Common Deficiencies in Preparation of Financial StatementsBruce NunnallyNovember 2021

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SSARS Preparation Engagements

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• Engagement Letter – Does not contain all required elements (continued):

– Identification of the applicable financial reporting framework for the preparation of the financial statements (Applicable to Audits, Reviews and Compilations also!)

– Whether the financial statements are to contain a known departure(s) or omit substantially all disclosures required by the applicable financial reporting framework (and/or cash flow stmt)

Preparation Engagements – Common Mistakes

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• Assurance Disclaimer

– AR-C Sec 70.14 indicates that a statement should be included on each page of the financial statements indicating, at a minimum, that “no assurance is provided” on the financial statements

– If the accountant is unable to include the legend on each F/S page, then a disclaimer should be issued that makes clear that no assurance is provided on the financial statements.

Preparation Engagements – Common Mistakes

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• Special Purpose Frameworks

– AR-C Sec 70.15 indicates that when preparing financial statements in accordance with a special purpose framework, the accountant should include a description of the financial reporting framework on the face of the financial statements or in a note disclosure.

• Example – Statement of Revenue and Expenses – income tax basis

Preparation Engagements – Common Mistakes

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• Omission of Disclosures

– When the financial statements omit substantially all disclosures (and/or cash flows if GAAP FS), the omission should be disclosed in the financial statements or in the notes.

• Example:

XYZ Company

Balance Sheet

Substantially all Disclosures and Statement of Cash Flows Omitted

December 31, 2020

Preparation Engagements – Common Mistakes

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AU-C 800.18 – Fair Presentation

In an audit of special purpose financial statements when the special purpose financial statements contain items that are the same as, or similar to, those in financial statements prepared in accordance with GAAP, the auditor should evaluate whether• the financial statements include informative disclosures

similar to those required by GAAP, and• additional disclosures, beyond those specifically required by

the framework, related to matters that are not specifically identified on the face of the financial statements or other disclosures are necessary for the financial statements to achieve fair presentation.

Disclosures - Financial Statements Prepared Using a Special Purpose Framework

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Common GAAP Deficiencies

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COVID-19 Effect: Increased Impairments

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Indefinite-Lived Intangible Assets

Amortizable Intangible and Other

Long-Lived AssetsGoodwill

Standard ASC 350 ASC 360 ASC 350

Impairment Testing Frequency

Annual and/or Trigger Based

Trigger BasedAnnual and/or Trigger Based

Calculation Method One Step Two Step One Step

Measurement Focus

Fair Value of the Individual Asset

Recoverability of Carrying Amount of

the Asset

Fair Value of the Reporting

Unit/Entity

Testing Order First Second Third

Asset Impairment

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Issued March 2021

• Allows private companies and NFPs to perform the goodwill triggering event evaluation as of the end of the reporting period.

• Standard is effective on a prospective basis for fiscal years beginning after December 15, 2019. Early adoption is permitted for financial statements that have not been issued as of March 30, 2021.

ASU 2021-03 – Goodwill – Evaluating Triggering Events

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Going Concern

Step 1: Assess if substantial doubt is raised. Is it probable

that the entity will NOT be able to meet its obligations?

No financial reporting

considerations

No

Yes

Step 2: Assess if substantial doubt exists. Is substantial doubt

alleviated by management’s plans?

Yes

Disclose that substantial doubt exists – Continue use of going concern basis until liquidation

No

Disclose that management’s plans

alleviate substantial doubt

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Going Concern – Auditor Reporting (SAS 134)

Step 1: Assess if substantial doubt is raised. Is it probable

that the entity will NOT be able to meet its obligations?

No financial reporting

considerations

No

Yes

Step 2: Assess if substantial doubt exists. Is substantial doubt

alleviated by management’s plans?

Yes

Disclose that substantial doubt exists – Continue use of going concern basis until liquidation

NoDisclose that management’s plans

alleviate substantial doubt

No mention in audit

report necessary

EOM paragraph optional for

auditor to draw reader’s

attention to disclosures

Separate paragraph with heading

“Substantial Doubt About…..”

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• Warranties that promise the customer that the delivered product is as specified in the contract (“assurance-type warranties”)– The entity accounts for the assurance-type warranty in accordance

with the requirements on product warranties in Subtopic 460-10.

– Debit warranty expense; Credit liability

• Warranties that provide a service to the customer in addition to assurance that the delivered product is as specified in the contract (“service-type warranties”)– Often occurs when the customer purchases a warranty separately

– Accounted for as a separate performance obligation

– Reduce recorded revenue and credit liability

ASC 606 – Revenue Recognition - Warranties

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• Revenue Recognition

– Disaggregated revenue• Performance obligations satisfied over time or at a point in time

– Contract balances• Opening/closing balances of receivables, contract assets and

contract liabilities

– Performance obligations• When performance obligations are typically satisfied

• Significant payment terms

• Nature of goods or services promised

• Obligations for returns, refunds, etc.

• Types of warranties

Financial Statement Presentation and Disclosure Reminders

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• Revenue Recognition (continued)

– Significant judgments• Method used to recognize revenue for performance obligations

satisfied over time, and how that method was applied– Input method

– Output method

• Methods, inputs and assumptions used to evaluate whether an estimate of variable consideration is constrained

Financial Statement Presentation and Disclosure Reminders

Probably a good idea to disclose treatment of sales taxes (i.e. net of) if applicable.

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Debt obligations are presented as current liabilities when:• Due within one year• Due on demand, even if not expected• Amounts callable due to violation of debt

agreement– Unless waiver obtained which removes the creditor’s

right to call the debt for one year from the balance sheet date

– Unless there is a grace period to cure the violation and it is probable that debtor will meet the requirements

Long-term Debt – Classified Balance Sheet

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Potential Deficiencies On the Horizon

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FinREC Project

Working draft issued May 10, 2021 - Comment period ended July 12, 2021.

Primarily focuses on changes related to implementation of ASC 606 and ASC 842

Intention is to include final guidance in the Construction Contractor AICPA Audit and Accounting Guide.

Construction Contractor Example Financial Statements

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• Fair value measurement of all unconsolidated equity investments (unless accounted for under the equity method)

– Will be measured at fair value at the end of each reporting period with the change in values recognized in net income

• Changes no longer reported as other comprehensive income

• Will no longer be able to elect the cost method for equity investments that do not have a readily determinable fair value. But wait……

ASU 2016-01 – Recognition/Measurement - Financial Assets/ Liabilities

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• Topic 321 – Measurement alternative forequity investments

– Equity investments that do not have a readily determinable fair value, and that do not qualify for valuation at net asset value (NAV)

• Report at cost…..

• Less any impairment…..

• Plus or minus subsequent adjustments for observable price changes

ASU 2016-01 - Measurement Alternative

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Measurement Alternative Investments

Privately held equity securities accounted for under the measurement alternative as of December 31, 2020 were as follows (in thousands):

ASU 2016-01 - Measurement Alternative – Example Disclosure

Year Ended

December 31,

2020

Net gains and losses recognized during the year on equity securities $ 548Less net gains and losses recognized during the year on equity securities sold

during the year (93)Unrealized gains and losses recognized during the year on equity securities still

held at December 31, 2020 $ 455

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• Topic 323 – Equity method of accountingapplies if an investor has the ability to exercisesignificant influence of the operating andfinancial policies of an investee. Ownership of20 percent or more of an investees votingstock (but less than 50 percent) is presumed toresult in the investor having significantinfluence.

ASU 2020-01 – Equity Securities, Equity Method, Derivatives/Hedging

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• Example – Entity owns 10,000 shares at $40/share representing a 15% interest in investee, accounted for under the measurement alternative.

• Investee issues additional 5,000 shares to entity at $50/share which is considered an orderly transaction and represents fair value. Entity now has significant influence. Equity method of accounting is required.

ASU 2020-01 – Equity Securities, Equity Method, Derivatives/Hedging

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• Investment balance after transaction:

A. $400,000+$250,000=$650,000, or

B. ($400,000+$100,000)+$250,000=$750,000

➢ Answer is B. $750,000

• Similar treatment if there is a partial investment sale which results in discontinuation of equity method

ASU 2020-01 – Equity Securities, Equity Method, Derivatives/Hedging

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• Examples of contributed nonfinancial assets (gifts-in-kind) include fixed assets such as land, buildings, and equipment; the use of fixed assets or utilities; materials and supplies, such as food, clothing, or pharmaceuticals; intangible assets; and/or recognized contributed services.

ASU 2020-07 – Not-for-Profits – Contributed Nonfinancial Assets

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• Requires a not-for-profit organization to present contributed nonfinancial assets as a separate line item in the statement of activities, apart from contributions of cash or other financial assets.

• The effective date is for annual reporting periods beginning after June 15, 2021, and applied on a retrospective basis. Early adoption permitted.

ASU 2020-07 – Not-for-Profits – Contributed Nonfinancial Assets

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Also requires a not-for-profit to disclose:• Contributed nonfinancial assets received

disaggregated by category type, and• For each category of contributed nonfinancial

assets received:– Qualitative information (and any entity policy) about

whether contributed nonfinancial assets were monetized or utilized during the reporting period

– A description of any donor restrictions associated with the contributed nonfinancial assets.

– The valuation techniques and inputs used to arrive at a fair value measure at initial recognition

ASU 2020-07 – Not-for-Profits – Contributed Nonfinancial Assets

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Contributed Nonfinancial Asset

Revenue Recognized

Programs or Activities

Donor Restrictions Valuation Techniques and Inputs

Office space – 100 Main St.

$24,000 General and Administrative

None Rent-free usage valued using recent comparable rentals in this market

Food $184,616 Community Shelter None Value based on wholesale values for similar products

Vehicles $33,000 NFP policy is to sell all donated vehicles unless used in a specific program

None Value based on actual net cash proceeds received. All donated vehicles were sold.

Services $18,000 General and Administrative

None Contributed services from attorneys based on current rates for similar legal services.

Contributed Nonfinancial Assets – Example Note Disclosure (partial)

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Effective Date for Calendar Year CompaniesPublic Business

Entities All Other Entities Early Adoption

2019 and interim periods within that year

2022 and interim periods in 2023

Yes

ASC 842 – Leases – Effective Date

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Key Issues

• Lease & Non-lease Components– i.e., common area maintenance

– Election of practical expedient to separate components

• Determination of Lease Term

• Determination of Lease Payments

• Determination of Discount Rate

• Lease Classification

• Short-term Leases

ASC 842 - Leases

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Lessee Accounting – Comparison

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A B C D E F G H I J K

LEASE EXAMPLETotal Payments 100,000 PV of Payments

Annual Pmt 20,000 86,590

No of Years 5

Disc Rate 5%

Finance

Expense

BOY Amortization EOY BOY Interest Principal EOY

1 86,590 17,318 69,272 86,590 4,329 15,671 70,919 21,647

2 69,272 17,318 51,954 70,919 3,546 16,454 54,465 20,864

3 51,954 17,318 34,636 54,465 2,723 17,277 37,188 20,041

4 34,636 17,318 17,318 37,188 1,859 18,141 19,048 19,177

5 17,318 17,318 - 19,048 952 19,048 0 18,270

86,590 13,410 86,590 100,000

Operating

Expense

BOY Amortization EOY BOY Interest Principal EOY

1 86,590 15,671 70,919 86,590 4,329 15,671 70,919 20,000

2 70,919 16,454 54,465 70,919 3,546 16,454 54,465 20,000

3 54,465 17,277 37,188 54,465 2,723 17,277 37,188 20,000

4 37,188 18,141 19,048 37,188 1,859 18,141 19,048 20,000

5 19,048 19,048 0 19,048 952 19,048 0 20,000

86,590 13,410 86,590 100,000

ROU Asset Finance Lease Liability

ROU Asset Operating Lease Liability

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FASB “Display Approach”

Video which describes a simple approach for operating leases

➢fasb.org

➢Standards

➢Implementing New Standards

➢Leases: A Quick Example of the Display Approach

ASC 842 - Leases

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Transition

• Upon adoption, an entity shall recognize and measure leases using a modified retrospective approach, to all leases that exist at the beginning of the earliest comparative period presented (However, see next slide re ASU 2018-11.

– A lessee that classified a lease as an operating lease under ASC 840, would use its remaining minimum rental payments (along with a discount rate) to measure the lease liability and right-of-use asset

ASC 842 - Leases

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Issued July 2018• Allows an additional transition method by

allowing entities to initially apply the new leases standard at the adoption date instead of at the earliest comparative period presented, and recognize a cumulative-effect adjustment to the opening balance of retained earnings.

• Provides lessors with a practical expedient to not separate nonlease components from the associated lease component as long as certain conditions are met.

ASU 2018-11 – Leases – Targeted Improvements

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Transition – Available Practical Expedients

• “Package” of practical expedients:

– Need not reassess whether expired or existing contracts contained leases

– Need not reassess lease classification for any expired or existing leases

– Need not reassess initial direct costs for any existing leases

• May elect practical expedient to use hindsight in determining lease term and in assessing impairment.

ASC 842 - Leases

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Balance Sheet - Requires lessees to present right-of-use (ROU) assets resulting from finance leases separately from ROU assets resulting from operating leases and separately from other assets, either on the face of the balance sheet or in the notes to the financial statements. The separate presentation also is required for lease liabilities.

ASC 842 – Leases – Financial Statement Presentation

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Income Statement

• Requires lessees to present expense from operating leases as an operations expense.

• For finance leases, interest expense and amortization of lease liability should be presented consistently with other interest expense and amortization or depreciation of similar assets.

ASC 842 – Leases – Financial Statement Presentation

Thank you!