Nothing attracts investors more than a company’s future earnings potential. But predicting growth isn’t a foolproof science.
“Investors look at historical financial statements and calculate earnings before interest, taxes, depreciation and amortization (EBITDA). That’s easy to do, but doesn’t provide the entire picture, and certain expenses associated with internal capital projects and leases might not be apparent,” says Tom Vande Berg, a partner with Crowe Horwath LLP in the Transaction Services Group.
Smart Business spoke with Vande Berg about these hidden expenses and how they can affect growth potential.
Why are capital leases an area of concern?
If a lease is capitalized, the associated expense is recognized on the income statement as depreciation and interest rather than rent. Therefore, EBITDA would not include an expense for the lease even though the company has ongoing monthly payments. If a similar piece of equipment were treated as an operating lease, it would incur a profit and loss expense.
When are leases capitalized?
The Financial Accounting Standards Board Accounting Standards Codification (FASB ASC) Topic 840 states that leases must be capitalized if they meet one of four criteria:
- Ownership automatically transfers to the lessee at the end of the lease term.
- The lease includes a bargain purchase option.
- The term of the lease is 75 percent or more of the asset’s useful life.
- Present value of minimum lease payments is 90 percent or more of the fair value of the asset.
Companies might have several pieces of similar machinery or equipment for which some leases are considered capital and others are categorized as operating.
What are other examples of hidden expenses?
- Nonlevel rent — If a company has periods of free rent or rent escalations, its rent expense might not equal its cash rent payments. For example, a company could have a 10-year operating lease that increases annually by 3 percent. An investor analyzing rent expense after year five of the lease would see an expense less than actual future cash expenditures.
- Machinery constructed in-house — In these cases, labor and overhead is typically capitalized in relation to the project. If the capitalized labor and overhead relate to salaried employees, the costs should be considered ongoing expenses in an EBITDA calculation.
- Capitalized repairs and maintenance — Companies without a formal capitalization policy might improperly capitalize normal repair and maintenance into fixed assets. These expenditures should be included as part of the normal operating expenditures.
- Capitalized internal-use software — Costs incurred creating new computer software for internal use can be divided into two stages: preliminary project phase and development phase. All costs of the preliminary project phase should be expensed. Development stage activities can be capitalized, but if capitalized payroll and related costs are for salaried employees who would be paid regardless of the current project, the costs should be considered ongoing expenses.
- Capitalized software to be leased or sold — According to FASB ASC 985-20, internal costs in creating computer software are expensed until feasibility is established. Then, the costs of coding, testing and other activities associated with producing product masters are capitalized, which may include allocated indirect costs. As a result, certain ongoing operating expenses such as payroll and rent may be capitalized and excluded from the initial calculation of EBITDA.
So an investor just looking at EBITDA would only be getting part of the picture?
While the EBITDA calculation is a valuable tool for analyzing future earning potential, it might not reflect all recurring expenses. Investors also must consider what expenses are lurking below the surface, as capitalized or lease costs could significantly affect future cash flow.
Tom Vande Berg is a partner in the Transaction Services Group at Crowe Horwath LLP. Reach him at (214) 777-5253 or firstname.lastname@example.org.
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Government pensions have received significant scrutiny over the past few years, and several studies indicate that the state and local government pension plans are severely underfunded, with cumulative estimates ranging from $1 trillion to $4 trillion in the U.S. New Governmental Accounting Standards Board (GASB) reporting standards will make the problem more apparent by making the shortfalls prominent on financial statements of the government employer. This transparency likely will drive increased scrutiny by legislatures, taxpayers, rating agencies and other stakeholders.
Instead of recognizing pension costs on balance sheets as annual expenditures based on a funding approach, government entities will need to address net pension liability — the difference between present value of projected benefit payments and investments set aside to cover those obligations.
“In some instances, reporting agencies could be required to show millions of dollars in new liabilities on their balance sheets and make sizeable adjustments to their income and expense statements as well,” says Kevin W. Smith, CPA, partner at Crowe Horwath.
Smart Business spoke with Smith about the new standards and how they will affect state and local governments.
How will the new standards take effect?
GASB Statement No. 67, ‘Financial Reporting for Pension Plans,’ and Statement No. 68, ‘Accounting and Financial Reporting for Pensions,’ take effect in fiscal years starting after June 15, 2013, and June 15, 2014, respectively. They replace requirements in GASB Statements Nos. 25, 27 and 50.
The fundamental change is that the previous standards did not require pension benefits to retired employees to be reported as a liability; employers disclosed an estimated amount of unfunded pension liability only in notes to the financial statements and in required supplementary information, but the net pension liability itself was not reflected on the balance sheet.
New standards require government entities to report the net underfunded pension obligations on financial statements prepared under the accrual basis — a statement of net position, for example.
Government entities also will have to adjust their estimate value of assets set aside to meet pension promises. Governments had been allowed to use an assumed long-term rate of return, with current rates of 7 percent or more as expected return on invested assets. If certain conditions are met, that will change to a blend between long-term rate of return and municipal bond rates, currently about 4 percent, which will have a significant impact on the projected liability.
How will local and state governments be affected by the change?
For many governments this ‘new’ liability will completely offset all of an entity’s net assets — similar to equity in a private entity.
Some cities, counties, school districts or special purpose governments might be affected by both new standards. As local government employers, these institutions must comply with GASB 68. If they administer pension plans for police, firefighters or others, they must adhere to GASB 67 plan administrator requirements.
The new standards spell out requirements for disclosing related information in the notes with the financial statements, which includes descriptions of plan and benefits provided, assumptions used to determine net pension liability and descriptions of benefit changes. Preparing these disclosures will take a significant effort.
What should be done now in anticipation?
The purpose of the new standards is to provide a clearer picture of financial obligations to current and former employees and to treat net pension liability like other long-term obligations. However, the standards might make government entities appear to be financially weaker, even though their financial reality is unchanged. Financial officers should be prepared to explain the situation to taxpayers, employees and other stakeholders. Management should take a proactive approach and begin now to explain anticipated changes to all stakeholders.
Local agencies also need to be ready to take on the extra workload that will be associated with the transition. The GASB is expected to release implementation guidance this summer that will clarify the next steps for state and local governments.
Kevin W. Smith, CPA, is a partner at Crowe Horwath. Reach him at (214) 777-5208 or email@example.com.
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The federal financial institution regulators want to avoid a repeat of risky lending practices that contributed to the recent recession. New guidance sets higher standards for borrowers, including private equity firms and companies, seeking leveraged loans.
“This is a proactive move on the part of bank regulators to avoid some of the underwriting pitfalls that institutions encountered prior to the recessionary conditions we had going into 2007 and 2008,” says Dickie Heathcott, a partner at Crowe Horwath LLP.
Smart Business spoke to Heathcott about the guidance — which had a compliance date of May 21 — and what it means for borrowers and financial institutions.
What is the guidance, and do financial institutions have to adhere to its provisions?
Although a guidance isn’t necessarily a rule, it effectively becomes one in the field. Banks have to follow it because that’s what regulators are going to use when they examine the bank.
The guidance, issued by the Federal Reserve, Federal Deposit Insurance Corporation (FDIC) and Office of the Comptroller of the Currency (OCC), covers transactions with borrowers who have a degree of financial leverage that significantly exceeds industry norms.
It focuses on sound, levered lending activities, including:
• Underwriting considerations.
• Assessing and documenting enterprise value.
• Risk management expectations for credits awaiting distribution.
• Stress-testing expectations.
• Pipeline portfolio management.
• Risk management expectations for exposures held by the institution.
The guidance applies to all financial institutions supervised by the agencies, but significant impacts are not expected for community banks because few have substantial involvement in leveraged lending.
Are there certain industries where leveraged lending is of particular concern?
Construction and development lending is being looked at very closely because of what’s happened in recent years. This type of lending is generally considered commercial real estate lending.
The OCC and the Fed released a white paper in April with findings from the regulators’ study of bank performance in the context of the 2006 interagency guidance, “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices.” That guidance established supervisory criteria for banks that exceeded 100 percent of capital in construction lending and 300 percent of capital in total commercial real estate lending.
According to the paper:
• 13 percent of banks that exceeded the 100 percent construction-lending criterion failed during the economic downturn from 2008 to 2011.
• 23 percent of banks that exceeded both the construction and commercial real estate criteria failed from 2008 to 2011, compared to 0.5 percent of banks that exceeded neither criteria.
• An estimated 80 percent of losses in the FDIC fund from 2007 to 2011 were attributed to banks exceeding the 100 percent construction-lending criterion.
What does the guidance mean for businesses seeking loans?
Business owners can look for financial institutions to be very cautious in their underwriting. They will not have access to credit like they did in 2006, even though it seems that the economy has stabilized.
Regulators are being proactive; they can see that credit underwriting is loosening up. Quality deals are being priced so thin that financial institutions are looking at areas where they can make more profit, which, of course, brings additional risk.
From a financial institution standpoint, it’s becoming a very competitive environment again. That means pricing more thinly or a loosening of underwriting standards. Institutions may be willing to finance certain types of loans they would have pulled the reins in on completely three or four years ago. The guidance is about ensuring that to the extent institutions enter into leveraged financing again, they do so in a more prudent manner.
Dickie Heathcott is a partner at Crowe Horwath LLP. Reach him at (214) 777-5254 or firstname.lastname@example.org.
Website: For more information on regulatory guidance for financial institutions, visit Crowe’s Regulatory Reform Competency Center.
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Failure to assess and plan for risks associated with third parties can be costly. Of the more than 250 executives surveyed by CFO Research Services, 75 percent were harmed by action or inaction of a third party, resulting in financial loss, supply chain issues and data breaches.
“Companies initially think about risks with high-cost providers. But they may have a $10,000 contract with a small marketing or advertising firm that fails to adequately protect their customer information. Their servers get hacked and experience a breach that in turn raises concerns with their customers and brings reputational and financial risk and penalties,” says Jim Stempak, principal at Crowe Horwath LLP.
Smart Business spoke with Stempak about assessing third-party risk and solutions to limit exposure.
What poses third-party management risks?
Relationships that drive the most risks are:
- Service providers — processing, accounting, computer services, IT, service centers, advertising and marketing, leasing, legal and collections.
- Supply-side partners — production outsourcing, research and development, material supplies and vendors, and software development providers.
- Demand-side partners — customers, distributors, franchises and original-equipment manufacturers.
- Other relationships — alliances, consortiums, joint ventures and investments.
The Japanese tsunami and Hurricane Sandy illustrated this. If something happens to a single-sourced company, what’s the impact on suppliers or business partners?
What are some gaps that expose risk?
A ChainLink Research study found that 70 percent of organizations reported no resilience and risk mitigation standards for service providers. It also noted that risk assessment often focuses on the easiest risks to quantify, such as financial viability and business continuity plans.
With supply-side partners, vendor risk assessments are hampered by a lack of good data and poor visibility into contractor use.
How often should companies conduct risk assessments of third parties?
Risk assessments should be done at least annually for all vendor relationships that are high risk. Those with moderate or low risk can be done on a rotational basis.
In determining high-risk relationships, consider the financial risk penalty if a supplier has a breach. Another risk is reputational, such as a third party compromising private health information found in hospital records. Other high-risk areas are protection of systems and data, and reliability or continuity of operations. Are there contingency plans if a vendor faces a natural disaster or labor strike?
Many organizations don’t address risk management of third-party relationships until a problem arises. Before that happens, establish ownership for the organization’s third-party risk management framework, and responsibility for review and monitoring of individual relationships.
What other solutions address these risks?
First, establish ownership and buy-in, which requires executive leadership and oversight, with clear goals and objectives. Strengthen the overall relationship with the third party. Then evaluate risks by developing a risk profile of the organization that covers financial, integrity and operational issues. This spurs initiatives to audit, inspect, benchmark performance and costs, verify, and gain assurance or attestation.
A third-party risk management program should have:
- Risk measurement and monitoring.
- Performance measurement and monitoring.
- Incident tracking.
- Evaluation of the value received from the relationship.
This information guides decisions about when and whether to renegotiate an agreement. Success depends on customizing the assessment to the relationship, using automation to streamline the process, and analyzing trends of incidents.
In the CFO Research Services study, less than half of companies had a formal process for assessing and managing third-party risks, and 97 percent said at least one aspect of their third-party risk management should be improved. Businesses do their due diligence when entering contracts but tend to take their eyes off of it once a contract is signed.
Jim Stempak is a principal at Crowe Horwath LLP. Reach him at (214) 777-5203 or email@example.com.
Website: Learn more about third-party risk management with a webinar, podcast, white papers and more.
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Recently a number of corporate tax and accounting professionals were surveyed to gain insight into their tax provision process. They identified three major issues with their provision process:
- Data collection — the provision model does not contain all of the required financial information.
- Resource constraints — the tax provision process is very labor intensive.
- Timing — more than half the companies surveyed reported that they have less than one week to prepare their consolidated tax provision.
The survey clearly demonstrates the need for automation. Corporate tax executives understand an automated system provides the standardized platform to consolidate data, eliminate many of their manual processes and be more time effective.
Tom DeMetrovich, director at Crowe Horwath LLP, says the survey results are indicative of the challenges faced by most corporate tax departments.
“Responsibilities are increasing and staffing trends generally are flat,” he says. “Implementing a Web-based software tool, such as the Thompson Reuters ONESOURCE Tax Provision, can be the solution that most corporate tax departments are seeking.”
Smart Business spoke with DeMetrovich about automating the tax provision process and the capabilities provided by a software solution to address the three major concerns expressed in the survey.
How can an automated solution assist with data collection?
An automated solution allows a company to consolidate the majority of its data into one platform. The software can interface with the existing accounting or financial reporting system and upload the required financial information. The software also is able to roll data forward from period to period. There’s no need to manually update and reconcile multiple Excel schedules for the new year or roll forward Excel workbooks. This functionality significantly reduces time spent gathering data and eliminates many of the errors in the current process.
How can an automated solution assist with resource constraints and timing?
Reducing the need for manual processes frees up corporate resources to handle more strategic, higher value tasks, leading to increased review time and increased time for analysis and forecasting.
An efficient, automated solution also reduces the time needed for processing the provision. The system allows multiple users to access and update the provision calculation in a controlled, secure environment. Therefore, the provision calculation is done more timely and accurately, which allows additional time for analysis, adjustments and reporting.
Can the software be implemented in-house?
Companies rarely implement a provision system in-house. The project generally is undertaken in conjunction with an outside provider, whether an accounting firm or the software provider. Tax departments have knowledge of their current provision process but lack the depth of knowledge necessary to select, install, configure and train their personnel on the new software.
The benefit of using an accounting firm for implementation is that the firm provides in-depth knowledge of the software and has broad-based knowledge of tax and the provision process. The company also has access to the accounting firm’s knowledge of its industry. The firm can:
- Align software to the company’s current processes.
- Make sure processes are correct from a technical tax standpoint.
- Use industry knowledge to provide best practices that can be incorporated into the new automated process.
Once implemented, can tax departments manage the software without assistance?
Once the software has been properly installed, configured, tested and training has been completed, the tax department staff should be able to maintain the software. One of the biggest benefits to a Web-based solution is that the company’s internal IT group rarely has to be involved. Software updates are handled directly by the software provider. And, the tax department will be able to handle updates for changes in general ledger accounts, the addition of new entities and other enterprise-wide changes.
Tom DeMetrovich is a director at Crowe Horwath LLP. Reach him at (214) 777-5272 or Tom.DeMetrovich@crowehorwath.com.
More information on tax provision automation.
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Businesses have been given more time to prepare for changes in the way they account for expenses related to tangible property, but it might be advantageous to get an early start.
The U.S. Department of the Treasury issued temporary regulations that were to be effective in 2012, but the Treasury and IRS revised the effective date to Jan. 1, 2014. Final regulations that include the new effective date are expected in 2013.
“The regulations focus primarily on whether an expenditure is for immediately deductible repairs and maintenance or for capital improvements that must be depreciated over time. An expenditure on tangible property can be a current deduction if it’s considered incidental in nature and doesn’t add to the value of the property or prolong its useful life,” says Tom Tyler, partner at Crowe Horwath LLP.
“The temporary regulations are of particular interest to businesses with significant amounts of brick-and-mortar properties or to machinery-intensive businesses,” he says.
Smart Business spoke with Tyler about the regulations and what businesses should do to prepare for the change.
Should businesses act now or wait for final regulations?
The IRS announced the change to the effective date on Nov. 20, 2012. The revised date covers tax years beginning on or after Jan. 1, 2014. However, taxpayers can early-adopt the regulations for their 2012 and/or 2013 tax years. The early adoption allowance is an acknowledgement on the Treasury’s part that taxpayers might have already expended resources in order to adopt the temporary regulations. Taxpayers still can apply the temporary regulations as long as they file an accounting method change if the final regulations turn out to be different.
Potential corporate tax reform also could affect decisions regarding tangible property. Because of that, it’s advisable to evaluate the effects of the final regulations now, regardless of whether you’re going to adopt them in advance of the required date.
Is the final version expected to vary much from the temporary regulations?
There were sections of the temporary regulations that generated a lot of feedback from taxpayers and practitioners, and the Treasury likely will incorporate that feedback into the final regulations. For example, there is a new de minimis rule that exempts certain acquisitions from capitalization. If it’s under a certain threshold dollar amount, a taxpayer can deduct the purchase price of the property for tax purposes as long as it follows a written expense policy and has an applicable financial statement. Under the rule, the amount paid and expensed must be less than or equal to the greater of 0.1 percent of gross receipts for income tax purposes or 2 percent of the total depreciation and amortization expense for the tax year.
Treasury officials have suggested the de minimis rule might be expanded to taxpayers without audited financial statements, and they may revise the way the ceiling limitation is computed. Temporary regulations regarding dispositions and safe harbor for routine maintenance also are likely to be revised.
What steps should businesses take now?
Don’t hold off on implementation plans; instead, proceed while bearing in mind the effect of potential revisions. If the de minimis rule is expanded but retains the written policy requirement, businesses should establish a written capitalization policy for financial reporting purposes by the first day of the tax year they want to apply those rules.
Additionally, taxpayers might need to file an accounting method change if the final regulations differ from the temporary ones, even if no changes are made to the deductions claimed under the temporary regulations.
Taxpayers should weigh the pros and cons of the options outlined by the Treasury and IRS to determine the most advantageous approach. Those options are:
- Adopt the final regulations in 2014 with their 2014 tax return.
- Early adopt the final regulations with their 2012 or 2013 tax return.
- Adopt temporary regulations with their 2012 or 2013 tax return with the possibility of filing a second method change to adopt the final regulations for the 2014 tax year.
Tom Tyler is a partner at Crowe Horwath LLP. Reach him at (214) 777-5250 or firstname.lastname@example.org.
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Business executives are demanding more than just operational improvement — they want to see profitability results as well.
“They want real, bottom-line improvements that increase earnings before interest, taxes, depreciation and amortization (EBITDA); they want to see initiatives that focus on the operational profitability of the business,” says John M. Hurlburt, principal with Crowe Horwath LLP. “What we find is that there are certain recurring levers that drive financial results.”
Smart Business spoke with Hurlburt about spotting operational inefficiencies and how to address them in ways that boost profits.
What are signs of operational inefficiencies?
There are some common themes among companies that are not reaching their maximum potential, including low productivity, pricing or margin challenges, unacceptable service levels, capacity management challenges, quality issues and lack of operational visibility. These inefficiencies occur in almost every type of industry from manufacturing to distribution to financial services, to name a few.
Businesses need to identify root causes of suboptimal performance and apply solutions to streamline processes, reduce waste, improve management and enhance revenue.
Where should you start in order to improve performance?
The most logical starting point is with business processes. You can change your people or implement additional software but not necessarily improve performance in the most optimal way — if at all. Focusing on the processes first makes certain that the fundamental drivers and infrastructure are in place to optimize your people and technology efforts. Improvements in processes produce the best results at a lower cost. Process-related initiatives should be measured in weeks rather than months. The focus is on speed.
Can you highlight areas to focus on?
Five levers of change that drive results can usually be found in the following areas:
1. Operational performance improvement. Lean and Six Sigma tools can drive results in weeks, not months, by focusing on efficiency, effectiveness and throughput of business processes.
2. Supply chain and inventory management. Typical issues are long lead times to customers, excessive inventory levels and inefficient operations scheduling. Levers include improving sales and operations planning processes, planning for capacity issues and implementing finite scheduling processes.
3. Estimating and pricing. Improving estimating accuracy and maximizing margins are typical key issues. Tools include initiating hurdle margins (aligning incentives on total sales before quota bonuses), customer segmentation and postmortem reviews.
4. Strategic sourcing. Maximizing volume purchases through a select number of vendors, improving delivery lead-time accuracy and improving product quality are some ways to improve purchasing practices across the organization. Typical tools in this area include implementing approved vendor lists, analyzing purchasing trends across different categories such as direct, indirect, freight, logistics and administrative purchases, and having consistent procurement processes across the entire organization. It’s not uncommon to find 10 to 15 percent savings in this area by improving a company’s purchasing strategy.
5. New product development. Innovation can provide necessary differentiation to capture market share and improve top-line revenues in a crowded market. Opportunities might exist for reducing hurdles and time to market to introduce new products and services.
What are some key ideas that will help make initiatives successful?
- Different challenges require different tools. First, look at the problem and then determine the tools needed to produce a solution. Don’t focus on implementing tools before you know the extent of the problem.
- Focus on initiatives that can be measured. The only way to know if a problem is real or perceived is to have a quantified ROI.
- Focus on impact and prioritize initiatives that produce the greatest results while requiring the least effort and resource strain.
- Make sure changes are sustainable and become part of the organization.
John M. Hurlburt is a principal at Crowe Horwath LLP. Reach him at (214) 777-5243 or email@example.com.
Website: For more information on operational improvement, visit www.crowehorwath.com/services/performance.
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A survey conducted by the Construction Financial Management Association revealed that participants felt their companies were ineffectively managing several key functional areas of business.
• 54 percent of respondents said contractors were ineffective in managing people;
• 37 percent said project sales and customer satisfaction management were ineffective;
• 35 percent said there was ineffective management of risks insurance, contracts, risk and safety; and
• 27 percent said there was ineffective management of project delivery.
Marc McKerley, CPA, partner at Crowe Horwath LLP, said the survey demonstrates the challenges the construction industry faces and the opportunity for improvement through a strategic planning process.
“Every business is faced with the same issue — limited resources. A dollar can only be used once. Material can only be used once. Organizations that best leverage limited resources have a greater chance to succeed,” McKerley says.
Smart Business spoke with McKerley about ways companies can simplify the planning process and implement performance management techniques that will get results.
What are the barriers to an effective implementation strategy, and how can they be overcome?
Several barriers exist that prevent successful implementation of strategic goals:
• Management — Management is busy ‘putting out fires’ and rarely discusses strategy.
• Resources — Budgets often are not linked to strategy.
• Vision — The work force does not understand management’s strategy.
• People — Incentives are not linked to strategy.
Overcoming these barriers is crucial to successfully implementing strategy. Using tools like strategy maps can help translate vision and strategy into action and results.
How can a project scorecard help with performance management?
Most people think of a scorecard as a tool to measure financial performance. Building an effective project scorecard that moves beyond the traditional financial performance model requires an understanding of the construction project lifecycle, including the significant risks inherent throughout this process and business processes designed to effectively manage those risks.
A well-designed project scorecard should include key processes intended to manage critical risks throughout the construction lifecycle. It should also define key performance indicators (KPIs) that represent desired performance thresholds. The exhibit provided (on the following page) illustrates a working grid for building a project scorecard for several key areas of the construction lifecycle. Other important factors in building a scorecard include:
• Weighting critical processes or KPIs.
• Identifying the source of data input. Is the information contained in the existing accounting information system or does it reside in spreadsheets or manual logs? Accessibility of the information is critical.
• Who is the responsible person? The project manager? The contract administrator? The project accountant?
The final scorecard can take many forms. Some choose to use a traffic light approach:
• Green light — Acceptable and desired compliance and performance.
• Yellow light — Warning signal that compliance and performance are below desired levels.
• Red light — High-risk issue that requires immediate attention.
When implementing performance management in your company, remember the following simple goals:
• Know what you’re trying to accomplish and why;
• Keep yourself accountable; and
• Move beyond traditional financial ‘rear-view mirror’ performance measurements.
Marc McKerley, CPA, is a partner with Crowe Horwath LLP. Reach him at (214) 777-5209 or firstname.lastname@example.org.
SAVE THE DATE Webinar: Implementing Performance Management Techniques, Wednesday, Feb. 20, at 10 a.m. CST. To register, visit www.crowehorwath.com/events.
Almost without exception, companies make the claim that they won’t make their auditor decision based solely on fees. While fees are important, those charged with corporate governance (typically the audit committee) should consider factors beyond quoted audit fees, which are only the tip of the iceberg.
“Of course you should select an auditor qualified to conduct the engagement according to professional standards. While the auditor must maintain independence, that should not prevent the auditor from being consultative. It is perfectly acceptable to talk to your auditor about business concerns such as improving access to capital markets, increasing revenue, using resources more efficiently, reducing costs and mitigating risk,” says Dickie Heathcott, partner at Crowe Horwath LLP. “An auditor with a deep understanding of the company’s industry and business concerns helps with the audit and can be helpful to management.”
Smart Business spoke to Heathcott about getting a return on your audit.
What should an audit committee consider in selecting an auditor?
Audit fees are a key consideration. Other important factors include internal cost, cost of capital and lost opportunities. For example, an efficient and effective audit can reduce the fee and the hours and energy spent by company personnel. In some cases, using a recognized audit firm can lower the cost of capital. Although management is responsible for preventing and detecting material misstatements, a qualified auditor can detect one that management missed.
How can the value of the audit be maximized?
It is important for the audit committee to understand the auditor’s approach, methodology and toolkit. An efficient and effective audit requires proper planning and design and as well as monitoring of its progress. An auditor should understand the company’s business, industry, customers and strategic plan as well as its company-specific IT systems, organizational charts and history.
The auditor’s approach to collecting information might involve technological tools for streamlining the process. Technology can provide clients with an efficient way to collect data, documents, spreadsheets and other material for the audit. It also can eliminate frustrating and time-consuming duplicate requests from the auditor.
How else can a well-run audit benefit a business in the long run?
An auditor who understands the company’s business can add value by pointing out risks that could result in accounting errors, internal control weaknesses and efficiency opportunities.
As an example, consider an undetected material misstatement. Restatement of previously issued financial statements can really jolt the capital markets and cause company-related uncertainty. As a result, the restatement might affect the cost of capital and result in fines and penalties. Furthermore, restating previously issued financial statements requires a lot of effort, not to mention filing, legal and auditor costs. A qualified management team, complemented by the right audit firm, is likely to get it right the first time, thus mitigating the risk and controlling this potential cost.
The choice of auditor can affect cost of capital in at least two ways. Investment bankers and capital markets typically want to understand the auditor’s reputation and whether the auditor is well-versed in the relevant industry. For example, having a successful initial public stock offering (IPO) might be difficult with an unknown auditor. Public companies and companies considering an IPO should consider whether the auditor is recognized and respected by those making a market in the stock. Similarly, terms on borrowed funds might be more favorable with a recognized auditor. The related cost of selecting the wrong auditor might be difficult to measure, but it has the potential to dwarf audit fees.
Whether your concern is growth, debt capital needs, equity capital needs, or simply building on an already solid reputation, an efficient and effective audit can help position your organization to move forward. Next time you are faced with a possible change in auditor, look beyond the audit fee.
Dickie Heathcott is a partner with Crowe Horwath LLP in the Dallas office. Reach him at email@example.com or (214) 574-1000.
Think the odds of being fined for immigration law violations are slim to none? Think again. Even if every person working in your business is a legitimate U.S. citizen and/or eligible to work in the U.S., you can still run into trouble if you file immigration law paperwork with errors or omission or, worse, fail to file the papers at all.
Until recently, Form I-9 infractions have not been top of mind because it’s just a one-page form filled out during the new hire process. The odds of an ICE (U.S. Immigration and Customs Enforcement Agency) inspector showing up on your doorstep were miniscule. However, the risk has significantly increased over the last few years.
“This is the quickest and easiest employment law violation to find,” says Kevin W. Smith, a partner at Crowe Horwath LLP. “Inspections have been growing in number over the last three years, and it can cost up to $1,100 for each form containing an error.”
Smart Business learned more from Smith about how businesses can avoid having to pay for not having the proper immigration paperwork.
What should employers know about Form I-9?
In order to verify that all employees — citizens and noncitizens — are eligible to work in the United States, every employer needs to complete a simple two-sided, one-page form within the first three days of hire. It’s called a Form I-9, ‘Employee Eligibility Verification.’ The employer must be provided with the employment eligibility and identity document(s) by the employee, determine whether they reasonably appear to be genuine and record this information on the I-9. The form must be kept by the employer either for three years after the date of hire or for one year after employment is terminated, whichever is later.
Why should employers pay attention to this issue?
ICE was established in 2003 with the emphasis on finding and deporting illegal immigrants. Beginning in 2009, the emphasis has shifted to enforcing employer responsibility to ensure that new hires are eligible to work in the U.S. This has led to a record 2,196 notices of inspections to employers in fiscal 2010, surpassing the prior year’s record of 1,444, and more than quadrupling the 503 inspections in 2008. In 2010, judicial fines and fines for final orders, forfeitures and restitutions came to a total of $43,567,346.
Fines are levied regardless of whether illegal immigrants are found, as in the case of Abercrombie & Fitch stores being fined $1 million for a technologically deficient I-9 record-keeping system.
How does ICE investigate an employer if it suspects employees are working illegally there?
Once ICE begins an investigation, the agency will use confidential informants, cooperating witnesses and electronic surveillance. ICE may also visit the worksite or the homes of employees. ICE uses the following factors when determining criminal liability: if there was a pre-existing immigration compliance program, how widespread the activity was, how high up the complicity of management was, timely voluntary disclosure of wrongdoing and cooperation in the investigation. One of the most serious ICE violations concerns the harboring of persons in the country unlawfully.
What else do employers need to be concerned about regarding this issue?
In addition to strategically shifting from the focus of deporting illegal immigrants to holding employers accountable for noncompliance, ICE has changed its enforcement strategies in other ways:
- Moving from high-profile, multisite raids to targeting a substantial number of small and medium-sized employers such as restaurants, construction companies and manufacturing plants.
- Working closely with other government regulators — including the U.S. Department of Labor Wage and Hour Division, the Social Security Administration, the IRS, FBI and state counterparts — in ‘fusion centers’ that cross-train inspectors from other agencies to conduct I-9 audits.
How can employers defend violations and avoid noncompliance?
Businesses should be sure to have a comprehensive immigration compliance and ethics program in place, which comprises of established standards for detecting and preventing criminal conduct, screening of human resources processes, training regarding compliance and ethics for directors and employees, monitoring/auditing compliance programs and appropriate response to violations. Having a reasonable compliance program significantly improves the odds of reducing fines and criminal liability if an employer is found to be noncompliant.
Some other processes to consider:
- Conduct a self-audit of your I-9 forms.
- Keep I-9 forms separate from employee personnel files. Also, separate present and past employee forms.
- Do not accept expired forms from new hires when completing the I-9 form.
- Re-verify any expiring work authorization documents before they expire. Do not allow employees to work if they have expired documents.
- Only accept documents from new hires that are on the List of Acceptable Documents and appear to be genuine.
- If ICE shows up to conduct an audit, ask for a Notice of Inspection and know that you have three business days before you have to turn over your original I-9 forms.
By checking only 14 form attributes, our auditors have been able to consistently find missing or incorrect dates, signatures, IDs referenced and, worst of all, missing forms. Correcting these small errors can save employers from significant fines and even criminal charges.
Kevin W. Smith is a partner at Crowe Horwath LLP. Reach him at (214) 574-1008 or firstname.lastname@example.org.