Brain stretching accounting articles for CPAs

Image courtesy of Dollar Photo Club before their merger into Adobe Stock.

Here are a few articles to stretch your brain when you are ready for some mental exercise:

  • Is the double-entry accounting system broken?
  • What is the recidivism rate for white-collar criminals and how could that affect my audits?
  • What  possible changes are on the horizon for the audit opinion?

5/17/17 – Tom Selling at The Accounting Onion – Double-Entry Accounting and Modern Times – As a real brain stretcher, consider whether our double-entry accounting system is fundamentally broken.

Work with me a minute while I highlight and summarize a few ideas from the article.

A basic concept of double-entry accounting is that debits on the left side of the balance sheet represent all the assets of the entity. This includes all of the resources that are available for the entity to use in order to make money and all the assets against which creditors have a claim.

On the credit side, liabilities represent all of the claims against the organization. The equity section represents the value that belongs to the owners.

Prof. Selling points out there’s a variety of problems with using the statement of financial position as a representation of economic reality.

He points out and then moves past the idea that not all debits are assets and not all credits are liabilities. That’s easy to understand.

More significantly is that not all assets are reflected as debits and not all liabilities are reflected as credits.

Consider the huge portion of stock market value which is represented by intangibles that are not on the balance sheet. This would include internally developed intellectual capital, value of brand names, and lucrative patents developed internally.

Article points out there are different recognition requirements and different measurement criteria for items on the asset side compared to the liability side.

Even on the asset side there is diverse measurement. Consider that investments are carried (usually) at market while fixed assets are carried at historical cost.

Oh, except for fixed assets obtained in an acquisition, in which case the fixed assets were recognized at fair value at the time you acquired them. So some fixed assets are marked up to fair value. Except that was only at one point. Oh, and they are depreciated afterwards, so they were at fair value once but aren’t now.

As for the model of recognition and measurement on the liability side, I merely need to say leases, pensions, post-retirement obligations, and variable interest entities.

The amount of liabilities (with an offsetting impact on equity) can jump up or shrink down dependent on what assumptions are pulled out of thin air for discounting pension obligations. Want to create equity or make it disappear? Just change the discount rate.

Where does this leave us? Here is a good description from the article:

…(T)he effect of two recognition criteria is to produce balance sheets for which the left-hand side displays a particular subset of economic assets; and the right-hand side displays a different subset of economic claims.

One ripple effect of this model is the net income measured by GAAP probably does not have a strong correlation to the bottom line in terms of economic returns.

Where do we go with this? Prof. Selling has some ideas. As for me, my brain hurts just getting this far in the discussion.

Check out the full article for a deeper mental workout.

5/25/17 – Jim Peterson at Re:Balance – Corzine and Cohen Seek Return to the Game: Who Wants to Play Along? – There is good value in this article for general fraud education of CPAs.

Context of article is discussing two of the big players in the finance world who got disciplined for, um, misbehavior and now want to return as players after their very brief time in the penalty box.

The part of the story dealing with extremely high level finance is irrelevant to readers of my blogs. I’ll guess it might be of slight interest just for awareness.

The real value from this article is Mr. Peterson’s opinion that the recidivism rate for white-collar criminals is close to 100%. He cites several examples from the financial world, politics, and a high-profile criminal incident to make his point that recidivism is high. Repeat behavior should not be a surprise to us. He cites Sam Antar’s public comments that he would resume a life of fraud if he merely had the opportunity.

That discussion is a value for auditors. We need to keep in mind that in the financial world the recidivism rate is really high. This has major bearing on an audit if we learn of a client that has brought on board a finance person with a history of fraudulent behavior.

This also points to the value of doing some sort of background check on key staff at our clients. With technology the way it is today, you can do a low-level check for little cost.

5/24/17 – Edith Orenstein at MACPA – PCAOB to vote June 1 on change in auditor’s report – Something at the PCAOB level is another issue that probably will not be of direct interest or relevance to most readers of my blog. However, is indicator of the direction our industry is heading and so it is worth paying attention.

The concept is the PCAOB may revise the accountant’s report for public company audits to include a discussion of critical audit matters (CAM).

CAMs would include issues that are considered complex, highly subjective, or subject to judgment.

Even though I stay as far away from the PCAOB world as I possibly can, as do most readers here, it might be worth paying a bit of attention. This gives a hint of where audit reports might be heading.

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