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Revenue recognition continues to be under the microscope
as regulators step up their scrutiny of financial statements.

At the same time, businesses, accounting firms and consulting advisors
are working to understand the full impact
of the coming converged standards.

Wise companies will walk parallel paths –
one to ensure compliance and their good reputation today
in the face of escalating oversight
and another to ensure the same when the new standards take effect.

Recent statements from the Securities and Exchange Commission (SEC) and Public Company Accounting Oversight Board (PCAOB) continue to emphasize the importance not only of proper accounting treatment of revenue recognition, but also the documentation, analysis and disclosures that underpin good reporting.

At the same time, all of us – businesses, audit firms and consulting advisors – are evaluating what it will take to implement the new converged standards for revenue recognition as they apply to all contracts with customers – what changes to practices, processes, systems and internal controls might be needed to capture new data and address changes in financial reporting.

In this newsletter, I’ll review some of the recent pronouncements from the SEC and the PCAOB and offer my perspective on how companies can ensure their reports withstand increasingly intense regulatory reviews. I’ll also discuss where finance and accounting professionals are beginning to think the new converged standards will have their biggest impact and suggest steps companies should be taking now to minimize costs and maintain investor confidence and compliance.

Spoiler alert: It’s my conclusion that companies can’t assume their practices and processes – even if they’ve been deemed best of breed in the past – will continue to produce satisfactory reports in the near-term – let alone further out. In addition to continually reassessing present procedures to meet sharper scrutiny, companies should also be looking at revenue recognition practices ahead of the looming changes that go into effect in the next few years. To succeed today and be ready for tomorrow, companies need to follow parallel paths.

The Current State: Staying Compliant in the Face of Increased Regulatory Oversight

Over the past months, SEC observers report that while the agency is considering ways to make disclosures more effective, it has decided for the present to leave it to companies to improve the content of their reports. That said, the SEC is also taking a proactive approach toward implementing the new standards and is considering making changes to its own rules that go beyond Financial Accounting Standards Board (FASB) directives.

Over at the PCAOB, that agency issued a practice alert in September 2014 on the audit of revenue in financial statements. The document emphasized that (1) revenue reporting will remain a significant focus area in PCAOB inspections; (2) PCAOB inspections staff continue to observe frequently significant audit deficiencies; and (3) the PCAOB continues to look to audit firms to ensure that PCAOB standards are followed. The alert detailed the following standards for an acceptable audit – standards the PCAOB believes will continue to have relevance under the new converged rules: testing the revenue recognition from contractual arrangements, evaluating the presentation of revenue, ensuring the inclusion of required disclosures, testing and evaluating controls, responding to fraud risks, applying audit sampling procedures to test revenue, performing substantive analytical procedures, and testing revenue in multiple locations.

Bottom line: Expect both agencies’ increased oversight to continue under current rules and when the new standards take effect.

What can companies do to ensure they pass such stringent reviews?

The most important action in my view is to ensure revenue recognition practices are adequate to current business models and revenue streams. Recently, Blythe Global Advisors has been helping companies who are finding that practices and processes that produced satisfactory reports for years are suddenly coming up short in PCAOB reviews because small, slow changes over time have resulted in a fundamentally different company requiring significantly different accounting treatment. The cost to companies caught in this situation is steep, including post-signoff auditor remediation, late filings, increased regulatory scrutiny on subsequent reviews, diminished image among stakeholders, etc. To remain compliant, companies need to be diligent that all aspects of revenue recognition practices remain appropriate to evolving oversight and rules on the outside and evolving business realities on the inside.

The Future State: Steps to Take Now to Remain Compliant Under the New Standards

Right after the FASB and IASB issued their converged standards on May 28, 2014, there was a flurry of articles – most of which summarized the FASB/IASB content but didn’t offer much insight into what companies needed to do to get ready.

A review that I conducted of 10Q reports for the quarter ended April 30, 2014 as submitted by several larger companies – traditionally the bellwethers for corporate policy – found that disclosures for that first reporting period after the FASB/IASB announcement were mostly generic with little insight into the potential effect of the new standards on strategic goals or future contracts and revenue.

The truth is that as of this moment none of us – neither corporate finance executives nor auditors nor non-audit consultants – are more of an expert than another. As the current regulatory state wends its way into the future state, the most important question we should be asking is, “What should companies be doing now – as opposed to two years from now – to be ready for full implementation?”

Here are the top areas that I believe companies should focus on today to ensure not just compliance but stakeholder confidence under both current and forthcoming rules.

1. Get comfortable with expanded judgment decisions: Current U.S. GAAP rules provide proscribed guidance. The new rules are more theoretical, requiring more judgment decisions in coming up with estimates that, in turn, must be supported by more accounting documentation and analysis and more detailed disclosure statements. All of this puts more pressure on your senior management team. Start a discussion now with your CEO, other C-level executives and your finance and accounting staff regarding what new or additional information is needed to make more knowledgeable, actionable decisions. These measures will also help compliance under current rules because, as noted above, documentation and MD&A are prime review areas for regulators.
2. Conduct a company-wide contract review: The entire focus of the converged rules is on the application of contracts. The language in all contracts needs to be evaluated and decisions made as to whether the company will continue doing business as in the past or make fundamental changes. This review needs to be a cross-functional effort involving finance, accounting, legal, human resources, sales and marketing – including counterparts around the globe for companies with multiple, worldwide locations and contracts in multiple languages.

    

   In some cases, adoption of the new rules may necessitate changes to contract language. And there are more questions: Regardless of contract stipulations, how do companies with multiple, worldwide locations ensure absolute consistency? How does the company communicate all this to stakeholders? How does it avoid stock fluctuations?

    

   Conducting a comprehensive contract review now will prepare companies to answer these questions while also ensuring that reporting under current rules continues to accurately reflect the company’s present revenue streams.

3. Review all mission-critical IT systems: Are current IT systems sufficiently robust to accommodate the new rules? Are they flexible enough to calculate revenue under current rules and also perform a multi-year retrospective under the new rules? Are two systems needed? Is ERP adaptable or will Excel become the default process?

    

   When the new rules go into effect, companies will need to know and may have to present up to five years of restated historical results. Because revenue growth is an increasingly important key performance indicator, it’s my opinion that most companies will choose to restate five years – instead of the SEC’s optional three years – putting more stress on systems.

4. Re-evaluate internal controls for proper revenue recognition: Just as the bar for complying with today’s rules is constantly rising, companies should be ready for cascading changes once the new rules are implemented. When it comes to internal control processes and practices, best of breed with regular stress tests is mandatory.

    

   As for the people who are responsible for maintaining effective internal controls, both public and private companies need to employ highly skilled professionals. Let’s take contracts as an example. Companies need to ensure contracts receive the right level of review. That means people with sufficient knowledge of accounting rules to recognize when new activities affect revenue recognition or to discern the tipping point when the business model has shifted significantly enough to warrant changes to accounting treatment.

Much of what I’ve outlined above involves new and different questions that require different processes and perhaps even different personnel to generate the appropriate qualitative and quantitative information necessary for compliance. However, I strongly believe that the pain in getting ready for these new standards will be lessened if companies start now. Here’s why:

First, even though the FASB may ultimately delay the implementation date, companies need to begin discussing the new standards in upcoming quarterly disclosure statements regarding any significant impact the new standards will impose on the company and what the company will do to address the impact. Taking the steps outlined above will enable executives to make more informed statements prior to full implementation and to prepare stakeholders for how future revenue will flow. Companies will be able to avoid surprises – and the publicity and volatility that surprises can generate — when they issue their first, full report under the new standards.

Second, with oversight of public companies on the increase, auditors are on heightened alert. Because the new converged rules apply to all companies – public and private alike – all companies can expect a domino effect in the form of intensified scrutiny from their auditors. To produce the level of documentation auditors are now asking for, many companies will find they need to augment their technical expertise and/or internal controls.

Deep, fundamental change is always difficult. Deep, fundamental change is coming to revenue reporting. The companies that will fare best are the companies that are the best prepared – the ones with a couple of dry runs under their belts.

In closing, let me recommend some people outside the finance and accounting functions that you can ask to join you on your parallel-path odyssey. First is your corporate communications function. As your organization’s professional storytellers, they can provide invaluable help in crafting extended disclosure statements. Second are your trusted partners – your audit firm, non-audit advisors (such as us at Blythe Global Advisors) and investor relations agency – whose job is to be ahead of the curve on these issues.

If you would like to discuss anything in this or any of my newsletters, please contact me. I’d be delighted to talk with you.

* As a reminder, implementation for public companies is currently set for fiscal years starting after December 15, 2016. For private companies, it’s for fiscal years starting after December 15, 2017. Companies using International Financial Reporting Standards (IFRS) must apply the new standards starting after January 1, 2017.

To discuss this important topic further
or if you’re looking for general accounting advice and counsel,
contact marc@blytheglobal.com

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As regulatory oversight increases,
audit firms are expecting clients
to expand their pre-audit preparation efforts.

For the best return on investment, companies
will use non-audit professional services wisely
to solve pre-audit workload issues
and to achieve long-term organizational improvements.

While the economy continues a slow but steady improvement, our industry finds itself at a phase in the recovery cycle that many of us have seen before. The uptick in transactions, especially in M&As and IPOs, is being muted by the pressures and associated costs of continuously expanding reporting obligations – an echo of Sarbanes-Oxley (SOX) 2002 implementation when audit firms and clients had to figure out how to deal with a raft of new requirements without bloating staffs or budgets.

As I watch clients try to maximize opportunities in this modest rebound, I’m also observing how they’re using non-audit professional services to meet this higher bar of compliance. In my view, many companies aren’t getting the best return on their investment for these third-party services.

In this newsletter, I’ll explore what’s driving this not-so-good practice and how companies can use non-audit service providers more wisely to solve immediate workload issues as well as to achieve near-term compliance and long-term organizational improvements.

Let me say at the outset that I speak regularly to folks on both the firm and client sides, and I’m very sympathetic to the issues and challenges discussed below.

To start, let’s put today’s highly scrutinized environment into context. Wherever you look, everyone – from regulatory agencies, banks and investors to analysts, shareholders and employees – is focused on greater auditor independence and transparency. In addition, stockholders have become more activist and challenging of boards of directors. Audit firms, public companies and private entities are all continually looking over their shoulders for the next new rule to drop.

Some quick examples of new requirements that appear imminent:

• The Public Company Accounting Oversight Board (PCAOB) is considering requiring substantially more auditor narrative around processes and judgment decisions as well as having partners’ names on audits.
• After several years of discussion, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have indicated they will issue final rules in the coming months on a new global standard for revenue recognition. Once completed, the new rules will apply to all U.S. companies – private and public, large and small. (See my April 2010 newsletter on how the convergence will affect revenue recognition.)

This continual escalation in scrutiny has firms and clients playing a perpetual game of catch-up. Before SOX and in the early years of its implementation, it was routine for firms to fill gaps in client expertise leading up to an audit. That model isn’t the norm anymore.

Like their clients, firms today are working with limited staff, and no expert anywhere sees a return to pre-2008 levels anytime soon. Of necessity, firms are applying available resources to meeting increased audit requirements. Additionally, many new regulations have limited what services firms may provide to both private and public companies alike that don’t violate auditor independence. As a result, firms and clients are grappling with two burning issues: who’s responsible for what to meet the upsurge in requirements and how can compliance costs be contained?

What’s evolving from this nexus of expanded requirements, limitations on firm services outside the audit and enlarged workload is a new model in which firms expect clients to complete more pre-audit activities than in the past.

From the firm’s standpoint, this new model will help contain compliance costs – a key client requirement. The operative word here is “contain.” As oversight has increased, total audit costs have risen an average of four to five percent a year. With oversight showing no sign of slowing, companies should expect to spend more effort getting ready for their next audit while possibly paying more for the audit itself.

This is where non-audit professional services firms are increasingly being seen as the bridge to help companies meet their growing pre-audit workload. And this is where that not-so-good practice comes in.

Before I go further, let me issue some disclosures: First, we at Blythe Global Advisors include this service in our portfolio of offerings so it goes without saying that if you need help meeting your pre-audit obligations, we’d be delighted to work with you. Second, irrespective of whom you choose to work with, the point of this newsletter is to offer my perspective on where I think companies can get a better return on their precious discretionary dollars.

It’s my observation that too many companies – in a well-intentioned attempt to react quickly to the latest reporting requirement – tend to hire individuals piecemeal and then assign them to isolated tasks. Individuals hired as “accountant,” “accounts receivable technician,” etc. can process an overdue stack of invoices quickly but they don’t – and can’t – solve deeper problems. Talented as these people are and hard as they apply themselves, folks hired under such circumstances work in silos down in the weeds with no connection to what others are doing or the company’s strategic needs. Simply put, the lens is too narrowly focused.

Companies need a partner that looks at a task more broadly and in context – connecting it to what the company is trying to achieve and how those achievements will ultimately be reported to regulators and stakeholders. Such partners will develop a plan that synthesizes the organization’s needs. They will then build a hand-picked team that will be supervised to ensure best practices are applied in a forward-looking manner for the best return on investment.

Here’s a quick example of a recent engagement where we helped a client understand the underlying disconnections in their organization, get their processes compliant and save money in the long run.

Our client is a fast-growing success story, but their accounting function has been unable to keep pace. Both receivables and payables were severely backlogged. From contractors to investors to the company itself, it was unclear who was owed what. A temporary staff — each hired for a specific skill and each spending long days poring over assigned documents — moved a lot of paper. Unfortunately, the processing of transactions did nothing to help management better understand their financial picture. At that point, the company turned to Blythe Global Advisors. We took their inputs, reviewed their processes, put the information into a single database and produced a report that identified organizational deficiencies from which we developed a plan. It was only then – with plan in hand – that we assembled a select team that brought receivables and payables up-to-date while resolving the company’s deeper issues and helping them become audit-ready. As with every engagement, we used our closed-loop service delivery process that is collaborative, geared to long-term value-add outcomes and covers the entire engagement cycle. You can learn more about our service delivery process at our Web site.

At this point, I’m sure some of you are saying, “Okay, but aren’t you more expensive?” The answer is yes – and no. I’m pretty sure our fees per person were a bit higher. On the other hand, our staff was smaller because the skills were more targeted. We solved the company’s problem for a better return on investment. And we set them on a path toward compliance and audit-readiness – a future cost-savings.

If your need is truly limited to augmenting your permanent staff to meet deadlines, individual supplemental professionals can probably help you. But, if that backlog is a symptom of a more profound problem that’s connected to an entire function or a critical process, then you should consider a non-audit services firm that will apply a holistic, Big Four perspective to the issue.

As I said at the outset, I’m very sympathetic to the pressures facing both audit firms and clients. Everyone is doing their best while looking over their shoulders. In our environment of continual change, clients and firms must adapt their relationship to our new normal. The good news is there are service providers that can help clients be ready when their auditors call. The better news is that all this is happening in an improving economy.

If you would like to discuss anything in this or any of my newsletters, please contact me. I’d be delighted to talk with you.

To discuss this important topic further
or if you’re looking for general accounting advice and counsel,
contact marc@blytheglobal.com

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The Sarbanes-Oxley Act
has transformed
how companies conduct business.

Companies can benefit
from considering the effects of SOA
on their internal audit function.

Some of my recent engagements have me thinking about the different ways internal audit functions interact with the rest of their organizations or more precisely, how the folks in internal audit view their role within their companies and their responsibilities to their companies. Unfortunately, I see an increasing trend in internal audit behavior that is costing my clients precious time and money while diminishing the function’s effectiveness among co-workers and external partners.

Let me say at the outset that I’m very sympathetic to the people who do this important and increasingly demanding job. There was a time when an internal audit job was seen as an opportunity to learn the whole company and then springboard to almost any other position. Compliance has changed that. Internal audit is now viewed more narrowly as a means to an end. In this newsletter, I’ll discuss how compliance requirements have affected the potential and value of this critical function and how it can be rehabilitated while still meeting all regulatory oversight.

In my view, the issues fall into two broad categories. The good news is that there are solutions for the taking.

The first is what I’ll call the “self-image” issue. Some internal audit functions in a legitimate and sincere attempt to comply with Sarbanes-Oxley have taken the current Institute of Internal Auditors (IIA) definition of “an independent, objective assurance activity” to an extreme where they hold themselves apart from their company. These folks are overlooking other key parts of the IIA’s definition that describe internal audit as “designed to add value” and “help companies achieve their objectives.” Instead of seeing themselves as an unbiased and beneficial force focused on ensuring that their company’s internal control environment is effective, efficient and compliant, they position themselves as a detached wedge between their company and the audit firm.

More than once I’ve watched this model make clients undergo in effect two audits. Here’s a quick example: When one of our U.S. clients acquired a foreign-based company, they also acquired an internal audit department that, in the name of independence, wasn’t forthcoming about the competency of the accounting function. Post-acquisition, the internal audit function assumed the role of corporate cop and shadow auditor prior to the external audit. From start to finish, the acquisition and integration processes were inefficient and costly to the acquiring company.

The solution here resides with the audit committee, CEO and CFO who need to work together to make their internal audit function comfortable that they can be fully objective while also exerting a positive effect on the company’s processes and outcomes. Internal audit needs to see itself as a powerful tool that can help the CEO and CFO assess the company’s near- and long-term risks in a way that helps the company achieve its goals while also maintaining the highest governance and regulatory standards. And while it’s clearly the responsibility of finance and accounting to be SOX compliant, it’s internal audit’s responsibility to help them. It’s a complex balancing act to be sure. But when it’s done right, the company is more efficient on all fronts; and external auditors have access to solid information to complete their engagements quickly and accurately.

The second issue is what I’ll call “SOX myopia,” and it affects companies in two ways.

The first is in the area of expanding oversight. External firms are finding their audits increasingly scrutinized by the PCAOB at more and more granular levels – the evidence for which is dependent on more specific documentation at every point of sign-off within the company. To close this gap, it’s critical for internal audit to move beyond traditional SOX compliance to ensure their company’s controls and processes are on par with the PCAOB’s expanding requirements. This effort will also enable external auditors to do their jobs efficiently, effectively and in compliance with new and evolving standards.

The second way “SOX myopia” affects companies is in how the function is perceived by the rest of the company. I’ve repeatedly seen internal audit departments so consumed with compliance that they become alienated from the rest of the company. In some of the worst cases that I’ve observed, internal audit is viewed as a “gotcha” organization that is simply a cost center and doesn’t contribute to the business. The solution here lies in changing internal audit’s modus operandi so that it approaches errors or omissions proactively. Suppose revenue recognition is the problem. Instead of looking for exceptions to report, internal audit can work with management to identify the source of the situation and help design processes to achieve maximum accuracy going forward. That’s a win-win-win – internal audit, affected department, company with everyone pushing in the same direction.

To repeat, I’m very sympathetic to the people who staff internal audit departments and to how compliance has narrowed what was once an almost ombudsman-like position. They walk a fine line every day because there’s no wiggle room when it comes to compliance. It’s absolute. However, it is possible for internal audit to be totally objective and still be an integral contributor to the company’s success. It’s all embedded in the IIA’s definition: “… an independent, objective assurance consulting activity designed to add value and improve an organization’s operations … bringing a systematic and disciplined approach to evaluate… risk …”

In closing, here are a few suggestions to mitigate against the effects of increased compliance and enable internal audit to realize its full potential.

• Make sure internal audit sees itself as part of the company not a silo. And then make sure the rest of the company sees internal audit as part of the team. The CEO and CFO can play important roles here by clearly communicating to the rest of the company that they support the internal audit function as both insurers of the company’s processes/controls and critical contributors to its success.
• Populate internal audit with people who can communicate effectively with both the company and with external auditors as rules, laws and directives continue to be issued with greater frequency. In the changing regulatory landscape that’s become business-as-usual, keeping everyone current must be a key initiative.
• Ensure all internal audit staff have broad-based skills to help design leading-edge processes that improve the business. The tick-the-box staffer is yesterday’s employee.

By following these simple steps, companies can have a robust internal audit function that is independent and objective to ensure compliance with evolving requirements and a stringent evaluation of risk while also integrated into the rest of the company to help implement enterprise-wide best practices and standards. Independence. Objectivity. Value-add. It’s what I call winning the internal audit trifecta.

At Blythe Global, we help companies of all sizes meet their reporting obligations by filling the gap in accounting and financial expertise. We’d be honored to help you with your finance and accounting needs.

If you would like to discuss anything in this or any of my newsletters, please contact me. I’d be delighted to talk with you.

To discuss this important topic further
or if you’re looking for general accounting advice and counsel,
contact marc@blytheglobal.com

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Investors and analysts
increasingly view financial reports
as incomprehensible compliance documents.

Wise companies will start now to transform
mandated reports into cohesive narratives
that enable investors and analysts
to make forecasts with confidence.

In helping clients meet an ever-increasing calendar of reporting requirements, I find myself more and more concerned about the tension between compliance and communication. In our efforts to satisfy a host of complex obligations and ensure investors, analysts, regulators, the media and other key parties know everything, we – companies, audit firms and independent consultants – produce voluminous report after voluminous report. We’re compliant. But are we communicating?

There’s a growing consensus in our industry that we’re not. Despite the avalanche of data we regularly release, target constituencies say they’re not getting what they need – a full, sharp picture of a company’s performance, financial state and outlook from which they can develop evaluations. There’s a growing perception among investors and analysts that financial statements have become strictly compliance documents overflowing with boilerplate in insider language. The reports may check all the boxes, but they often fail to connect key points or convey risks clearly. By their own admission, investors and analysts often don’t understand what they’re reading. Multiply by the number of companies professional investors and analysts typically cover and you have a lot of incomprehensible data out there.

The result is increased calls worldwide to reform corporate reports. In this newsletter, I’ll summarize the best thinking of what such reform needs to encompass and how companies can stay ahead of the curve amid all the other challenges they must deal with.

One point bears stating at the outset. Financial statements are and will remain the foundation of all corporate reporting. Global markets can’t operate without them. But, 21st century reporting requires transparency and disclosures beyond business results and boilerplate.

What must a 21st century financial report look like?

For starters, it must tell a compelling, cohesive story of a company’s performance in plain English. Obvious as it seems, readers of financial reports should be able to figure out easily how the business is doing, the key drivers, and the company’s prospects over the short and long term.

That means we – the professionals inside and outside the company who develop, analyze, document and audit the data – need to move from scorekeepers to storytellers. Abandoning boilerplate, the management discussion and analysis section needs to provide clear linkage from the business results to the business model/strategy as well as to the tangible and intangible drivers. With a forward-looking bent, there needs to be a clear exploration of risks versus the competition, the other organizations with which the company engages and how the company is addressing changes in the marketplace. The extent to which the narrative can align management information with the various external data that stakeholders can easily access is a welcome bonus.

To be sure, U.S. GAAP will remain the standard for communicating financial results (until convergence of GAAP and IFRS takes effect). That said, investors and analysts need context for the numbers. The rehabilitated management discussion and analysis section plus the array of external resources available – such as competitive information, market research reports, trade magazines, analysts’ briefings, conference calls, etc. – will provide that context.

In short, the more corporate reports enable investment professionals to assess a company’s viability with confidence, the more the reports will engender positive forecasts. Investors themselves substantiate this, reporting in a PricewaterhouseCoopers survey that they apply bigger discounts to companies whose reports they don’t understand.

Admittedly, this is a tall order – especially given responses from corporate executives in our recent survey regarding heavy demands on their time. The good news is there are incremental steps companies can start to implement now – with help from partners – to be in the vanguard of this movement.

• Keep current with changing rules and regulations. There’s no getting around the fact that we’re in an age of increased regulation and disclosure so look to trusted advisors and audit firms to keep you and your staff up-to-date. Clarity and context will be for naught if the report is not compliant.
• Implement enterprise management software. By aligning data collection and consolidation, companies can improve the integrity of both financial and non-financial information. See my March 2011 newsletter on how automated processes can upgrade accounting and finance competency while saving time and costs in the long run.
• Leverage your corporate communications function. As the professional storytellers in your organization, they can provide invaluable help in crafting a strong, compelling company narrative. Involve them from the beginning for greatest benefit. These folks have a pulse on trends for enhancing brand equity such as the growing importance of governance, sustainability and social issues in corporate reports. They’re also in the forefront of repurposing information across multiple platforms to accommodate user preferences. If your company doesn’t have a corporate communications function, see if your consulting partners can provide this service or consider engaging a third-party expert. It’s that important.
• Increase your social media presence. The ubiquity of mobile devices and the growing number of people inside and outside your company for whom electronic documents are second nature and integrated applications are king are in the ascendant. It’s only a matter of time before this group effects their own reporting revolution. Satisfied as we may be with our investor relations Web sites, they are essentially electronic versions of paper documents. Companies need to start thinking now how to repurpose mandated reports into interactive applications across multiple platforms complete with tools that help users connect internal data with external resources. Many companies have a cadre of these folks – dubbed the “mobile elite” – on their IT staffs right now. Embrace and encourage them to help transform your corporate reports into innovative, customer-centric applications that can drive growth.

At Blythe Global, we’re committed to helping companies meet all their accounting and financial requirements efficiently, accurately and on time with reports that tell the story of their company’s strategy and potential in a clear, compelling manner. We’d be honored to help you tell your story.

If you would like to discuss anything in this or any of my newsletters, please contact me. I’d be delighted to talk with you.

To discuss this important topic further
or if you’re looking for general accounting advice and counsel,
contact marc@blytheglobal.com

View/Download the Entire Newsletter (PDF) »

Good relationships and good information
are critical to overcoming challenges.

Our interviews revealed that while
clients and firms have good relationships,
clients continue to seek
real-world lessons to develop solutions.

In my March 2013 newsletter, I presented the first set of findings from the interviews some of you generously gave to our representatives. In this newsletter, I’ll share the findings from the remaining questions. Before I reveal those findings, let me remind you of the objectives and parameters of the interviews.

We had two objectives with the interviews: First, to find out your most urgent needs to ensure we at Blythe Global Advisors are focusing on offerings that provide the greatest value. Second, to use the findings to foster greater understanding and better communication among all of us – clients, accounting firms, audit partners and trusted advisors – in the hope that greater sharing will lead to better solutions. In terms of sampling, we interviewed small to mid-sized clients in different industries as well as Big Four, national and local accounting firms.

Once again, let me thank all of you who took time to talk with our representatives. As I reviewed the second set of findings, I was struck again by the trust you exhibited in your responses. To repeat, all responses remain confidential.

We focused the interviews on two broad areas: the most pressing challenges in the near term and the client/firm relationship. Where time allowed, we asked company executives how they stay current with constantly changing rules and regulations and with how their peers are responding to those changes. My March 2013 newsletter discussed the challenges. This newsletter will reveal the relationship findings, how clients currently receive information and how they would prefer to get information. I’ll give you my perspective at the end of the newsletter.

Relationships

In terms of relationships, there’s good news on the client side. Most respondents in our interviews engage more than one firm for a variety of reasons such as geographical proximity to far-flung offices; the execution of strategic moves such as mergers, acquisitions or initial public offerings; etc. For the most part, those multiple relationships were evaluated positively. Comments included “thoroughly enjoys working with the entire … team,” “no major problems,” “no concerns” and “satisfied.”

That said, some respondents cited areas for improvement in their respective relationships. Two examples: A private company felt that their accounting firm’s tilt toward public company regulations in all engagements prevented the firm from fully appreciating their specific private-company concerns and risks. A VC-backed company felt their smaller size and smaller fees directly correlated to a lower level of responsiveness from their public accounting firm.

On the firm side, all discussions with firm executives regarding relationships boiled down to three elements: The first two – open, frank communication and a strong demonstration of value by the firm – foster the third – trust and respect between the parties. And trust and respect are generally acknowledged as the basis for successful, long-term relationships.

Here are two specific observations from firm executives:

• Both parties must be proactive in sharing knowledge and discussing concerns to ensure every issue is approached with a 360-degree view of all possible ramifications and side-effects.
• To sustain long-term relationships, firms must add value to every engagement, issue and work product – at a cost that’s fair to the client and to the firm. Inertia can be costly to the client. Being purely compliant can be a death-knell for the firm.

How Clients Currently Receive Information and How They Would Prefer to Get Information

As reported in my March 2013 newsletter, clients cited the constantly changing and expanding universe of rules, regulations and laws as one of their most pressing challenges. When asked how they keep up-to-date, they described a perpetual game of catch-up and voiced little confidence that they are ever truly current. Despite the volume of available printed and electronic information, most clients look to their accounting firm to keep them apprised of changes and to keep their companies in compliance – a process one client called “reactionary.” On the firm side, executives widely acknowledged the burden posed to clients by the continually changing accounting landscape as well as the downstream costs that can accrue when clients are not fully capable of complying with new regulations. In other words, both parties described a process that is simultaneously adequate and inadequate.

When asked, however, how they would prefer to receive information, clients drew a different picture. They described small, face-to-face, peer events focused on topics specific to either their industry or to companies of their size. In this preferred venue, they could network, share information and discuss the real-life impact of and possible responses to changing rules, legislation, etc. Interactivity is key. As one executive put it, “… present as opposed to getting lost listening … or watching …”

My perspective

Regarding relationships, the favorable results bear out what I’ve observed during many Blythe Global Advisors consulting engagements. Time and again, I’ve seen both clients and firms working hard to communicate clearly, to ensure senior management on both sides is sufficiently involved, and to put the right skills and experience in place.

Let me add one point about communications. While both parties in our survey assigned themselves the responsibility to keep the lines of communication open and to be proactive in raising issues before they require costly adjustments, it’s my perspective that this responsibility weighs heavier on the client side. Firms can keep their clients aware of changes as they occur, but firms can only assess and advise on the full impact of such changes to the extent that clients keep their firms informed of current activities and strategic plans.

If you’d like to read more on this topic, see my October 2010 newsletter, ‘Five Ways to Maximize the Client/Auditor Relationship.’

On the subject of how clients receive information, clients provided a lot to think about. The way clients get information today – mostly from their audit firms and trusted advisors – may not be ideal but it’s expedient. In my opinion, this ad hoc process will continue despite its shortcomings because changes will continue to outpace executives’ ability to keep up with them.

When asked how they’d like to receive information, clients identified a different model. Our respondents would prefer small, highly interactive meetings where executives of like positions, industries or company size could discuss similar challenges, possible solutions and lessons learned. I’ve often said that many of us are seeking solutions to the same challenges. Sharing approaches and lessons learned can be a powerful tool in that search by moving the frame of reference from the impersonal directive to real-world application.

If you would like to discuss anything in this or any of my newsletters, please contact me. I’d be delighted to talk with you. If you need to fill a gap in financial and accounting expertise, we at Blythe Global Advisors would be honored to help you.

To discuss this important topic further
or if you’re looking for general accounting advice and counsel,
contact marc@blytheglobal.com

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Sharing perspectives can promote
better understanding and communication
among all of us.

Our interviews showed that
many of us are seeking solutions
to the same challenges.

Over the past few months, Blythe Global Advisors has engaged the services of an external firm to interview some of you – both companies and accounting firms. We had two objectives with the interviews. First, we wanted to find out what you consider your most urgent needs to ensure Blythe Global is focusing on the right services and offering the greatest value. Second, we wanted to use the findings to foster greater understanding and better communication among all of us – clients, accounting firms and audit partners – on the premise that it always helps to know that our problems are not unique and that we’re not alone in searching for solutions. We’ve synthesized the responses into top-level findings that I’ll share in two newsletters starting with this one.

Before I launch into the details, let me thank all of you who generously took time from your busy schedules to talk with our representatives. I read each interview and was humbled by the trust you exhibited in the frankness and scope of your responses. As promised, we’re treating your input with complete confidentiality.

On the client side, we interviewed companies in the small to mid-sized range, each in a different industry. On the accounting side, we interviewed Big Four, national and local accounting firms. We focused the interviews on two broad areas: the most pressing challenges in the near term and the client/firm relationship. Where time allowed, we asked company executives how they stay up-to-date both on financial and accounting issues and with their peers. In this newsletter, I’ll focus on the challenges. In my next newsletter, I’ll address the relationship findings and where/how clients prefer to get information. At the end of each newsletter, you’ll find my perspective.

In terms of challenges, the responses were remarkable in their consistency – albeit with clients and firms each having their own perspective on the issues. Here are the top three challenges:

• Resource constraints
• The continually changing and expanding universe of rules, regulations and laws
• Lack of internal (client) technical accounting knowledge

Let’s look at each in detail.

Resource constraints: On the client side, respondents are committed to doing more with less. They’re looking to their current, experienced staff to carry additional responsibilities. As one respondent put it, management is looking to leverage resources to their maximum. In some cases, executives themselves are responsible for multiple functions. For instance, one CFO is also responsible for IT and Legal. That said, respondents were candid about the tension between the bottom line and investments needed to keep staff current on issues and technology, with one respondent citing the availability of resources (or lack thereof) as the most significant challenge to meeting reporting requirements. Clients expect this pressure to continue in the foreseeable future.

Their clients’ need to run a lean shop is not lost on accounting firms. Several respondents connected the impact of limited resources to some clients’ inability to meet deadlines. And while one firm executive acknowledged that the burden on clients’ staff to handle routine business and strategic functions AND meet audit and other deadlines can sometimes be unrealistic, he also pointed to the reality that the requirement for clients to produce audit-ready financial statements with full documentation is not negotiable. Several accounting firm executives cited the negative results when reports are not audit-ready: an often cumbersome back-and-forth that puts pressure on the client/firm relationship both in terms of maintaining firm independence and fees.

To be clear, the pressure on resources is happening across the board – in small, mid-sized and large companies, public and private, as well as within accounting firms themselves. And while clients often look to external partners to fill the gap in expertise, it’s not an automatic solution and is only taken with great prudence. Finally, resource constraints have tentacles, directly affecting the ability of executives and their staff to keep current – which brings us to our next finding.

Changing and expanding rules, regulations and laws: This finding wasn’t a surprise. Many finance and accounting firms, as well as consulting agencies have devoted a lot of communications over the last two years to discussing the pace, requirements and ramifications of changing regulations and increased scrutiny that show no signs of easing. Despite the volume of information from both private and public sources, the changes are outpacing executives’ ability to keep up with them.

On the client side, executives described a constant game of catch-up with little confidence that they are ever truly current. While most clients look to their accounting firm to keep them apprised of changes and to keep their companies in compliance, they portrayed a reactionary approach. Issues are addressed as they arise – a model that one executive said was not ideal but was the company’s reality. Specific issues that clients cited included IFRS convergence, FASB clarity and the Affordable Care Act.

On the firm side, respondents widely acknowledged the burden posed to clients by the continually changing accounting landscape. While their clients are usually aware of specific changes, their staff sometimes lacked the skills to complete new documentation requirements or apply new principles (see reactionary approach above). The result is usually additional costs that strain both the relationship and clients’ already squeezed bottom lines. The specific issues about which firm executives are concerned for their clients included anticipated changes to revenue recognition and lease accounting (with the latter putting greater pressure on management and affecting fair value investments), IFRS convergence and how to best leverage the Jobs Act.

Lack of internal (client) technical accounting knowledge: Client respondents did not specifically cite this issue; however, its incidence among firm respondents was significant enough to warrant inclusion. Firm respondents connected the challenge of meeting the rigors of an audit to the lack of internal technical knowledge of the nuances and supporting documentation required for a quality audit. For their part, accounting firms stand ready to help clients better understand accounting literature and principles in order to address accounting issues proactively.

From my perspective, these challenges are interconnected. Bottom line pressures lead to resource constraints which lead to additional responsibilities which inhibit staff from keeping up with changes. Clients look to their firms to help fill the gap. Firms, who are having their own internal cost pressures, respond as best they can without putting too much strain on either their fees or the client relationship and while also remaining independent. This is where external partners can help. While freelance accountants can augment routine recordkeeping, a full-service external advisory firm (such as Blythe Global Advisors), should be considered when the need is ensuring reports and documentation are audit-ready. To get the best return on any investment of precious budget dollars, clients need to make certain they’re matching the right level of expertise to the need. Advisors may not be the most cost-effective solution for lower-level engagements; however, “lone ranger” accountants often lack the skills to meet complicated regulatory requirements.

With regard to the continuing changes to rules, regulations and laws, the repeated delays to the convergence of U.S. GAAP and IFRS standards make it difficult for companies to justify defraying precious resources now to prepare for an implementation that’s been a long time coming. While this lack of preparation is concerning to firm respondents and to me, it’s understandable given the current economic environment. That said, we all need to keep in mind that the changes are coming, and we’ll all have to scramble at that time.

On the other hand, when it comes to changes to U.S. GAAP, SEC, Sarbanes-Oxley, IFRS, PCAOB or the implications of evolving legislation such as Dodd-Frank and the JOBS Act, these require immediate and complete application. And that’s the point of intersection where both clients and audit firms feel the rub according to our survey.

Look for my next newsletter in which I’ll share what respondents told us about their client/firm relationship and where/how clients’ executives prefer to get information – a topic of interest to all of us who want to provide value outside of our engagements.

In the meantime, if you need to fill a gap in financial and accounting expertise, we at Blythe Global Advisors would be honored to help you.

To discuss this important topic further
or if you’re looking for general accounting advice and counsel,
contact marc@blytheglobal.com

View/Download the Entire Newsletter (PDF) »

Launching a successful IPO
is a complicated and complex process.

Smart companies will start making
investments at least two years before
to meet objectives.

Over the course of this year, I’ve been watching a definite uptick in IPOs – both throughout the country and here in Orange County, CA where Blythe Global Advisors is located. That’s good news for all of us. In fact, in response to a burst of IPO engagements in the first half of 2012, we decided to formally add a full spectrum of IPO readiness services to Blythe Global’s solutions offerings. As the year comes to a close, we’re continuing to garner new IPO engagements.

In the event that some of you are considering an IPO, I’m focusing this newsletter on what I’ve observed during those engagements with the hope that the lessons my clients learned can help you. And I’ll tell you the bottom line at the outset: When it comes to IPOs, an ounce of readiness can reap huge dividends.

Launching a successful IPO adds an immense bubble of work above and beyond a business’s normal activities. Those of you who have gone through this process know what I’m talking about and probably have scars to prove it. I tell my clients an IPO is like changing tires on a car while the car is moving. Moving the car is running your business; simultaneously changing the tires is launching the IPO.

That said, readiness is not as obvious or simple a concept as it might first seem.

Readiness is expensive. Companies need to make a decision early on – when an IPO might still only be a remote possibility – as to whether or not they’re going to make the necessary investments and cultural changes to enable them to operate to public-company standards before they are obligated to do so. Two years before is the minimum timeframe a company should consider for transitioning to public standards. Even with a two-year window, companies should be prepared for lots of stress and more than one or two surprises or setbacks – especially in the current expanding regulatory environment.

For companies who determine they can’t afford such early investments, the decision should be a conscious one and made with awareness that the company is not avoiding pain; they’re simply delaying it – with the likelihood of greater pain and cost down the road.

Where should a company invest their precious revenue and time for optimum results? Here are my top issues based on our 2012 engagements.

Skilled resources: Thinking and acting like a public company require executives and staff with public-company skills and experience. A qualified CFO should be in place at least two years before the planned IPO – one with experience growing businesses who can build a top-flight accounting and finance team capable of delivering audit-ready reports that comply with the requirements of U.S. GAAP/IFRS, the Sarbanes-Oxley Act, the SEC and the PCAOB as well as take into consideration the implications of evolving legislation such as Dodd-Frank and the JOBS Act. These folks will need a robust IT infrastructure to enable repeatable, predictable processes to forecast the business correctly; produce accurate, on-time reports; and implement and maintain effective internal controls.

Qualified advisors: The road to public status also requires highly specialized skills for which a company needs trusted advisors. Here, that qualified CFO is essential to help the company hire and establish relationships with the necessary external organizations – audit firm, law firm, investment bank, investor relations agency and trusted IPO advisory firm. The first four organizations have very specific responsibilities with rigid rules to avoid conflicts of interest. The fifth, an experienced IPO advisory consultant, can fill the gaps between internal and external responsibilities without such conflicts – helping to build the right infrastructure, filling resource shortfalls, assisting in the preparation of current and historical statements, and generally providing a broad range of pre-, during and post-IPO advice and services to ensure the company always knows what’s needed and when it’s needed.

Timeline and communications: Going public is foreign territory. Companies do best when they have a road map. Setting major target dates gets everyone on the same page and provides the framework for establishing priorities and drawing up the master schedule. Having all key internal and external parties participate in determining the launch date ensures more realistic targets are selected and helps engender buy-in.

On the communications side, implementing a strong and consistent employee communications plan may be a significant investment, but it will move the culture to a public mindset – which is absolutely critical for the successful implementation of new processes and procedures. Regular meetings with external constituencies may be billable, but they’ll ensure strong cross-functional communication, enable more efficient teamwork and keep the schedule on track.

Documentation: The level of documentation required for a public company is incomparable to how a private company operates. What was acceptable in the past can create a false sense of security and come back to haunt a company during IPO preparation. Even companies that had employed an audit firm all along will find the scrutiny ratchet up. Investment bankers, regulators, lawyers as well as auditors will require extensive documentation of all policies, transactions, backup, etc. Companies backed by venture capital firms and operating on a shoe-string budget are especially vulnerable in this respect.

This is where that conscious decision to invest in advanced processes and practices comes into play. Reviewing documents for proper accounting outcomes is a large, complicated, labor-intensive undertaking for which most companies engage an IPO advisor. How costly those engagements ultimately are depends on whether the company has built a foundation of public-standard operation or whether work has to start from scratch – with all the accompanying confusion and inefficiency that going back and rebuilding the past implies.

Technical review/accounting guidance: Have transactions been supported, reported and accounted for as required under relevant accounting literature? Were revisions to agreements properly appended to original transactions? Were all transactions tracked against their impact on profit and loss? Were potential shareholders well informed? If the answer to any of these questions is no, then the company needs to undertake what can only be described as a forensic engagement that will be largely dependent on oral history – recreating the past, revisiting the full impact and, possibly, restating results. Anticipated transactions should be included here, too, to make sure any future deals achieve the desired and right accounting and save costs going forward. Here again, the ultimate time and cost depends on the level of public compliance to which the company has been operating.

Reporting and forecasting tools: The upgrade from simple financial statements to the full panoply of quarterly and annual reporting requirements is steep. And the process goes beyond the expense of installing advanced tools and an enterprise-wide accounting system. It needs to be a combination of upgraded tools and upgraded skills – those experienced people I cited above who are able to use the tools and augment the output with the management statements and footnotes required for public reporting. This is another area where that conscious decision to invest long before an IPO is at hand comes into play. It’s my observation that companies that don’t make early investments but opt to change from inadequate accounting systems to more sophisticated tools after beginning an IPO journey incur the most costs and the most pain – with the greatest pain being possibly unable to go public on time and losing public confidence.

Even companies that are better prepared have a hard time moving up to regular, compliant, accurate reporting. The good news is that upgrading reporting capability and skills early provides a good foundation for whatever option a company might eventually choose – merger, acquisition, sale – albeit with varying returns on investment.

Stock award tools: Some companies wrongfully calculate this as a “one and done” – install some tracking software, input available data and check it off the to-do list. Here again, readiness goes beyond tools. Most private companies have a wide-open process involving many different kinds of potentially complex options and other awards along with an incomplete approach to documenting and archiving those issuances. To pass public scrutiny, companies need to get their equity structure buttoned up. That means implementing a formal, disciplined, defined program that has board approval and then ensuring that all awards issued – under old and new plans – are fully and properly executed, documented and valued.

In summary, for most fast-growing companies going public is often the next logical step to increasing value. Happily, we’re in an environment where IPOs are on the increase after a long period of inactivity. Unfortunately, most fast-growing companies are not as prepared to go public as they might assume. The good news is that with the right investments and trusted partners companies can make the leap successfully.

At Blythe Global Advisors, we have the experience to help companies launch an IPO efficiently and on time. As trusted consultants, we can fill the gap in financial and accounting expertise between a company and their audit firm, investment bank or law firm without conflict of interest. If you’re considering an IPO, we’d be honored to help you.

To discuss this important topic further
or if you’re looking for general accounting advice and counsel,
contact marc@blytheglobal.com

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Although originally conceived as
legislation to regulate the financial industry,
the Dodd-Frank Act
has already touched public companies
and has the potential to affect private companies, too.

Smart companies will keep abreast
of the law’s on-going implementation
to deal proactively with any increased scrutiny.

A while ago, I spoke at a CFO conference hosted by a Big Four firm. My topic was the implications of the Dodd-Frank legislation 18 months after passage. It’s a monumental piece of reform legislation that was originally intended to apply only to financial institutions. But, the law is proving to have long tentacles – even with much of the implementation still to be done.

My presentation focused on how specific areas in the law’s initial implementation have already affected public companies in surprising ways. Public companies, private companies and auditing firms should pay attention to the law’s on-going rollout because implementation to-date demonstrates how regulatory activities can have far-reaching and unintended consequences that sometimes only become evident farther down the road. Certainly, the law has the potential to affect the actions of investors in public companies as well as the actions of private companies that want to become public.

In this newsletter, I’ll discuss some areas in which Dodd-Frank has already affected public companies, point out where there’s the possibility to impact private companies and offer a key takeaway on each topic. The areas are:

• Permanent deferral of 404(b) for small filers
• Whistleblower incentives
• Say-on-pay
• Clawback policies
• Proxy access

Permanent deferral of 404(b) for small filers: Dodd-Frank has allowed smaller companies (under $75 million market float) a permanent exemption from Sarbanes-Oxley Act (SOA) provision 404(b) which requires outside audit of companies’ internal financial reporting controls. This is an obvious cost savings for smaller companies; however, management of these smaller companies must still attest to the compliance of their internal financial reporting controls and monthly bank reconciliations do not assure the required level of stringent review. The key takeaway: It’s in smaller companies’ interests to have their outside audit firm provide insight and feedback into their internal financial reporting controls at the time of the financial statement audit. Companies considering a public offering should engage trusted financial advisors to help put best practices in place early in the IPO cycle.

Whistleblower incentives: Under Dodd-Frank, the Securities and Exchange Commission (SEC) has established a program to provide both incentive awards and protection for whistleblowers. Accordingly, the SEC has put aside half a billion dollars for whistleblowers who report cases of fraud or malfeasance exceeding $1 million. This is a controversial provision because it has the potential to drive whistleblowers immediately to the SEC without using company channels. To maintain the ability to resolve issues internally, public companies must invest in a values-based, ethical culture underpinned by strong processes. Employees must understand the urgency of reporting any wrongdoing immediately. They must be confident that action will be taken quickly and they will be shielded. The key takeaway: This ruling has the potential to weaken the ability of businesses to handle wrongdoing themselves. Companies must communicate zero-tolerance for any impropriety at any level of the business and implement best practices to ensure quick and transparent resolution. It goes without saying that beyond Dodd-Frank or any oversight agency, all companies should consider an open, transparent, ethical environment part of their DNA.

Say-on-pay: The intent here is to extend shareholder engagement to include investor views on prospective executive compensation plans. To be sure, shareholder input is advisory and not binding. Nonetheless, under Dodd-Frank, larger public companies are now required to get shareholder views on executive compensation plans at least every three years. The requirement as it applies to smaller public companies is scheduled to be finalized by January 2013. The key takeaway: To meet this expansion in investor relations, companies need to beef up shareholder communications – especially with institutional investors. Sharing planned executive compensation changes before putting them out to vote will avoid unfavorable reaction and enable companies to keep control of their narrative.

Clawback policies: Under current proxy statement rules, public companies already have voluntary clawback processes that ensure payback of excess CEO and CFO bonuses in the event of a financial misstatement. Dodd-Frank expands the scope of these policies by requiring payback by all executives regardless of whether or not they were involved in the misconduct/misstatement. The SEC has been directed to write new rules that are expected to be finalized by June 2012. Of note here is that the blanket expansion connecting all executives receiving bonuses to any restatement means that some executives might be required to return bonuses earned for incentives not attached in any way to the misconduct or the restatement. The key takeaway: It’s obvious that these expanded rules will motivate executives to ensure their financial statements are right the first time. On the other hand, tolerance for errors is becoming lower while repercussions are rising.

Proxy access: Like say-on-pay, the intent here is greater shareholder involvement – in this instance by allowing qualified individual investors or groups of investors to nominate board directors. Because the Supreme Court has already rejected the SEC’s initial rules in this area, it’s not clear what the future holds. However, the key takeaway is that companies should expect that new rules and regulations will tilt toward shareholders having a greater voice in more areas of a company’s business.

In summary, the overall takeaway from everything I’ve discussed in this newsletter ties back to my October 2011 newsletter concerning proposed (and controversial) PCAOB changes. In that newsletter, I said it’s clear that oversight is not going to lessen any time soon. Given Dodd-Frank’s broad scope and ambitious agenda, my conclusion here is the same: Companies should expect increased scrutiny into how they conduct business and report results – along with new rules and regulations that will determine the look and form of compliance. When those new rules are issued, wise companies and their audit firms will be proactive and employ best practices to make effective adjustments.

At Blythe Global Advisors, we have the experience to help navigate new rules and to fill the gap in financial and accounting expertise without conflict of interest. We’d be honored to help you.

To discuss this important topic further
or if you’re looking for general accounting advice and counsel,
contact marc@blytheglobal.com

View/Download the Entire Newsletter (PDF) »

With the recent comments from the PCAOB
regarding audit quality and auditor independence,
there’s widespread concern about how increased oversight
will affect both public and private companies.

A careful analysis reveals
that the PCAOB’s proposed changes
can lead to streamlined processes, reduced risks,
fewer surprises and improved relationships –
if approached properly.

The key is taking the right steps at the outset
for mutual advantage.

I’ve been getting an earful from many of you about the recent comments by James Doty, Chairman of The Public Company Accounting Oversight Board (PCAOB), regarding that organization’s assertion that the existing audit structure is not independent or transparent enough.

To remedy the situation, the PCAOB is proposing to expand their oversight of the audit process and to ensure auditor objectivity through a variety of regulations including mandatory rotation of audit firms. The stated goals are to improve the overall quality of audits and to insulate auditors from client pressures so they can focus on protecting investors.

In this newsletter, I’ll give you my thoughts on the impact of these potential changes and how to manage them for everyone’s advantage. (Full disclosure: There is a role for consulting firms like Blythe Global Advisors in my recommendations.) But, first, let me share what I’ve been hearing.

In one ear, those of you on the client side are telling me that the current burdensome oversight process has resulted in strict adherence to the “checklist.” Judgment decisions, the few times they are issued, take too long. Clients increasingly feel that audit firms are reinforcing processes primarily to pass PCAOB muster – sometimes at the expense of genuine, hard-earned business results. Surprises at the end of audits are on the rise, as are costs. Relationships are on the decline.

In the other ear, audit firms are telling me that the new proposals will raise the temperature in an already strained environment. With PCAOB oversight at its most burdensome ever, audit partners in CPA firms feel that proposals for them to take on more risk via personally signing audits, more work via expanded emphasis paragraphs, and more overall scrutiny will put them in a zero-tolerance situation. The need to walk the PCAOB gauntlet will continue to put pressure on fees and on the client/auditor relationship.

I haven’t heard much from those of you in the private company sector, but you should not think you’re exempt. These proposed regulations will have an overarching effect on how audit firms do business. Once implemented, the audit firms will apply the same processes and standards to all clients – regardless of whether the client is privately or publicly held.

Sounds like harsh days ahead, right?

Perhaps not.

While there’s no denying that increased oversight has the potential to make client-auditor relationships more adversarial, I believe the new rules, if approached correctly, can actually stabilize the client-auditor environment – resulting in improved relationships, lower risks, a streamlined audit process and a minimum of late-breaking surprises. If implemented, I also believe that mandatory rotation of audit firms every five years will not have the cataclysmic effects some are predicting.

Let’s focus first on what actions are needed for increased oversight to result in positive outcomes.

For starters, both parties need to understand the obligations and constraints that expanded oversight will impose on each other’s respective roles and responsibilities. Then, each party needs to establish new processes to work within those obligations and restraints.

Clients and auditing firms that don’t change how they work together will do so at their own peril. In order to achieve the kind of independence the PCAOB is demanding, audit firms will need to limit their services strictly to the audit process – with few to no gray areas. With audit services so narrowly defined, companies will be on their own in terms of preparing for the audit – no matter who the audit firm may be.

Let’s be clear: This is not entirely new. As I’ve emphasized in previous newsletters, audit firms are in the business of reducing their risks and making sure their work stands up to review by outside regulators. It’s why they were hired. Managing the audit for maximum efficiency is important but not their priority, and identifying/resolving accounting issues is not their principal responsibility – nor should it be. For the most part, the PCAOB’s proposals reinforce these standards while diminishing opportunities for conflicts of interest.

All of the above said, the proposed restrictions will leave a gap in financial and accounting expertise that companies have historically looked to their audit firm to provide.

That’s where a good consultant with Big Four experience comes in.

Because consultants are not auditors, they can offer clients advice and counsel without any conflicts of interest. On the non-audit side, they can determine the appropriate accounting treatment for complex business issues or identify current and future accounting implications and recommend on-going accounting treatment. On the audit side, they can help companies ensure their accounting processes and records are in order for an efficient audit and can review preliminary documents to avoid surprises.

Importantly, a good consultant can help a company understand complex or controversial positions their audit firm might take. At Blythe Global, we recently helped a company that had decided to fire their auditors because of a particular position. With no guarantee of what the outcome would be, Blythe Global researched the issue in detail, determined the audit firm’s position was correct and helped the company understand why it was correct. The company is still considering changing auditors, but they’re doing so with better information.

The benefits that accrue to both parties when companies add a consultant into the mix are significant:

• Accounting processes are improved, and potential audit issues are addressed in a timely manner – resulting in lower risk for companies and auditors.
• Companies get the kind of expert advice they need at a reasonable (usually set) fee.
• Auditors are relieved of non-audit services. They maintain their independence but are secure in the knowledge that there’s an expert level between them and their client.
• Client costs are contained because auditors stay within the scope of audit work.
• Audit firm profitability increases because client records are “audit ready” and auditors are not spending time on out-of-scope (and potentially non-billable) services.
• Relationships improve all around.

It’s my view that this proposal will not lead to the disaster some see looming. Most critics are focusing on the institutional client knowledge a legacy audit team possesses and the familiarity between client and firm regarding processes. The reality is that audit firms rotate people all the time and they change processes regularly to stay current with new rules and regulations. Without minimizing the effects of changing auditors, I think this idea is worth considering – which is exactly what the PCAOB is doing right now. They have issued concept releases and are seeking comments.

Clearly, oversight is not going to lessen any time soon. When new rules are issued, wise clients and audit firms will make adjustments that are proactive and mutually beneficial – a business model that will serve them for the long term.

At Blythe Global Advisors, we have the experience to help navigate new rules and to fill the gap in financial and accounting expertise without conflict of interest. We’d be honored to help you.

To discuss this important topic further
or if you’re looking for general accounting advice and counsel,
contact marc@blytheglobal.com