Special Earthquake Edition

Yesterday when the earth began trembling, I did what I do every time I am in a life threatening situation. I asked myself, “What would Jennifer Aniston do?” So I kicked off my high heeled pumps and ran screaming from the building. Then I went shopping. What really happened isn't as interesting. I was working at a client's office in Manassas when the building started shaking. I was entering a couple of journal entries into their accounting system and didn't see a need to interrupt that. One of the owners came by and remarked, “Wow, Frank didn't even stop working.” I replied, “Did you really want me to keep billing you as I ran screaming out of the building like a little girl?” When I was done at that client's office, I rushed back to my office to make certain none of our Jennifer Aniston pictures had fallen off the men's bathroom wall. That would have been a real tragedy. We can rebuild the Pentagon, but an autographed picture of Jen is irreplaceable. Thanks to all of you who expressed your concern for Jen's pictures on Facebook. I tried calling Jen on her cell phone to make certain she was unhurt, but all of you wussies were busy calling your families and prevented me from getting through. As I drove back to my office post-quake, I listened to WTOP news on the radio. They had someone from everywhere call in to share their experiences – even Woodbridge. Who gives a damn about how people in Woodbridge feel? The Loch Ness monster called in from Scotland to tell us his lake shook. Big Foot probably couldn't get through on his cell phone. AT&T service was down – as usual. If you've made it through my earthquake diatribe, you at least deserve some real business advice. I wish I had a good stock tip to pass on – say what to buy when the earth is shaking, but I don't. There is a punch line in there that eludes me. If I find one, I'll post it on Facebook. If you have a good one, let me know. I'll take the credit for it – but not the blame if it bombs. Last week, I was preparing a set of financial statements for a client. This was no big deal. I spent a few hours working on them and then send the owner a draft. After reviewing the draft, he called me, “Frank, I need you to make me look good for the bank.” You might reasonably inquire why he would make that statement. I might reasonably answer that his company's financial statements weren't very impressive. By that, I mean that he had small losses, not profits, for both years presented in the financial statements. He was hoping to get a new bank loan. The financial statements certainly would not look great to a bank. I hear this owner's plea about a dozen times per year. In each case, a company owner is looking for something from a bonding company or a bank and needs financial statements prepared by a CPA. I prepare the financial statements as requested and then get the phone call. “Frank, can you make my financial statements look better?” Apparently, there is some trick I missed in CPA school that will magically turn losses into profits. Jesus turned one loaf of bread into many. That is a miracle. I dare him to turn some of these ugly-assed profit and loss statements into something a banker might believe. Take a guess why banks and bonding companies want financial statements prepared by CPA's. No that isn't right. That isn't either. You get half credit if you guessed that banks just want someone to sue when the loan goes bad. The real reason is that banks trust CPA's to present financial statements that are truthful to the best of our abilities. That reason would seem to eliminate the possibility of my fudging the numbers to make the company owner happy. I should mention, however, that in the past I have had mortgage companies ask me to falsify financial amounts. We all know where that practice led the mortgage industry. In case you haven't guessed by now, my answer is “No.” My job isn't to make a company's financial statements look good. My job is to make them look accurate. The owner's job is to make the financial statements look good – by managing his company well. Now that you have accepted my plea not to ask me to commit fraud, let's discuss the types of financial statements a bank or a bonding company might request. There are three basic types of financial statements a CPA can issue. They are compiled financial statements, reviewed financial statements, and audited financial statements. These three types of statements differ in the amount of responsibility the CPA takes for the accuracy of the numbers and consequently the amount of work the CPA performs. A quick explanation of the three types of financial statements is as follows. If it looks like a duck, it is a duck. That describes compiled financial statements. If it looks like a duck and quacks like a duck, it is probably a duck. That describes reviewed financial statements. If it looks like a duck, quacks like a duck, and is genetically proven to be a duck, it is a duck. That describes audited financial statements. Let's look at the three types in a little more detail. When a CPA prepares a set of compiled financial statements, he takes no responsibility for the accuracy of the financial statements. The CPA is required to read the financial statements and gain an understanding of the company, but that is all. There is no assurance whatsoever that the financial statements are correct. This, obviously, is the lowest level of assurance a CPA can provide in that no assurance is provided at all. The only responsibility for correcting the financial statements arises when the CPA notes an obvious departure from accounting principles generally accepted in the United States. Then he can either correct the financial statements or note in his report the departure. From a practical standpoint, most CPA's including me, don't issue compiled financial statements without performing at least some work to determine that the numbers in the financial statements aren't total garbage. We will normally make certain the bank accounts and a few other important balance sheet accounts have been reconciled. But – we aren't required to do that. Compiled financial statements are the least expensive set of financial statements a CPA will issue. Compiled statements normally run from $500 to $2,000 depending on the complexity of the statements and the amount of work the CPA performs. Reviewed financial statements provide a higher level of assurance than compiled financial statements. A CPA is required to do at least a little more work before issuing reviewed financial statements. We have to perform all of the procedures for a compilation, but we must also make inquiries as to the balances in the financial statements. In other words,we might inquire as to whether the bank accounts have been reconciled and whether all accounts receivable are collectible. From a practical standpoint, most CPA's will prepare workpapers that support the balances of all the significant balance sheet accounts and some of the accounts on the income statement. We aren't required to actually test any of the transactions that make up the financial statements. In other words, we don't examine canceled checks or confirm accounts receivable balances with customers. We also do not do any testing for fraud. A set of reviewed financial statements gives some assurance that a company's financial statements are accurate, but certainly not absolute assurance. A set of reviewed financial statements will typically cost between $1,000 and $5,000 for a small business again depending on the complexity of the financial statements. The highest level of assurance that a CPA can provide comes with audited financial statements. An audit includes all of the compilation and review procedures but also includes testing on a sample basis the transactions in the accounting system. For example, in an audit, a CPA will test count year end inventory and confirm bank account balances with a company's bank. The CPA will also evaluate the risk that fraud may have occurred and perform some fraud testing. However, testing extensively for fraud isn't part of an audit. This surprises most people. The general public perception is that an audit is primarily about detecting fraud. It is not. An audit for a small business will typically start at not less than $15,000 and could run to over $100,000. Audits aren't for most small businesses. Audits are also risky for CPA firms from a liability standpoint. We don't perform them for that reason. They also aren't nearly as much fun as preparing tax returns. Yes, I take medication for this condition. What type of financial statements should you want for your small business? Banks and bonding companies love audits for obvious reasons. They also understand that most companies can't afford them. For companies with less than $10 million in annual revenue, most banks and bonding companies will accept reviewed financial statements. For very small companies with less than $1 million in annual revenue, banks will typically accept compiled financial statements. In most cases, I recommend selecting the least costly service that your bank or bonding company will accept. Yes, I would love to bill you for reviewed financial statements. However, if I ask myself what Jennifer Aniston would do, I realize that she would probably go shopping. So she is no help there. I try to put my clients' best interests first. I sleep better that way. I end up with plenty or work to do anyway. As always, if you want non-snarky tax and accounting advice, please visit our main S&K web site at HTTP://www.skcpas.com. In the meantime, make certain your life insurance bill is paid. With the next earthquake, we will all surely die!