Journal of Accountancy

Letters

Communication Is Key

By Matthew R. Johnson

april 2008

Catherine Allen et al.'s article ("Navigating the Crossroads of Control and Independence ," Dec. 07, page 42) was an excellent article clarifying the guidance in Statement on Auditing Standards (SAS) no. 112 as it applies to private company auditors' responsibilities of communicating internal control matters. Page 46 of the article provided an example of a client failing to detect an error that the practitioner identified as a significant deficiency in internal control over financial reporting that "would have caused a misstatement in the financial statements."

While the article did not elaborate if the misstatement was material to the financial statements, if a material misstatement would have been reflected in the financial statements due to a deficiency in the internal control over financial reporting (for example, was not detected or prevented by the client's internal controls), it may rise above the level of a significant deficiency and be a material weakness.

SAS no. 112, Communicating Internal Control Related Matters Identified in an Audit, states that, "a material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected..."

Additionally, PCAOB Auditing Standard no. 5 states a similar definition for material weaknesses detected during integrated audits for public companies.

The evaluation and assessment of internal control deficiencies is highly dependent on auditor judgment and other engagement-specific factors, in addition to quantitative materiality thresholds. Auditors should apply their own professional judgment when aggregating and concluding on internal control deficiencies.

This article did a good job of providing an overview of the new responsibilities that auditors have when conducting audits of private companies. Communication of these new auditing requirements with clients is a key aspect of the practitioner's job to properly educate their private company clients as to the potential implications of the new internal control communication requirements and the auditor's responsibilities under Generally Accepted Auditing Standards. The new standards can also provide practitioners opportunities to serve their clients as trusted business advisers with regard to their private company clients' internal controls over financial reporting.

Matthew R. Johnson, CPA
Omaha, Neb.

Letters

Audit Purchases to Check Revenue

By Gary M. Barnbaum

april 2008

I just took your test, “What Is Your Fraud IQ?,” (Dec. 07, page 56). I received a score of 90%.

However, I do want to take issue with the wording in one of the questions. In 10(a), you described “Cost of Goods Sold” as an account. Technically, that’s not accurate. Cost of goods sold is a subtotal made up of a number of accounts, including the account “purchases.” (Although, oftentimes, cost of goods sold is reflected as one number on a published condensed financial statement.)

Therefore, one way to validate fictitious revenues (and also unrecorded revenues) is to audit purchases. This type of so-called “backward auditing” is not only commonly used for the purpose of validating sales, it is commonly used by government agencies for the same purpose, especially with sales tax audits.

Gary M. Barnbaum, CPA
Woodland Hills, Calif.

Letters

Minding One's Own Business

By Chuck Barnewolt

april 2008

I find it ludicrous that your article, “Software Revenue Recognition on the Rise” (Dec. 07, page 50) not only insinuates but even goes so far as to actually state that companies are changing their business practices because of SOP 97-2. While the accounting profession, of which I am part, is indeed an honorable one, our profession should in no way dictate, or limit, how we, as businessmen, conduct business with our customers.

Chuck Barnewolt
Raleigh, N.C.

Authors’ reply: While we certainly agree that the accounting for a transaction should not drive the related business decision(s), we do believe that it is critical that a company’s decision makers are made aware of the accounting consequences involved in sales arrangements. A clear precursor to being able to provide useful and accurate guidance to a company’s decision makers is an understanding of the facts and circumstances involved in a given transaction or product offering. Once this information has been gathered and the applicable accounting treatment has been derived, an accountant can then provide a company’s decision makers with the tools to understand which direction is most beneficial for their particular entity. Similar to profit margin analyses, cash flow analyses, and various other financial metrics, it is reasonable to expect an assessment of the timing of revenue recognition, as well as the cost of compliance, to be considered as part of the set of factors a decision maker considers. Armed with this insight, a decision maker can be comfortable in knowing that they have the full picture associated with an arrangement or type of arrangements, and have been empowered to pursue the best course of action.

Greg Regan, CPA,
and Tim Regan, CPA
San Francisco

Letters

Found: Client Evaluation Template

By David B. Tenney

april 2008

The article, “Letting Go: Evaluating and Firing Clients” (Jan. 08, page 54), was well written and exactly on point for my firm.

I am the sole owner of a two-office, 23-person firm. In late 2006, my business partner unexpectedly passed away. During 2007 we had some expected—and some unexpected—changes in our client base. My overall goal for 2007 was to stabilize our client base and make sure we had no net fee revenue loss.

For 2008, my overall goal is to put an annual client evaluation and firing process in place. It would also include formalizing new client acceptance standards and processes.

Is the PCPS template for client evaluation mentioned in the article available?

David B. Tenney, CPA
Marietta, Ohio

Editor’s note: The PCPS Client Evaluation template is available at www.aicpa.org/pubs/jofa/jan2008/downloads/Client_Evaluation_v2.pdf.

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