A full-scale audit provides a qualified CPA’s formal opinion on whether a company’s financial statements are in compliance with Generally Accepted Accounting Principles (GAAP). This type of report serves as a detailed and reliable snapshot of the business’s entire operations. But what if you, as lender, need specific, targeted information on a potential problem, or set of problems, that requires a quick response? Consider hiring a CPA to perform certain “agreed-upon procedures” (AUPs).
How do AUPs differ from audits?
An AUP engagement uses methods similar to those of an audit, but on a smaller and limited scale — and with no assurance on the part of the CPA. Although the American Institute of CPAs regulates both audits and AUP engagements, these two types of accounting services are actually quite different. When a CPA firm performs an audit, its client is the borrower. With an AUP engagement, the client is typically the lender — a fact that usually alleviates potential conflicts of interest.
Another key difference is that of responsibility. Audits require CPAs to provide a formal opinion on whether the company’s financial statements have been prepared in accordance with GAAP.
On the other hand, CPAs make no formal conclusions when performing AUPs. They simply act as “finders of fact.” It’s the client’s responsibility to draw conclusions based on the CPA’s procedures and findings.
What can a hypothetical example show us?
An AUP engagement can be used to identify specific problems that require immediate action. For instance, when Susan, an experienced lender, received the 2017 year-end financial statements for Kitchen Solutions, a kitchen remodeler and supplier, she felt like something wasn’t quite right. Inventory had grown substantially over the last three years and the company’s profit margin had deteriorated. Additionally, the borrower had nearly maxed out its $1 million line of credit.
Susan identified several options. She could call the credit line, thereby adding to the borrower’s problems. She could ask the borrower to upgrade from reviewed financial statements to audited financial statements. Or she could gather more information through an AUP engagement. Susan chose the last option and met with Kitchen Solution’s CPA to discuss her specific concerns.
They defined the scope of the engagement and selected the procedures to be performed. Specifically, Susan asked the CPA to independently evaluate the company’s inventory, including materials in the warehouse and jobs that were in progress. Then the CPA reconciled his physical inventory counts and the progress he observed on jobsites to what was recorded in the company’s accounting records.
When these procedures were completed, the CPA presented his findings, including any discrepancies, to Susan. From there, Susan and her supervisors at the bank decided on the next course of action, based on those findings.
What are some advantages?
AUPs boast several advantages over audits. AUPs can be performed at any time during the year — not just at year end. And because you, as lender, have the flexibility to choose only those procedures you feel are necessary, they can be cost-effective. So, if you have doubts or questions about a borrower’s financials, AUP engagements can resolve issues quickly and effectively.
In the case of Kitchen Solutions, the AUP engagement revealed several issues. First and foremost, the company’s controller, the owner’s 22-year-old son, was unfamiliar with percentage-of-completion accounting. So, the CPA provided some guidance to get the accounting records back on track. In addition, one of the company’s laborers had been pilfering materials, such as faucets, copper tubing and appliances, for his side business. Management was shocked by the findings of the AUP engagement and fired the dishonest worker.
How can you dig deeper?
If a red flag arises about any aspect of a borrower’s financial or business operations, an AUP engagement can help you, as lender, selectively investigate and identify issues that may benefit from immediate action. Engaging a CPA to perform an AUP engagement concerning a precarious borrower ultimately will help protect your loan portfolio.