Tag Archives: Audit

Does Accounting Add Value?


For many businesses-owners, accounting is perceived as a necessary evil. It is a cost that you have to bear but does not create value the way that other departments do, such as marketing, engineering, or finance. Some may argue about whether the accounting department of a firm is “productive” in the classical sense, but their support role is essential for any successful business. Accountants are derided for not providing as much value (especially by the finance and economics types, even though they are not productive in the classical sense, either) but without the accountants, large businesses could not operate.

Even for a small business, accounting is crucial. When your profit margin is in the thousands, you need to make sure and collect all receipts as soon as possible. Maintaining current books is crucial for this task. It becomes both more difficult and more important to discharge accounting duties as sales climb along with your need for new capital. As you move up the ranks and become a  larger company with many employees, accounting techniques, practices, and procedures enable managers to maintain control over cash flows and company resources. Anyone who has overseen cashiers knows the importance of keeping up with revenues.

Accounting information can also be used to make cost-benefit decisions, like the cost-benefit decision of how much accounting detail should be pursued. To make the cost-benefit decision, you have to use the tools of finance as well, and this is where the artificial distinction between finance and accounting dissipates. Without the building blocks of accounting, finance would have to start from scratch and end up with less reliable results. This is not because finance is not capable, but because there is value in comparative advantage. Financiers can focus their efforts on long-term capital budgeting, marketers can drum up sales, engineers can design, and accountants can precisely tally it all up.

Many companies also need accountants to report financial results to stakeholders, including stockholders, the Board of Directors, the government, and lenders. Although much of reporting for big business is typically seen as a legal requirement, the value of such standard reporting is still great and can be found in the cost of capital. Without assurance that a company’s financial reports are accurate, cost of capital would be higher to accommodate the additional risk. This concept applies to both small businesses that want to grow as well as large public corporations.

Further, our tax system in the US is quite complicated, and many companies do not have enough scale to warrant having in-house tax staff to navigate every complexity. In this way, tax accountants can help companies minimize tax expenses and associated risks. With their specialization and familiarity with tax law, tax accountants can consult with timthumbmanagement about strategies that can help them reduce their tax burden.

CFOs around the world agree that accountants add value not only to their company but to the public in general. We do this by performing critical functions that enable other business departments to do their work more efficiently. Next time you hear accountants being diminished as less important in some way, you can remind them of all these ways that accountants add value.

The Pur$uit of Happine$$: Part 3

Hi everyone,

Like Melissa, I just wanted to cap my experience spending a semester interning. Melissa talked about how she utilized the things she learned from her academic studies for her internship, so I thought I would talk about some of the softer and more intangible skills that I took to public accounting from my time at UT.

Being patient: I assumed that when I would start my internship, I’d be put in the same room to interview some high ranking officers. Surprisingly, that doesn’t happen in your first week. I know as business and McCombs students, we want to be given the opportunity to prove ourselves and be challenged. However that takes time. Being given grunt work is how you learn about the industry you work in and allows you exposure to the professionals that you hope to become.

There’s no “I” in “Team”: I can’t even tell you the number of times I made dinner, Route 44’s, and Walmart runs. As an intern, your number one prerogative is to keep your team happy. Auditing/Performing Tax Services/Assessing Risk comes second. Help out where you can and do what you can to help the team. And keeping them content makes them more inclined to let you do real work.

Being professional: I don’t care how wacky the client or senior management is, professionalism is a requirement in the working world. We have to play extra, extra, extra nice. When I interned, there was definitely a relaxed atmosphere. People were cracking jokes, talking about current events, analyzing Sean’s actions from The Bachelor. It definitely made 8 hours a day in the audit room fly by faster, but as an intern, it’s important to distinguish when you’re overstepping your boundaries. Save all that raunchy humor for the intern events!

Accountants are people too: I’m sure it’s been drilled into your heads if you’ve done MPA spring recruiting, but accountants are people too, and they don’t want to talk about work all day. The same principal applies to when they’re working. Yes they work hard, but everyone needs a couple breaks throughout the day. When you aren’t calling XYZ bank to confirm 123 account, ask how their daughter’s play went or if they enjoyed their trip to the beach over the weekend.

Internships are an incredible opportunity to learn these little lessons that have a major impact on the success of your career. I’m grateful for the experience but so glad to be back at McCombs!

Melissa Takes Boston: Part 4

Hello everyone!

I am back with one last installment about my internship experiences this semester. McCombs provides  its students with a well-rounded business education and as I reflect on my internship, I realize that I used far more than just what I learned in my accounting classes. I thought I would share with you all how I used the McCombs core curriculum to succeed at my audit internship.

Finance: As as auditor, you will be exposed to a variety of financial instruments for which you need to audit and a background in finance is very helpful. I couldn’t have audited equity if I didn’t first understand present value!

Operations management: Throughout the course of the audit, you are exposed to the entirety of the business. As you audit certain areas such as inventory, you will identify fluxes (variances) that will need explanations. With my knowledge of operations management, I understood the nature of a supply chain (obtaining supplies, manufacturing, distributing, etc.) and thus I was able to dive deep into the numbers and understand what exactly was happening behind the scenes.

MIS: The MIS department will tell you this, and it’s definitely true- MIS is EVERYWHERE! Whether its the implementation of a new accounting system or database, or RFID tagging on your client’s inventory, you are definitely going to be exposed to a variety of information systems as an auditor.

Business communications: My BA324 experience is certainly a cliche one- I was a terrible public speaker (or as my professor so gracefully described it, an “inexperienced public speaker”) and the presentations and exercises in BA324 were crucial to my success in this realm of the business world. As an auditor,  you will need to be able to speak professionally with the client.

Management: As you move up in the public accounting world, or even if you leave and work in industry, eventually you are going to be in charge of some of your colleagues. And even before that, you are going to be the one being managed. This being said, the concepts that we are taught in management are always going to surround us in the business world.

Marketing: One thing that stuck with me from marketing classes, and something that I try to use in my career, is that you have to know how to market yourself. This trait did not apply so explicitly to my actual internship, but moreso the recruiting process that led up to it. I had to know how to showcase my strengths as I recruited so that my potential employers knew that I would be an asset to their firm.

I just think that McCombs is great and I hope you all agree! Remember this week that you can donate for BBA Legacy (even though we are MPA students- some of us are BBA too!)

Bitcoin for Accountants

Most blogs, including ours, operate on the WordPress content management system, the most popular blogging platform in the world. Last year WordPress began accepting a new, secure digital currency called bitcoins for payments and donations. This new currency combines open source software with cloud computing to dramatically lower the cost and delay of transferring funds.

Bitcoins are bought with dollars, euros, and other conventional currencies on centralized exchanges much like any other liquid asset. The currency is currently in a bull market, with the price of one bitcoin increasing from $5 to almost $18 over the past year.

Once purchased, bitcoins are used to make payments for goods and services using a distributed transaction clearing system (PDF). Instantaneous fund transfers cost less than a penny and are free if rapid execution is not a priority.  The clearing system continuously broadcasts all transactions between anonymous addresses (hashes of public keys) using a “block chain” or public ledger; the equivalent of check clearing between bank accounts. This level of transparency, combined with modern cryptography (SHA-256 & ECDSA), prevents any tampering or double spending.

Over the last couple of months approximately 1,000 merchants started accepting bitcoins thanks to a start-up called Bitpay. This trend has been driven by the low costs and high security of the Bitcoin payment processing system as well as the monetary stability of the underlying bitcoin currency. Perhaps the greatest advantage of Bitcoin over the current payment system is “immediate funds transfer” or IFT. Rather than wait for overnight clearing through ACH, CHIPS, or SWIFT, payments can be deposited or disbursed instantaneously wherever there is an internet connection.

From a financial and tax accounting point of view, bitcoins are the same as any other foreign currency. However, from an auditor’s point of view they do present an unprecedented peculiarity: the entire system relies on cryptographic proof rather than human trust. It is important for auditors to understand how to verify bitcoin transactions and value a company’s inventory of bitcoins.

The public ledger is called the “block chain” because it is a series of “blocks” that contain information about transactions. All of the bitcoin transfers from one address to another that have ever occurred are recorded in the block chain. This is very convenient for auditors since transactions recorded in the company’s internal systems can be instantaneously verified by searching the block chain for the company’s addresses. The block chain can be downloaded at the cut off date from Sourceforge and its integrity can be checked using the open source Bitcoin client. Not only does the block chain make payment verification simple, it also dramatically reduces the risk of defalcation while simplifying internal controls and bank reconciliations.

It is important for accountants and corporate treasurers to be aware that all bitcoin transfers are recorded in a public ledger and that transaction patterns may reveal the identity of an address. An astute competitor or investors could quickly develop a cash-flow statement from such information. For this reason, it is best practice to generate a new address for each transaction.

Bitcoins are stored in a digital wallet after they are received. The wallet can be cloud-based for mobile payments and browser access or stored on a local system to maximize security. Treasurers should be careful to divide funds into several different wallets stored on separate systems. Managers that would normally sign and countersign checks should similarly be entrusted with the passwords to prevent unauthorized payments.

Once the physical system is properly secured, the only potential threat is the password. Management should have a password policy that balances security with the risk of one person being responsible for an unrecoverable password. Internal control designers and auditors should consult with an I.T. specialist to ensure that the wallet is stored and backed up on encrypted drives attached to dedicated systems.

Similarly, audit teams should employ an I.T. specialist to verify the bitcoin balances held in wallets. Verification includes sending a traditional confirmation letter to a 3rd party wallet custodian and obtaining the balance from the block chain. Tools like Block Explorer make independently authenticating the existence of individual bitcoins straightforward and instantaneous. Control of the addresses themselves can be evidenced with walk-throughs as well as bitcoin transfers to and from an address controlled by the auditors.

After the amount of bitcoins at the balance sheet date has been established, the auditors need to verify that this amount is translated into the reporting currency pursuant to ASC 830-20-25. The currency translation from bitcoins to dollars is effectuated through an adjusting entry that contains the gains and losses reflecting changes in the exchange rate between bitcoins and dollars. This translation must also be done for receivables and payables the company expects to settle in bitcoins. The exchange rate used for measurement at the balance sheet date, called the current rate, can be observed on liquid markets like Mt. Gox.

Cash management with bitcoin is now finally entering the Internet Age: payments are processed around the clock, anywhere in the world, and with little to no transaction costs. We can expect that this disruptive innovation will transform the treasury function just as much as social media transformed marketing campaigns. Does your business accept bitcoin payments? How do you think internal controls and audit planning should adapt to this new digital currency?

Macroprudential Regulation: Moving Beyond Dodd-Frank & Basel III

Last semester I had the pleasure of taking Law for Finance with the renowned Professor Prentice. It was incredibly helpful to learn how our work as accountants flows through a regulatory framework that seeks to create a level playing field for companies issuing securities and their investors. As auditors we’re most familiar with Sarbanes-Oxley and GAAP/GAAS, but these are only a few pieces of the puzzle that contribute to the rational accumulation and allocation of capital so critical to economic growth.

It’s also important to look at what policymakers call “macroprudential regulation”. These are regulations which seek to mitigate the damage done by the emotional swings among financial intermediaries from exuberant optimism to irascible pessimism, also known as systemic risk or the boom-bust cycle. The Dodd-Frank Act was an important new addition to the macroprudential regulatory framework by requiring the trading of derivatives to be on exchanges and prohibiting banks from gambling with depositors’ money in financial markets. Accountants are instrumental in implementing these regulations and monitoring for continued compliance. Likewise, through the calculation of the Allowance for Loan and Lease Losses (ALLL), accountants must be familiar with the credit risk models mandated by Basel II, an international accord between central banks designed to minimize systemic risk.

During my Big 4 internship I examined credit risk models for a large retail bank to verify that their ALLL was properly calculated. This ALLL feeds into the next pillar of Basel II, capital adequacy standards that help the banking system through downturns and protect deposit insurers like the FDIC.  In light of the 2008 financial crisis, regulators made the capital adequacy guidelines more stringent with the introduction of Basel III. However, few are optimistic that this will prevent future economic bubbles.

Academics have argued that this patchwork of regulations around depository institutions is a case of the doctors treating symptoms instead of the underlying disease. In accounting terms, the disease is that depositors do not have an investing cash outflow when they deposit their money, whereas depository institutions have a financing cash inflow. No other transaction in the economy has this accounting asymmetry, which is commonly known as fractional reserve banking. Professor Jesús Huerta de Soto, from Rey Juan Carlos University in Spain, wrote a book in 2005 (PDF) detailing how this shaky accounting creates systemic risk in the banking system. Most recently, Michael Kumhof, a professor at Stanford University and one of the top economists at the IMF, published a paper (PDF) detailing how a financial system could simultaneously transition from fractional reserve banking to 100% reserves, reduce excessive leverage, and prevent the boom-bust cycle.

I had the honor of meeting Professor Kumhof at the Association for the Study of Peak Oil & Gas’ annual conference which was co-hosted by the University of Texas. He was optimistic that policymakers will come around to what is called the “Chicago Plan”, originally devised by a group of economists at the University of Chicago.

In a nut shell, the plan would have depository institutions finance their investing activities from private investors and loans from the government rather than lending out deposits. Deposits would be much like segregated accounts in a trading house or bailments; the bank is a custodian of the funds but is not allowed to lend them out. This would prevent excessive credit creation since banks would have to borrow real savings, much like a mutual fund or a securitization deal that issues bonds.

Perhaps the most fascinating aspect of the plan is that depository institutions in the United States would have to borrow 180% of GDP from the government to meet the 100% reserve requirement. This would mean that the Federal Government would have a negative level of net debt. Similarly, this would immediately solve the European sovereign debt crisis.

To prevent deflation, the government would have to create and spend new money at a rate of 2 or 3% per year, which would help reduce the budget deficit. This nominal money growth would be one aspect of macroprudential policy under the Chicago Plan. The amount and riskiness of credit creation would still be controlled by capital adequacy rules like Basel III and interest rates would be set by how much the government (or an independent central bank) charges financial institutions for additional liquidity needed to finance large productive investments.

Professor Kumhof estimates that changing the regulation of deposits would result in a 10% boost to GDP growth. This is why he is most optimistic that the Chicago Plan will, over the coming years, become a cornerstone of financial reform. Here is his presentation of the paper he published in August:

Accountants will play an important role in advising depository institutions with restructuring their balance sheet and revising their internal controls to reflect the new accounting treatment of deposits. That said, the greatest benefit for us will be that the manic instability of financial markets will be give way to steady real economic growth.

What benefits or drawbacks do you see from the Chicago Plan?