Acuity Blog

A brave new world in audit confirmations

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Electronic financial tools — such as online banking, mobile payment apps and paperless invoicing — are increasingly popular in today’s business world. But existing auditing standards still require auditors to send out paper confirmation letters through the U.S. Postal Service. To modernize the confirmation process, the Public Company Accounting Oversight Board (PCAOB) may revive a 2010 proposal to expand the definition of “confirmation responses.” Here’s how confirmation procedures will likely change if the proposal is reissued and approved.

Traditional procedures

Auditors send third-party confirmation letters to customers to verify accounts receivable and to financial institutions to confirm notes payable. They also may choose to substantiate notes receivable, inventory, consigned merchandise, long-term contracts, accounts payable, contingent liabilities, and related-party and unusual transactions.

When confirmation responses signal exceptions, auditors follow three steps: 1) Determine the cause, 2) extrapolate the misstatement to see whether additional testing is necessary, and 3) consider fraud.

Control issues

Auditors must maintain control over confirmation procedures to minimize the possibility that the results will be biased because of alteration of the confirmation requests or responses. So, they typically send paper requests through standard U.S. Postal Service mail in accordance with Interim Auditing Standard AU Section 330, The Confirmation Process. This can be time-consuming, especially if recipients fail to respond.

Need for change

AU Sec. 330 went into effect in 1992. In addition to mailed confirmation responses, it refers to confirmation responses received orally or via facsimile — but not to electronic communications or online records.

In 2010, the PCAOB issued a proposal that, among other changes, defined a confirmation response to include electronic or other media. This would make the confirmation process more efficient — although auditors would need to take into account the risks associated with electronic confirmation responses.

Work in progress

After tabling the proposal for five years to work on other projects, the PCAOB is planning to revive it. If electronic responses are accepted, the confirmation process could soon be more efficient.

© 2016

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Does your company have a Roth 401(k) plan for employees?


Although Roth 401(k) accounts have been around for 10 years, many employers don’t offer them and many people still don’t understand them. As the name implies, these plans are a hybrid — taking some characteristics from Roth IRAs and some from employer-sponsored 401(k)s.

 A 401(k) with a twist
An employer with a 401(k), 403(b) or governmental 457(b) plan can offer designated Roth 401(k) accounts.

As with traditional 401(k)s, eligible employees can elect to defer part of their salaries to Roth 401(k)s, subject to annual limits. The employer may choose to provide matching contributions. For 2016, a participating employee can contribute up to $18,000 ($24,000 if he or she is age 50 or older) to a Roth 401(k). The most you can contribute to a Roth IRA for 2016 is $5,500 ($6,500 for those age 50 or older).

Note: The ability to contribute to a Roth IRA is phased out for upper-income taxpayers, but there’s no such restriction for a Roth 401(k).

The pros and cons
Unlike traditional 401(k)s, contributions to employees’ accounts are made with after-tax dollars, instead of pretax dollars. Therefore, employees forfeit a key 401(k) tax benefit. On the plus side, after an initial period of five years, “qualified distributions” are 100% exempt from federal income tax, just like qualified distributions from a Roth IRA. In contrast, regular 401(k) distributions are taxed at ordinary-income rates of up to 39.6%.

In general, qualified distributions are those:

  •   Made after a participant reaches age 59½, or
  •   Made due to death or disability

Therefore, you can take qualified Roth 401(k) distributions in retirement after age 59½ and pay no tax, as opposed to the hefty tax bill that may be due from traditional 401(k) payouts. And unlike traditional 401(k)s, which require retirees to begin taking required minimum distributions after age 70½, there’s no mandate to take withdrawals from Roth 401(k)s.

If you’d like to add a Roth 401(k) to your benefits lineup, contact us for more information.
© 2016

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How to minimize surprises during physical inventory counts

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Counting inventories of raw materials, work in progress, finished goods, and parts and supplies is necessary for accurate recordkeeping, but it can be tedious. There’s almost always a variance between what’s on the shelves and what’s in your perpetual inventory system or general ledger. A relatively small difference shouldn’t give rise to panic. But a variance that exceeds 3% to 5% is a cause for concern. Here are some ideas for minimizing discrepancies.

Finding the cause

Most differences result from timing gaps between order entry, physical receipt of inventory items and invoice entry. Open orders and returns also cause legitimate discrepancies. But some variances signal problems, such as careless receiving and ordering practices, billing and data entry errors, poor communication between the production, warehouse and accounting departments, and even fraud.

Monthly inventory counts can catch errors before they spiral out of control. Your objectives: Identify sources of any discrepancies; locate missing, damaged or inaccurately priced items; and train employees to prevent mistakes from recurring.

Implementing safeguards

Inventory can be a prime target for thieves inside and outside your organization. To prevent shrinkage, conduct background checks on personnel and consider such physical controls as:

  • Locking inventory storerooms even during business hours,
  • Limiting access to the storeroom and its keys,
  • Installing security cameras, alarms and mirrors,
  • Recording serial numbers or tags for high-value items, and
  • Spot-checking inventories periodically.

The cost of these safeguards is recouped with fewer write-offs for lost, stolen or damaged items. They also create a sense of accountability for personnel with access to the storeroom.

Outsourcing your count

A third-party count not only may be more objective than one done by employees — especially in case of fraud — but also can be faster. We participate in dozens of physical counts each year and know the most efficient approach. Contact us for help counting and managing your inventory.

© 2016


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Borrowing from your corporation? Structure the transaction carefully



Whenever cash or property passes between a closely held corporation and its shareholders, there are generally tax consequences. You can control the consequences by documenting your intentions for the transactions and by following through accordingly.

For example, let’s say a shareholder takes withdrawals from a corporation’s accounts that are intended as tax-free loans — but they aren’t properly documented. In an audit, the IRS will likely recharacterize them as constructive dividends with capital gains tax due.

Important factors

The IRS and courts examine a number of factors to determine if payments to a shareholder are proceeds from a tax-free loan or a taxable corporate distribution. Some questions:

  1. Was there a written promise to repay the loan evidenced by a note or other document?
  2. Was there a stated interest rate, repayment schedule or balloon repayment date?
  3. Were principal and interest payments made on time?
  4. Was there adequate security or collateral for the loan?
  5. Did the borrower have a reasonable prospect of being able to repay the loan?
  6. Did the parties conduct themselves as if the transaction was a loan? For example, did the shareholder show loans owed to the corporation as liabilities on his or her personal balance sheet?

When transactions are intended to be loans, the factors above should be considered and respected. Otherwise, the IRS could recharacterize the transactions in ways that have negative tax consequences for shareholders, their corporations, or both.

Plan ahead

Properly structuring corporate loans is critical to getting the best tax and financial results. Contact us for assistance plotting the best strategy.

© 2016

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Financial statement disclosures: A closer look at materiality


Shakespeare thinking.

Shakespeare thinking.

The concept of “materiality” helps management identify what’s important enough to a company’s financial well-being to warrant additional disclosures in the financial statements. Unfortunately, the FASB doesn’t currently define what information should be considered “material” under Generally Accepted Accounting Principles.

Investors don’t generally view materiality in terms of rule-of-thumb percentages. Instead, they see it as a qualitative, legal concept. The U.S. Supreme Court’s description of materiality is a “substantial likelihood” that omitting the information would be viewed by a reasonable investor or creditor as having “significantly altered” the total information available to make a decision.

Proposals attempt clarity

In late 2015, the FASB released two related proposals to guide businesses on when to include information in a footnote disclosure and when to omit it. Under the proposals, businesses would be required to assess whether investors will find the information useful and whether the information fits the legal concept of materiality.

Concerns mount

Many businesses are concerned that the Supreme Court’s definition of materiality could evolve over time — and potentially morph into something that’s overly prescriptive or otherwise undesirable from a financial reporting perspective. So, the FASB is considering omitting any specific references to the Court’s definition.

To further complicate matters, if the FASB adopts these proposals, its definition of materiality could differ somewhat from the definition set forth by the International Accounting Standards Board.

Materiality is a gray area

The proposed changes to the materiality framework are designed to help facilitate management’s decision-making process. They aim to eliminate unhelpful, boilerplate information in the footnotes that makes it harder for investors to get at important facts.

During a March 2016 meeting, the FASB reviewed comments letters on its proposals. Now the project is back in the re-deliberation phase. Contact us for the latest information about this fundamental financial reporting concept.

© 2016

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