By Jeffrey D. Solomon, CPA, CVA, Partner

Levine, Katz, Nannis + Solomon, P.C.

Most likely, you won’t be surprised or think it unusual for your company’s financial statements to be scrutinized more closely this year as a result of the fear created by the accounting improprieties of companies such as Enron and WorldCom. A fear exists, justified or not, that financial statements do not reflect reality. The actions (or lack thereof) by management, their boards and their outside auditors have created a feeling of unrest throughout the United States. In fact, many of our clients' audit committees of the Board of Directors are much more aware of these risks and will be more intimately involved in the details of our audits than ever before. They are now analyzing management’s estimates and inquiring about the more "risky" areas that exist in the financial statements. It would seem that as the outside CPAs, we are spending much more time educating and informing these committees on how we got comfortable with our audits and conclusions. Where were they before? I don’t know. But, as accountants, our most important objective in preparing or auditing financial statements has always been to provide the reader with useful, clear and objective information about the company.

Obviously, one of the most scrutinized areas is revenue recognition. For technology companies, the rules have been more clearly focused in recent years by the issuance of certain FASB pronouncements and SEC and AICPA rulings. Discussions on reporting revenues at "gross" or "net", and whether revenue should be recognized or not, are commonplace today in preparing financial statements. Additionally, the SEC, has scrutinized its public companies’ policies and issued SAB No. 101, "Revenue Recognition in Financial Statements", which addresses revenue recognition for software/technology companies. This statement requires a company to meet four criteria before revenue can be recognized, including (1) pervasive evidence of an arrangement (documentation), (2) delivery has occurred or service has been rendered, (3) the price is fixed and determinable, and (4) collection is reasonably assured. In addition, a company must "unbundle" the revenue components of a sale and make sure each type of revenue is accounted for and handled separately, such as upgrade rights or maintenance costs. Companies need to consider these standards when establishing their sales policies and procedures. It is also critical that financial management be closely involved in the sales contract process, since contract provisions will affect revenue recognition.

It is not just revenue recognition that is being put under the microscope. Regulators and the users of financial information are also examining asset valuations. Two recent accounting pronouncements specifically address this issue and create additional complexity for accountants. SFAS 142, "Goodwill and Other Intangible Assets", requires companies to eliminate the amortization of goodwill, evaluate remaining useful lives for intangibles (i.e. trademarks, patents and licenses) each reporting period, and review goodwill for impairment at least annually. SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", requires that any long-lived asset be tested for recoverability when events or changes in circumstances indicate its carrying amount may not be recoverable. This test will generally require a determination of the future cash flows that the asset is expected to generate, compared to its carrying amount.

SFAS 144 applies to internally created computer software as well. Under existing standards, a company must establish technological feasibility before related costs can be capitalized. SFAS 144 will also require that companies review these capitalized costs for impairment under the provisions noted above. Clearly, the auditor has a much more difficult job in determining whether or not an asset has been impaired and what should be recorded in the financial statements.

The footnotes to your financial statement have become a short novel. They are getting much more detailed. Debt arrangements and equity transactions must give information about potential rights and possible commitments. Derivatives must be fully disclosed and accounted for and related party transactions, including officer loans or transactions with related sister/brother entities, must be described in detail, disclosing the gross amounts involved, the potential income or expense and the terms, as well as the balances due/owed as of the financial statement date.

Other business activities with unconsolidated limited purpose entities, or SPEs (special purpose entities) require special accounting treatment and disclosure as well. Stock option accounting is also a hot topic. Although not required, more and more companies are electing to expense stock options. Due to the fact that stock prices have recently tumbled, companies may choose to issue new grants of options to employees "in the money" and, at the same time, cancel old "out of the money" options. Beware, this situation will likely result in the need for current expense recognition in your income statement.

The complexity of preparing a financial statement in today’s ever-changing business world can be immense. There are sure to be more changes ahead for the accounting industry, as a result of intense public pressure and a new public accountability board that, with the SEC, can further accounting practices. You must make sure that your accounting firm has the expertise and resources to guide you through the multitude of complicated accounting standards. And please make sure that you, as the owner or management, take time to read and understand your financial statements, as well.

Jeffrey D. Solomon, C.P.A., C.V.A., is a Partner with the CPA/business consulting Firm of Levine, Katz, Nannis + Solomon, P.C. (LKNS), located on Route 128 in Needham, Massachusetts. Mr. Solomon helps to head the technology/emerging growth practice for the Firm. LKNS recently ranked as one of the top 25 largest accounting firms in Massachusetts in 2001 by The Boston Business Journal.