The signing of the Jumpstart Our Business Startups Act (JOBS Act) in April of this year has put the spotlight on auditing. Startups raising between $100,000 and $500,000 must be reviewed by a CPA while startups raising between $500,000 and one million dollars are required to be audited by a CPA. To get an idea of how this will affect CPAs across the country, CPA Magazine sat down with Angie Moss, CPA, audit partner with Sanford, Baumeister & Frazier, (SBF) in Dallas, Texas, Don Pfluger, CPA, audit partner with Gallina in Rancho Cordova, California, and Mike Sharp, CPA, Director at Sharp & Cash, LLP (a pseudonym) in New York.
How did you get involved in auditing and what do you like about it?
Moss: Well, I was hired off campus to join KPMG from the University of Texas Arlington.
Pfluger: After receiving a B.S. in Accounting from California State University, I started with Gallina 32 years ago. I originally wanted to be a lawyer, but I enjoyed accounting so I stuck with it. If there are technical issues they call me. I am also a practicing partner with assigned clients.
Sharp: My background is audit and tax because when you are dealing with entrepreneur companies, they may require an annual review and tax planning. I started with a larger firm, after graduating from college, and later moved to a boutique firm.
What is your experience with small firm audits?
Moss: I do a lot of audits of funds and broker/dealers who are required to be audited no matter what size they are.
Pfluger: We don’t audit publicly traded companies, we audit large and small firms [general building contractors, engineering contractors, specialty subcontractors, and suppliers]. One firm [we audited] has over $1 billion in revenue.
Sharp: For clients to raise capital on crowdfunding sites regulated by the SEC, these portals will put in safeguards on how companies can raise money, since technically they are not going public. The biggest criterion is the SEC wants to protect the small investor. Anyone with over $100,000 annual income can invest 10% of yearly income. If under $100,000, the investor can invest 5% of annual income or up to $2,000. There are three parts of the Act. One focuses on startups, another on accredited investors with over $1 million net worth, and the third part is that they are lifting the ban on advertising. Previously, when over 500 investors or $5,000,000 capital is raised you would have to register with the SEC. Now, you do not have to register until after you have over 2,000 investors.
For our firm, we will focus on startups and established companies who are looking to expand for these emerging growth companies. Certain sites will focus on different specialized areas.
How do you approach an audit engagement for a firm that has not yet been audited?
Moss: You really have to do some due diligence to determine the capabilities of how the accounting comes together.
It may be the owners themselves. You determine an approach around that. You may need to get some help for the client [to put their books in order]. They may have only kept cash books. Or you may be able to make audit adjustments. A lot of them, almost all of them, use QuickBooks.
Pfluger: They may not have any books. We may help them select their accounting system. It will be all along the gamut. They may have QuickBooks or they may be pure startups with no transaction history to speak of.
Sharp: Generally we are going to look for the purpose of the audited statements. They may have obtained a line of credit, and now they need the audit to maintain their covenants. You look to see how long they have been in business and what kind of accounting they have. Smaller companies usually have a few people doing everything. They don’t have segregation of duties or internal controls.
CPA Magazine: How big of a staff does it take?
Moss: I can do the whole audit or a staff member can with my involvement. It is not something a new, inexperienced person can work on. It may not take that much time, but there are particular reporting needs and SEC requirements even though they are not required to register [with the SEC]. You have to know the regulations that need to be addressed.
Pfluger: If it is a true startup, there may be nothing to audit because an audit is a historical review. If there are statements based on prospective financials we have procedures to review those.
Sharp: You would have a partner on the account who would budget for staff. We are peer reviewed and follow the standards for issuing financial statements.
How do they budget for the engagement?
Moss: In the smaller entity world the fee is very important. How do you juggle the work that has to be done to comply with the SEC and staff the engagement appropriately so you are not out of the range of what the small firm can tolerate? You need qualified people but you can’t run up a large budget. A lot has to do with getting to know the client, including their skill set, before you even get started. One of the things I like to do is to explain, “this is what it costs no matter what we do, and here is what it costs to do your audit.”
Pfluger: We perform analytical procedures. We still have to look at the entity and the internal control. They [smaller companies] will be thinly staffed and rarely have segregation of duties. So we have to provide them some guidance in the management letter according to SAAS 115 to help them improve on internal controls and to enhance the business based on best practices that we know from other companies. [For them] It’s kind of like seeing a trainer at a gym. The low cost provider [for an audit] will not be the best value. Suppliers, vendors, and other customers send prospective audit clients. It varies, but if there is no balance sheet, and a quarter or year-end [period to audit] with no transactions there is nothing to audit. The audit opinion cannot audit his hopes and dreams.
Sharp: When you are doing an initial audit it is hard to quote a fee unless we are able to get a good feeling on their books and records and their accounting staff. We hope to keep it in a certain range, but it is an estimate. We can’t lock ourselves in or we could always quote it at our standard hourly rates. Each situation is different.
How long does an audit take on average?
Moss: Depending on the size of the fund, and the transactions, you can complete an audit in 1-2 weeks.
Pfluger: A couple days or a week or a month depending on what is there.
Sharp: On a small company it could take 2-3 weeks including planning, field work, and wrap-up.
What problems do you encounter?
Moss: When it becomes more difficult is when the investment is not marketable, like stock in a private company. That investment is hard to value. That is where the issues come in. You determine their valuation and determine fair value from other sources.
Pfluger: There are many issues faced in the initial audit of a startup company: 1) Lack of past history – typically auditors look to past financial information to compare with the current year information to perform analytical procedures. With a startup there is no meaningful prior history to use. Often then we will try to benchmark against similar companies. 2) Lack of stability in employees performing key functions – there may be a lot of turnover in staffing the accounting area for a startup as it grows. This lack of stability can make it hard to ask questions of people as they may have not been there for the entire reporting period and many individuals may have been performing the tasks at different times. 3) Lack of focus among personnel – startups are generally a hubbub of activity with many personnel wearing many hats within the organization. They may lack the time and focus to be able to answer an auditor’s questions and respond in a timely manner. 4) Poor or weak internal controls.
Sharp: These startups don’t have much of an accounting staff, and are without decent books and records and documentation or people in place to get the information. So you spend more time obtaining the records from the client. Most of them use QuickBooks because it’s inexpensive and it gets the job done.
What software helps with the workpapers and trial balance prep?
Moss: I used CCH ProSystem fx Engagement, like many non-national firms do. I currently use CaseWare. They are all pretty similar. They each have pros and cons for workpaper management. We use Practice Aids from Thomsom Reuter’s PPC products. They have tools that address specific industries. The larger firms tailor their approach to a specific industry. The overall time is probably 10% for the financial statement and note preparation.
Pfluger: We use PPC for workpapers, and CCH ProSystem fx Engagement handles the trial balance.
Sharp: CCH Engagement and PPC.
CPA Magazine: What is the range of costs if there are no problems?
Moss: Say it is a $10,000,000 fund, $20,000 is not a bad number for an audit. It is based on who is doing the accounting at the client firm, how it is maintained. Is it a once a year thing? Some may be less, but they don’t have any issues. There are audits that are under $10,000. The number of investors increases the fee. There is additional work to determine if the investors are accredited.
Pfluger: We have to do a risk assessment and audit planning and assess internal controls. Then we go in and audit the numbers. There may not be an awful lot to do for a startup, so it can be reasonably priced. It could be as little as $5,000 to $10,000. Associated with that is what the promoter says about the company. There will be MD & A (management discussion and analysis) to review.
On a startup, you need to get a retainer and make sure you get paid. We have a milestone billing practice. We match invoices with our workflow. So on the first day of field work we send out a bill. Then we send one at the end of field work, one at drafting of financial statements, and one at the end. They have to be paying as they go along. We may take a retainer of 50% for a brand new client. Then will invoice the remaining amount, 25% at the start of field work, and then the quarterly bills.
Sharp: We obtain a retainer on anyone who is new. One of the provisions of the engagement letter includes the retainer before we begin work. This is a totally new area that has opened up for companies to raise money. Part of the engagement could be to receive a consulting fee to get them to where they want to be. This is really new to everyone, so it is hard for everyone. Part of raising money is accounting fees. It is part of raising money. But it was not available to them before.
CPA Magazine: What is the exposure for risk?
Moss: There may be a qualified financial statement, for an investment not valued according to accounting principles. I have not had an adverse or disclaimer of opinion. It could happen. If it was so material to the statements you might end up there. You find that out when you do your due diligence when you first get involved in the engagement. You go through that in the client acceptance process. You find that out in the beginning. They may have invested in something after the end of the year and it is difficult to determine fair value. Now you are facing a situation because they are already a client.
Pfluger: We talked to our E & O carrier who said this would have an added cost because of these startups. These crowdfunded companies do not fall under PCAOB [Public Company Accounting Oversight Board] so the peer review is the same. Depending on the procedures and how many startups you audit there would be additional costs [according to our professional liability insurance provider].
Sharp: The fees for professional liability can go up; so it exposes you to a greater number of people rather than to a bank. You could have a slew of people coming after you if something goes wrong. It is definitely more exposure. What will end up happening is firms that don’t do audits will look to a larger firm to do the audit.
CPA Magazine: Do you also perform valuations?
Moss: The valuation itself has to be determined by another firm, because that would be an independence issue. The firm will have to hire another valuation firm, which may be another CPA firm. There is a business valuation credential, and CPAs have it. If you are providing any assurance for an attest client a valuation would impair your independence. A separate valuation, as long as it has nothing to do with the audit could be performed-- like, for an estate planning engagement [for the same client].
Pfluger: We don’t do that kind of valuation for stocks. There are valuation credentials. It could be from the AICPA or another credential. That is not our area. We have to choose what we are going to be good at.
Sharp: It is not an area we are pursuing at this time.
Do you audit companies that you previously reviewed?
Moss: A review provides limited assurance that is limited to inquiry and analytics to evaluate whether the statements have material misstatements and correcting them. There is no confirmation, or third party verification. Some banks accept reviews. You don’t confirm anything. You make inquiries whether cash was reconciled. You ask, was accounting consistent? You perform analytics on the numbers themselves. Then you write up the statements. A review can be a $10,000 engagement.
Pfluger: A review is a different level of service. You do ratio analysis and ask questions. You get limited assurance that things are not materially misstated. With an audit you get reasonable assurance there are no misstatements. The general rule is if an audit is $1, a review is 60 cents because you don’t have to do the audit tests.
Sharp: A review is still an analytical procedure. It’s the same disclosure for both. There is not as much third party verification or confirmation. You are relying on what the company is telling you in a review. A review is certainly less. If a review is $5,000, an audit could be $10,000, $15,000 to comply with all of the procedures and documentation internally to make sure we have done everything.
CPA Magazine: What do you like to do when you’re not auditing?
Moss: Generally boating.
Pfluger: Reading and gardening, traveling and fishing. Spending time with family, my seven grown children; my youngest is 18.
Sharp: I generally like interaction with clients, helping them manage their businesses and planning taxes. I play tennis in my off-time. I play singles to stay in shape. I played doubles in the summer USTA [United States Tennis Association]. If I am losing it, it is because they are wearing me down. After 15-16 shots on one point, that is a lot for a recreational tennis player.