[matt]

Not sure if this thread is welcomed here – if not please delete. Figured this would be a good way to throw a real world accounting problem to CPA candidates, refresh my rusty CPA memory, and avoid posing the question to our outside auditors who’ll happily charge us $200+/hour.

I was active on the Another71 forums when I was studying for the CPA exams 5+ years ago. I’ve since passed and have climbed my way up the financial leadership ladder. I recently accepted a position as the controller of a family owned manufacturing business! The company maintains a GAAP set of books but really is concerned more about taxable income over Net Income. (BDE isn’t a factor in taxable income)

Here’s our problem:

1. Annual revenue varies from $175m/yr to $225m/yr.

2. We maintain an outside firm to assess credit risk before shipping to a customer. This same firm is an insurance policy were one of our customers to default. If a customer were to default this insurance policy covers 90% of our receivable written off.

3. Because we’re very tight extending credit most of our customers wire cash before goods are shipped. Only our largest and most valued customers maintain AR. Because of this in the past 10 years total AR write offs have been less than $10,000.

4. For some reason I can’t understand our previous controllers have built up a bad debt reserve of almost $1,000,000 and keep adding $40k per year to the reserve. (Entry: Dr Bad Debt Expense, CR Bad Debt Allowance).

5. This reserve is obviously not warranted because (1) we have our receivables insured and (2) our past history of write-offs is virtually zero.

I need to unwind this reserve and make it realistic. The reserve has been built up over the past 10 years. I know if I unwind it all it’ll be a shock to the GAAP statements in the month of the entry.

Here’s some thoughts on how I should address:

1. Unwind slowly so Net Income isn’t shocked. Maybe do it over a few years.

2. Unwind in one month against Retained Earnings.

3. Put the past 12 months of BDE as a credit to expense and the balance as a credit to RE.

Thoughts?

done

FAR: 89
BEC: 88
REG: 81
AUD: 76

CPAexcel, NINJA 10 point combo, & NINJA MCQ

"Pain is temporary, it may last for a minute, or an hour, or a day, or even a year...but eventually it will subside and something else will take its place. If I quit however, it will last forever."

[dukenuke]

If the company has an audit maybe discuss the issue with the auditors to see if they agree with your assessment of where the allowance should be and then propose a client AJE to be included with audited AJEs for the year. I personally wouldn't want to make that adjustment in just some random monthly reporting period.

“Get to the chopper.”

79 FAR-5/2019

76 AUD-6/2019

81 REG-8/2019

78 BEC-2/2020

[Recked]

I'm curious how the outside auditors let this continue to accrue to such a large balance given your past history as you explained it.
I don't do audit, or financials of this magnitude but I feel that this might qualify as a mistake that could lead to corrected statements?
What are the audited financials used for? If you are trying to get this to slide under the radar, letting it out over a period of time seems the most logical solution.
What is the profit range for a year based on 175-225m in gross? With a 1M change in bottom line be noticeable in a given year?
Does management have any desire to retain this level or Bad Debt coverage? Will you ruffle feathers of someone further up the chain by making this decision?
_
Unwinding it and posted it against RE almost seems like a correcting entry and would probably raise some questions.

Memento Mori - Kingston NY CPA & EA (SUNY Albany 2002)

FAR-93 11/9/17 (10wks, 250 hrs, Roger 1800+ MCQs, Gleim TB 600+MCQs, SIMs)
AUD-88 12/7/17 (3 wks, 85 hrs, Roger 1000 MCQs no SIMs hail mary)
REG-96 1/18/18 (6 wks, 110 hrs, 1400 MCQs, no SIMs)
BEC-91 2/16/18 (4wks, 90 hrs, 1240 MCQs)

[matt]

Actually found out the logical answer to this question this morning when I raised my concerns with the CFO. (Note the CFO was recently promoted to CFO when the old CFO retired. The new CFO was the Controller before me. He isn't a CPA and holds a bit of a grudge against CPAs (my guess is because the market undervalues him…). To his credit he knows a TON about the industry, the players, etc but is weak on accounting operations knowledge. He's worked with the company for 30 years so he's resistant to change. The CEO, who is also a relative newcomer to the company, wanted to hire a real CPA. Our outside audit firm recommended to the board that they hire a CPA as well. Needless to say there is a bit of a power struggle going on!

Answer was this:

1. About 90% of our AR is from 5 customers. Each of them owe between $1m and $10m at any given time. One of them isn't insurable since they won't release financials to our credit insurance vendor. They are slow to pay and word in the industry is that they're barely treading water. The fact that we haven't written off any bad debts shouldn't the logic used to decide if our reserve is sufficient. Auditors have signed off on this approach for years.

2. The credit insurance is capped at $5m per approved customer with a 10% deductible per claim, so we'd have bad debt expense even if an insured customer defaults, regardless of the amount.

To answer your questions:

Audited financials are largely used to provide assurance to owners that no one is cooking the books/stealing, we have proper controls in place, and for management decision making.
Net Income isn't impressive – about 6%. If we weren't family owned there could be a TON of fat trimmed and I'm sure margins would be in the 15% range.
Yeah, they want to keep it and after talking with CFO I'm thinking it makes sense.

Just goes to show that the real world isn't in a CPA study guide!

done

FAR: 89
BEC: 88
REG: 81
AUD: 76

CPAexcel, NINJA 10 point combo, & NINJA MCQ

"Pain is temporary, it may last for a minute, or an hour, or a day, or even a year...but eventually it will subside and something else will take its place. If I quit however, it will last forever."

[Asja]

I thought by “done' at the end of your post meant you are done posting, but I guess it means you're done with the CPA exams…

“The strongest of all warriors are these two — Time and Patience.” ― Leo Tolstoy (War and Peace)

[matt]

Ha! That's correct. Finished almost four years ago. Best investment I've ever made. Tough 2 years in exchange a TON of opportunities. Keep on going. Don't give up!

done

FAR: 89
BEC: 88
REG: 81
AUD: 76

CPAexcel, NINJA 10 point combo, & NINJA MCQ

"Pain is temporary, it may last for a minute, or an hour, or a day, or even a year...but eventually it will subside and something else will take its place. If I quit however, it will last forever."

[Asja]

two year investment? Apparently some people here only take ten weeks to study for a section. I'm thinking that isn't happening for me :(.

Actually your encouragement has perfect timing…thanks…I've been really pumped to start studying and I was a bit over confident, and now I feel like I'm having to relearn everything all over again, being out of school and work since 2013.

Your story is very encouraging! I'm going to fight for the return of each accounting memory. DIdn't realize the gold that I had. Threw it away thinking its nothing great…:( May God Forgive Me!

“The strongest of all warriors are these two — Time and Patience.” ― Leo Tolstoy (War and Peace)

[matt]

Sorry – should have been more clear. I just used 2 years as rough guess.

In 2012 I decided I wanted to become a CPA. I already had a bachelors in finance/economics and an MBA. I had to go back again to get the credits needed to sit for the CPA exams. Finished the credits at the end of 2013. Started studying 1/1/2014. My strategy was to take the low and slow route. I remember seeing people bang them out in crazy short times and I knew that wasn't going work for me since I was married, had a full-time career, and a baby on the way (July 2014). I budgeted 2-3 hours a day and stuck to it. That allowed me to take FAR in May 2014 (89), BEC in Oct 2014 (88), REG in Feb 2015 (81), and AUD in May 2015 (76).

So I guess the actual CPA study/exam process was about 1.5 years. My plan was slow and steady but your situation may differ. Either way I recommend building a realistic plan and sticking with it.

done

FAR: 89
BEC: 88
REG: 81
AUD: 76

CPAexcel, NINJA 10 point combo, & NINJA MCQ

"Pain is temporary, it may last for a minute, or an hour, or a day, or even a year...but eventually it will subside and something else will take its place. If I quit however, it will last forever."

[Asja]

Well, thanks! I wish you luck and congratutaltions on your success as well! Thanks for sharing your real world example. Even though, I can't understand most of it.

“The strongest of all warriors are these two — Time and Patience.” ― Leo Tolstoy (War and Peace)

[matt]

Any time! You'll get there – just keep grinding and keep your eye on the prize.

done

FAR: 89
BEC: 88
REG: 81
AUD: 76

CPAexcel, NINJA 10 point combo, & NINJA MCQ

"Pain is temporary, it may last for a minute, or an hour, or a day, or even a year...but eventually it will subside and something else will take its place. If I quit however, it will last forever."

[Author]

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