraud. Such restatements may signal problems that require corrective actions.

Communication is key

The restatement process can be time consuming and costly. Regular communication with interested parties — including lenders and shareholders — can help businesses overcome the negative stigma associated with restatements. Management also needs to reassure employees, customers and suppliers that the company is in sound financial shape to ensure their continued support.

Your in-house accounting team is currently dealing with an unprecedented number of major financial reporting changes, which may, at least partially, explain the recent increase in financial restatements. We can help accounting personnel understand the evolving accounting and tax rules to minimize the risk of restatement, as well as help them effectively manage the restatement process.

© 2019

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M&A Transactions: Avoid Surprises From The IRS

If you’re considering buying or selling a business — or you’re in the process of a merger or acquisition — it’s important that both parties report the transaction to the IRS in the same way. Otherwise, you may increase your chances of being audited.

If a sale involves business assets (as opposed to stock or ownership interests), the buyer and the seller must generally report to the IRS the purchase price allocations that both use. This is done by attaching IRS Form 8594, “Asset Acquisition Statement,” to each of their respective federal income tax returns for the tax year that includes the transaction.

What’s reported?

When buying business assets in an M&A transaction, you must allocate the total purchase price to the specific assets that are acquired. The amount allocated to each asset then becomes its initial tax basis. For depreciable and amortizable assets, the initial tax basis of each asset determines the depreciation and amortization deductions for that asset after the acquisition. Depreciable and amortizable assets include:

  • Equipment,
  • Buildings and improvements,
  • Software,
  • Furniture, fixtures and
  • Intangibles (including customer lists, licenses, patents, copyrights and goodwill).

In addition to reporting the items above, you must also disclose on Form 8594 whether the parties entered into a noncompete agreement, management contract or similar agreement, as well as the monetary consideration paid under it.

IRS scrutiny

The IRS may inspect the forms that are filed to see if the buyer and the seller use different allocations. If the IRS finds that different allocations are used, auditors may dig deeper and the investigation could expand beyond just the transaction. So, it’s in your best interest to ensure that both parties use the same allocations. Consider including this requirement in your asset purchase agreement at the time of the sale.

The tax implications of buying or selling a business are complicated. Price allocations are important because they affect future tax benefits. Both the buyer and the seller need to report them to the IRS in an identical way to avoid unwanted attention. To lock in the best postacquisition results, consult with us before finalizing any transaction.

© 2019

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Private Companies: Beware of SEC Scrutiny

The Securities and Exchange Commission (SEC) doesn’t monitor just publicly traded companies. It also looks at the dealings of some private companies, often to the surprise of their owners and executives.

Reasons for SEC scrutiny

The SEC’s mission is to protect the public as well as the integrity of the financial markets. That mission extends to not only public companies but also private ones that may be acquired by a public company or that are large enough to consider an initial public offering (IPO).

Ultimately, whether a private company attracts regulatory scrutiny depends on its disclosures regarding current and projected financial performance. Therefore, private companies must walk a fine line between 1) enticing would-be investors with attractive financial projections, and 2) painting an overly optimistic picture that’s unhinged from reality.

Interest in private company activities

Increasingly, the SEC has unleashed enforcement actions and investors have filed lawsuits related to allegedly misleading or erroneous statements made by private (or formerly private) companies. So, companies contemplating an IPO or a merger with a public company should begin developing their approach to SEC compliance as soon as possible.

The risk of attracting the attention of the SEC is particularly concerning if there’s a secondary market for your company’s pre-IPO shares. These are known as “security-based swaps” for purposes of SEC regulation. If the swaps are available to retail investors who don’t meet the criteria of an “eligible contract participant” under the Dodd-Frank Act, the securities must follow specific rules, including the existence of a registration statement and the ability to trade on a national securities exchange.

Additionally, the Financial Accounting Standards Board (FASB) recently proposed Accounting Standards Update No. 2019-600, Disclosure Improvements — Codification Amendments in Response to the SEC’s Disclosure Update and Simplification Initiative. The updated FASB guidance — which would apply to both public and private entities — would better sync U.S. Generally Accepted Accounting Principles (GAAP) with the SEC’s updated disclosure requirements.

Proactive compliance

It takes time to create and deploy an effective corporate governance program that complies with the SEC rules. Start the process by determining whether retail investors participate in trading that raises your company’s compliance risk. Pay close attention to every financial disclosure and the publicly available information that may affect trading. This effort should also include keeping track of material, nonpublic information available to insiders who may sell shares in the secondary market.

Next, create and deploy policies regarding how your company compiles its financial reports. Implement tools and procedures designed to prevent financial crime — such as internal fraud, bribery and corruption — and ensure compliance with SEC regulations. For example, you might consider setting up an anonymous whistleblower hotline for employees to report concerns regarding the company’s activities.

We can help

Companies on their way to becoming public represent a small, but growing, segment of the SEC’s enforcement activity. Protect your company against unwanted scrutiny by learning and complying with the SEC’s financial reporting rules and regulations.

Contact us to get a comprehensive assessment of your private company’s corporate governance practices. Now’s the time to shore them up, rather than waiting for an IPO or a merger with a public company.

© 2019

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In Pursuit of Global Tax Transparency

In today’s global economy, multinational corporations engage in numerous cross-border transactions. But how they report those transactions is often vague. To help minimize stakeholders’ exposure to potential hidden risks, the Financial Accountability & Corporate Transparency (FACT) Coalition wants multinationals to disclose more information about corporate taxes.

A global movement

The FACT Coalition is a nonpartisan group of more than 100 state, national and international organizations working toward a fair global tax system and curbing corrupt financial practices. Its website reports that, until the passage of the Tax Cuts and Jobs Act (TCJA), the 500 largest U.S. companies had $2.6 trillion stashed offshore, costing taxpayers over $750 billion in unpaid taxes. But tax reform didn’t completely stop the problem. Under the TCJA, offshore tax avoidance is expected to cost an additional $14 billion in lost tax revenue over the next decade.

As of March 2019, the United States and 77 countries require multinationals to file country-by-country reports privately to tax authorities, according to a standard set by the Organisation for Economic Co-operation and Development (OECD). But few countries require public disclosures of such information, except by certain banks and oil, gas and mining companies.

What inquiring minds want to know

The FACT Coalition recently issued a report titled Trending Toward Transparency: The Rise of Public Country-by-Country Reporting. It urges Congress, the U.S. Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB) to up the ante.

Specifically, the FACT Coalition wants multinational corporations to publicly disclose, on an annual, country-by-country basis:

  • The number of entities,
  • The names of principal entities,
  • Primary activities of these entities,
  • The number of employees,
  • Total revenues broken out by third-party sales and intragroup transactions of the tax jurisdiction and other tax jurisdictions,
  • Profit/loss before tax,
  • Tangible assets other than cash and cash equivalents,
  • Corporate tax paid on a cash basis,
  • Corporate tax accrued on the profit or loss (including reasons for any discrepancies), and
  • Significant tax incentives.

The FACT Coalition believes that “these enhanced disclosures are essential for investors to effectively value and assess the risks related to the public companies in which they have invested.”

Transparent reporting

Some multinationals, such as Vodafone and Unilever, voluntarily provide country-by-country tax disclosures. Should your company report similar information? Companies that are upfront about their tax strategies may engender trust and goodwill with stakeholders.

Contact us to discuss whether the benefits of expanded global tax disclosures outweigh the costs. We can help you collect this information and report it to your investors to a user friendly format.

© 2019

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How Auditors Use Nonfinancial Information

Every financial transaction your company records generates nonfinancial data that doesn’t have a dollar value assigned to it. Though auditors may spend most of their time analyzing financial records, nonfinancial data can also help them analyze your business from multiple angles.

Gathering audit evidence

The purpose of an audit is to determine whether your financial statements are “fairly presented in all material respects, compliant with Generally Accepted Accounting Principles (GAAP) and free from material misstatement.” To thoroughly assess these issues, auditors need to expand their procedures beyond the line items recorded in your company’s financial statements.

Nonfinancial information helps auditors understand your business and how it operates. During planning, inquiry, analytics and testing procedures, auditors will be on the lookout for inconsistencies between financial and nonfinancial measures. This information also helps auditors test the accuracy and reasonableness of the amounts recorded on your financial statements.

Looking beyond the numbers

A good starting point is a tour of your facilities to observe how and where the company spends its money. The number of machines operating, the amount of inventory in the warehouse, the number of employees and even the overall morale of your staff can help bring to life the amounts shown in your company’s financial statements.

Auditors also may ask questions during fieldwork to help determine the reasonableness of financial measures. For instance, they may ask you for detailed information about a key vendor when analyzing accounts payable. This might include the vendor’s ownership structure, its location, copies of email communications between company personnel and vendor reps, and the name of the person who selected the vendor. Such information can give the auditor insight into the size of the relationship and whether the timing and magnitude of vendor payments appear accurate and appropriate.

Your auditor may even look outside your company for nonfinancial data. Many websites allow customers and employees to submit reviews of the company. These reviews can provide valuable insight regarding the company’s inner workings. If the reviews uncover consistent themes — such as an unwillingness to honor product guarantees or allegations of illegal business practices — it may signal deep-seated problems that require further analysis.

Facilitating the audit process

Auditors typically ask lots of questions and request specific documentation to test the accuracy and integrity of a company’s financial records. While these procedures may seem probing or superfluous, analyzing nonfinancial data is critical to issuing a nonqualified audit opinion. Let’s work together to get it right!

© 2019