You may have noticed that many accounting firms, Armanino included, now refer to audit departments as “Assurance Services” and wondered what exactly that is intended to convey.
This is the broad term that encompasses many types of engagements beyond traditional audit and review services—all of which are designed to provide higher levels of confidence in information received. Over the coming issues, we’ll describe some different types of assurance engagements that can reduce risk in business acquisitions, enhance marketing efforts by providing information to customers or help strengthen donor support.
Most assurance services are highly customized engagements designed to fit the specific needs of the users. For example, a company in the process of acquiring a competitor might be very interested in the valuation of assets, identification of all liabilities and the quality of the target’s earnings. While all of these are addressed in a conventional audit engagement, the extent to which they are considered depends upon the risk assessment made by the audit firm.
By contrast, a due diligence assurance engagement would be designed together with management and would include specific procedures addressing the precise concerns of the acquirer. Additionally, an engagement of this type can include procedures that will produce data that is useful in forecasting performance and cash flows.
Consider sales allowances in a company that accepts sales returns. An audited financial statement may separately state the provision for sales returns, but is less likely to provide detail on how the number is calculated. In a due diligence engagement, management and the CPA firm could develop an extensive set of procedures to validate the estimates used in generating the sales allowance. The CPA could also provide detailed analysis of sales and returns by customer that would provide a foundation for forecasting sales by customer or market segment.
Assurance services can also help in identifying off-the-books risk. For example, the IRS and state labor agencies are very focused on correct classification of employees versus independent contractors. While a labor attorney would probably be needed to make a final determination of appropriate status, a due diligence project could identify the make-up of the workforce and provide summary information on means of compensation, cost of benefits, rate of overtime, etc.
Out-of-state sales might also be a consideration. The due diligence process could accumulate information on sales that might result in unrecorded sales tax obligations or nexus for income tax purposes.
Understatement of liabilities is a common problem. If not identified, they will impact cash flows after the acquisition as well as working capital.
An example is the liability due on gift cards sold by hotels, spas, grocery stores or other retail businesses. In California, there is no expiration date on most gift cards, and a detailed consideration of the redemption rates and gift card sales over time can prevent an acquirer from dramatically overpaying. In a recent project with a client, the Armanino team helped identify approximately $750,000 in estimated gift card liabilities and the purchase price was adjusted accordingly.
Use of a CPA firm to advise in a merger can also help mitigate risk in a situation where the target company does not have audited financial statements. Because auditors are trained to gain an understanding of accounting policies and procedures, they can quickly identify areas in which a company may not be using standard methods to recognize transactions.
A frequent problem with acquisitions of smaller companies is the fact that books may not be kept entirely in accordance with Generally Accepted Accounting Principles (GAAP), and purchase agreements will typically specify “in accordance with GAAP or other customary basis of accounting.”
For example, a technology services company might charge for a full year of fees up-front. If the company is recognizing revenue upon invoicing, the ongoing obligation to provide the services might not be wholly apparent, or easy to quantify. A full audit might be both cost and time-prohibitive in the midst of an acquisition. Using the accounting firm to focus on a particular revenue recognition situation could provide the necessary information to appropriately price an acquisition target or prevent litigation after the acquisition.
Involving your CPA firm in considering a business acquisition can help identify potential unknown costs and strengths and weaknesses in the quality of the target earnings. The analysis and assurance that the firm can provide in a potential acquisition can increase the confidence in the transaction and potentially result in a more advantageous purchase price.
June 17, 2013
