Buttoning Up the Year-End Close

As calendar-year companies approach the year-end close, auditors are are drawing up detailed checklists of issues they plan to study carefully this year, largely based on persistent economic gloom that stresses rosy assumptions, but also based on issues they expect regulators to scrutinize.

Economic uncertainty is a huge driver of numerous assumptions and estimates that roll into financial statements, says Dennis Whalen, the incoming partner in charge and executive director of KPMG's Audit Committee Institute, so companies should check them carefully. “The challenge is for preparers, auditors, and boards to make sure the processes companies go through are robust, consistently applied, and transparent,” he says.

Companies should double check anywhere they are relying on estimates in their financial statements to assure their estimates are sound and based on current conditions, says Chris Smith, a partner at BDO USA. He tells companies to begin by studying their disclosures in their management discussion and analysis. “What are the items disclosed in your critical accounting estimates?” he asks. “Those are the large, important subjective ones.” That might include impairments, forecast, reserves for inventories, deferred tax assets, and any fair-value measurements, he says.

Auditors are getting clear signals from regulators to pay closer attention to estimates, Smith says. Auditors may pull out a list of significant estimates made in prior years and compare those to what actually occurred, to get a sense for how accurate the company's estimates typically are. “There's no reason a company couldn't perform that assessment on itself,” he says. “To the extent you're hitting it out of the park, keep doing what you're doing. If maybe historically estimates have not been spot on, how can you improve and get better inputs?”

Any items measured at fair value are sure to be checked carefully, says Bob Dohrer, national director of assurance services for McGladrey & Pullen. Whether those values are established for investment securities, pieces of property, or other financial assets, auditors will be focused on management's controls over establishing those values. It won't be enough to rely on third-party valuation services, he says.

Regulatory Priorities

The Public Company Accounting Oversight Board through its inspections has alerted auditors that management must demonstrate more understanding of the values they assert beyond simply hiring an outside vendor, according to Dohrer. “Even though they are outsourcing this work, they have to understand the assumptions around things like discount rates,” he says. “That's been a big area of focus.”

CFO ECONOMIC OUTLOOK

Below are some key findings from FEI's CFO Outlook Survey:

Global Leadership: CFOs differed by region when it came to the global leaders they respected most. U.S. CFOs were most favorable of Chancellor of Germany Angela Merkel for economic policies, but ranked their own President Obama to number four out of twelve. CFOs in Europe shared a reverence for Merkel, but also weighted Obama high on their list (above their own leaders).

Hiring: Despite their pessimism about the economy, a surprising 54 percent of U.S. CFOs are still planning to hire additional employees at their company in the next six months (about a third (34%) do not plan to hire) -a similar sentiment to what was reported in the previous quarter. Meanwhile, 52 percent of Europe CFOs are not planning to hire additional workers in the next six months, and only 38% plan to add to their workforce. More than a third (34%) of U.S. CFOs consider the continued economic volatility to be the factor with the biggest impact on hiring decisions.

Unemployment: U.S. and European CFOs are both forecasting generally high unemployment rates for the next year, but while CFOs in U.S. on average see this slightly declining (9.2% six months from now to 8.9% in a year), European CFOs feel the rate will increase (8.1% six months from now; 8.6% in a year).

Taxes: With respect to tax reform proposals, U.S and European CFOs were least willing to give up the exclusion of employers' contributions for their employees' medical insurance premiums and medical care (21% in the U.S. and 29% in Europe) in exchange for lower business tax rates. For U.S. respondents, the mortgage interest deduction (18%) was the next tax benefit they would prefer not to lose, closely followed by the exclusion of contributions to and earnings of employer-provided and individual retirement plans (17%), which was also favored by 23 percent of CFOs in Europe.

Inflation: Concerns over inflation are worsening among European CFOs, but it appears to be less of an ongoing concern among their U.S. counterparts. When asked to rate their inflation concerns on a scale of one to five (with five being the highest level of concern), 76 percent of U.S. CFOs selected a three or lower, while 62 percent of European CFOs selected a three or higher. While the majority of those surveyed in both regions felt their level of concern was unchanged from last quarter, nearly a fifth (19%) of European and U.S. respondents said they were more concerned since last quarter -- 12 percent of U.S. and 6 percent of European CFOs said they were less concerned.

Oil Prices: This quarter, CFOs also expect oil prices to drop and remain under $100 -- the overwhelming majority of CFOs in the U.S. (77%) and Europe (74%) predict the price of oil per barrel will be at $90 or lower in the next six months, which was nearly $103 when the survey was conducted.

Risk Controls: In light of rogue trading scandals over the past few years, most U.S. CFOs have not considered increasing budgets toward improving risk management controls (65%), while the majority of European CFOs have considered increasing their budgets in this area (56%). CFOs believe risk management oversight should lie at the Board level (39% of Europe CFOs and 33% of U.S. CFOs), but many take the responsibility on themselves, believing the task should fall with the CFO (25% of Europe CFOs and 29% of U.S. CFOs).

Fraud: In today's highly digital world, 53 percent of European CFOs stated that they regularly review content on their company's social media activity to identify potential fraudulent activity, compared with only 34 percent of those in the U.S.

Source: FEI.

Kevin Pianko, a partner with accounting firm WeiserMazars, says companies should expand their sensitivity beyond the normal range when looking at key data inputs to fair-value measurements. “There's more uncertainty in the markets, so more could go wrong,” he says. Whatever the typical standard deviation from a midpoint, companies should consider stretching that deviation a little further to reflect current uncertainties, he says.

The focus on economic conditions, estimates, and fair value extends significantly into impairment analyses, Pianko says. Companies should look hard at any assertions around goodwill, intangible assets, long-lived assets, and others to study the indicators that might suggest impairments are warranted. That could include any number of factors—political or economic unrest in given countries, loss of key customers or key employees, general deterioration of economic or business conditions, and numerous others. “Those need to be addressed and discussed,” he says.

Whalen is advising preparers to pay close attention to any significant transactions late in the period or early in the next period, looking for terms or conditions that are not typical for the company. “We need to understand whether a company is inadvertently directing an outcome to one side of the fairway or the other and assess the implication to the financial results,” he says. “Now is the time of year when people may be trying to make up ground, or trying to push something out into the future if they've already had a good year. Scrubbing significant transactions is always top-of-mind for me at the end of the year.”

Paul Kepple, chief accountant at PwC, says the Securities and Exchange Commission is still scrutinizing disclosures of contingencies, or pending legal issues that might affect financial results, looking for reasonably possible ranges of losses or sound basis when companies say those estimates can't be made. The SEC has been studying those disclosures looking for increasing detail as contingencies move closer to resolution, to minimize surprises for investors. “That's been an area of focus all year, and it's not letting up,” he says.

Revenue recognition also remains a high priority on auditors' check lists, says Kepple. They will be especially vigilant this year looking for proper gross or net presentation of revenue, depending on whether the company reporting the revenue is the principal provider of goods or services or an agent acting on behalf of another entity. They also will look at cash going back and forth between entities to assure proper gross vs. net presentation. “In any situation where you have cash going both directions between two entities, the SEC is looking to be sure they are appropriately classified,” he says.

Given economic conditions, companies also should take a fresh look at receivables, as well as receivables that have been converted to long-term notes. “Are they ever going to be able to pay?” asks Andy Burczyk, a shareholder with audit firm Mayer Hoffman McCann. Likewise, companies need to look at their own debt covenants and their own ability to meet lenders' terms. “A lot of debt covenants were written when companies were more profitable than they are now,” he says. “As you lose money, you get closer to possible violations, so you need to be aware of it.”