• A financial statement audit evaluates whether a company’s financials are fairly presented in accordance with applicable accounting standards. An integrated audit also includes an assessment of internal controls over financial reporting.

• Common audit mistakes include late or missing provided-by-client (“PBC”) requested submissions, insufficient or unreliable documentation that hinders effective risk assessment, weak internal and IT controls, and errors in applying accounting standards.

• Preparing early, understanding the internal control environment, and training staff can help your company provide relevant and reliable information, which is critical for assessing audit risk and demonstrating compliance with applicable laws and regulations.

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Financial statement audits are a critical checkpoint for companies, stakeholders, and investors. While the process has its limitations, the goal of an audit is to provide reasonable assurance that the company’s financial statements are free of material misstatement (whether due to error or fraud).

However, the audit process is only as effective as the broader environment supporting it — including timely and reliable financial information, a well-resourced accounting function, effective oversight by the board or audit committee, and a clear understanding of the entity’s operations and the regulatory landscape of its industry.

Many organizations approach audit season underprepared or unaware of the common pitfalls and complex or nontraditional transactions that can delay the process, increase costs, or raise compliance concerns.

In this article, we explain the financial statement audit process, common mistakes we see companies make during external audits, and best practices that lay the foundation for a smoother audit experience.

Understanding Financial Audits

During a financial statement audit, an independent registered public accounting firm follows generally accepted auditing standards (GAAS) and assesses your company’s financial records, transactions, and reporting processes. Independent auditors gather and evaluate relevant and reliable evidence to determine whether the financial statements are presented fairly — following generally accepted accounting principles (GAAP), international financial reporting standards (IFRS), or another applicable financial reporting framework.

The process typically follows these phases:

1. Audit planning and risk assessment: External auditors work closely with company management to understand the operations of the business, identify significant risk areas, and develop an audit strategy that is unique to the organization.

2. Internal control evaluation: The auditor assesses the design and operating effectiveness of internal controls over financial reporting, often through walkthroughs and targeted testing of key controls. The results of this evaluation directly inform the auditor’s risk assessment and the nature, timing, and extent of substantive audit procedures. In an integrated audit, this process also includes gathering information to develop an opinion on the effectiveness of internal controls. Auditors pay particular attention to information technology general controls (ITGCs), which are foundational to the reliability of automated processes and system-generated reports. If the auditors identify material weaknesses, they may need to disclose them in the financial statement footnotes or the auditor’s report (depending on the severity and context).

3. Substantive testing: The auditor gathers evidence by examining transactions, account balances, and disclosures through sampling, confirmations, and recalculations. Strong internal controls impact the audit team’s risk assessment and may allow the team to reduce the amount of substantive testing required.

4. Conclusion and reporting: The auditor drafts the opinion letter, communicating findings to management and those charged with governance.

10 Common Types of Mistakes Made in Public Audits

Despite best intentions, many organizations encounter issues during the annual audit that delay timelines, increase costs, or raise red flags. Here’s a look at some common mistakes and why they matter:

1. Inadequate Documentation of Internal Controls

Many companies fail to maintain sufficient documentation around their internal control procedures. This lack of documentation makes it difficult for auditors to understand and — if necessary — test the design, implementation, and effectiveness of key controls. As a result, auditors may need to perform additional walkthroughs or expand their substantive testing — potentially increasing audit costs and timelines.

For publicly traded companies, this issue can have additional implications under Section 404 of the Sarbanes-Oxley Act (SOX). Section 404(a) requires management to assess and report on the effectiveness of internal control over financial reporting (ICFR). Section 404(b) requires the independent auditor to attest to and report on management’s assessment for accelerated filers.

If the auditors deem internal controls ineffective, management must disclose material weaknesses in its annual filing with the SEC. This can affect investor confidence, internal resource allocation, and external perceptions of the company’s governance. These findings may also place added pressure on the accounting team to remediate deficiencies under tight deadlines while still managing the financial close and reporting cycle.

2. Late or Incomplete Audit PBC Requests

Prior to audit fieldwork, the audit team sends a “provided by client” (PBC) list to management outlining the documents and financial data auditors need. Submitting incomplete or delayed items stalls fieldwork and may increase audit fees.

3. Improper Revenue Recognition

Misapplying Accounting Standards Codification (“ASC”) 606 or lacking support for revenue transactions — including cutoff periods around year-end — is a recurring audit issue. Companies often struggle to identify and document performance obligations in their contracts with customers and allocate the transaction price appropriately among those obligations.

These issues are especially common in arrangements involving bundled products or services, where the timing and pattern of revenue recognition may differ by deliverable. Inadequate documentation or inconsistent application of these principles can lead to audit adjustments or the need for expanded testing.

4. Weak IT General Controls

Deficiencies in ITGCs — such as user access management, change management, physical security of IT systems, intrusion detection, and system backup and recovery processes — can compromise the integrity of financial reporting systems and result in control deficiencies or audit findings. Increasingly, cybersecurity risk is also a critical area of concern, particularly as companies face heightened exposure to data breaches and unauthorized access.

In cases where companies outsource key processes or use cloud-based platforms that affect financial reporting, it’s important to obtain and evaluate SOC 1 Type 2 reports from service providers. These reports help assess whether the third party’s control environment supports reliable financial reporting. Failing to obtain or properly review these reports can result in audit scope limitations or the need for additional procedures.

5. Errors in Lease Accounting

ASC Topic 842  introduced significant changes to lease accounting — increasing complexity in how companies identify, measure, and disclose lease arrangements. Common mistakes include misclassifying leases, failing to identify embedded leases in service or supply agreements, and incorrectly applying accounting treatment for lease modifications and remeasurement events.

Errors can also arise in calculating the right-of-use asset and lease liability, selecting the appropriate discount rate, and preparing the required footnote disclosures. These issues can lead to material misstatements and require substantial audit follow-up — especially when a company maintains a large or decentralized lease portfolio.

6. Inaccurate or Unsupported Estimates

Many key areas in financial reporting rely on management’s judgment, especially when it comes to technical estimates such as goodwill impairment, valuation of long-lived assets, fair value of debt or equity instruments, and contingent liabilities. These estimates require a disciplined process of identifying the appropriate valuation method, documenting key assumptions, and evaluating both supporting and contradictory information.

Errors often arise when companies fail to update assumptions based on current market conditions, skip critical steps in the impairment testing process, or use inconsistent inputs across related estimates. A lack of documentation or transparency around the basis of these estimates raises audit concerns and can result in restatements or material weaknesses in internal controls over financial reporting.

7. Failure to Perform Timely Reconciliations

Account reconciliations help ensure accuracy and reliability in financial statements by comparing information in your financial records with third-party support — such as bank statements or loan documents. Delayed or inconsistent reconciliations of bank accounts, intercompany balances, and key general ledger accounts can indicate larger issues with the financial close process.

8. Insufficient Segregation of Duties

In smaller or rapidly growing companies, it’s common for individuals to handle multiple steps within a transaction cycle — such as initiating, approving, and recording transactions. This increases the risk of errors and intentional misstatements.

A lack of proper segregation of duties introduces risk at the process level and signals broader weaknesses in the company’s control environment (a key component of internal control frameworks). When auditors identify these gaps, they may reduce their reliance on controls and expand the scope of substantive testing — increasing the time and resources required for the audit and potentially causing delays.

Strengthening segregation of duties supports the integrity of financial reporting and reinforces a culture of accountability.

9. Poor Communication Between Financial Reporting and Operational Teams

A disconnect between accounting and other departments — including operations, legal, and procurement — can result in incomplete or misclassified transactions and missed disclosures. This issue is especially common in areas like inventory management, project accounting, and deferred revenue recognition.

It can also impact the identification and disclosure of related party transactions, legal contingencies, and other matters that require input from departments outside of finance. For example, if legal teams do not communicate the existence of pending or threatened litigation, the accounting team may fail to properly record or disclose a loss contingency — resulting in audit findings or misstatements. Clear, documented communication channels between departments are critical for complete and accurate financial reporting.

10. Lack of Readiness for New Accounting Standards

Companies often underestimate the effort required to adopt new standards — such as those related to segment disclosures (ASU 2023-07), income tax disclosures (ASU 2023-09), and business combinations (ASU 2023-05). Late-stage implementation leads to rushed adjustments and audit stress.

Fortunately, many of these issues are avoidable through proper preparation, communication, documentation, and adherence to regulations.

How to Prepare for a Smoother Audit Season

Here are a few best practices to reduce audit risks and improve efficiency in the financial statement reporting process:

• Start early: Preparing for the year-end audit should begin months in advance. Develop and assign internal timelines for PBC deliverables, reconciliations, and close procedures.

• Assess and document internal controls: Clearly document your control procedures. Perform regular controls testing throughout the year and update them to reflect changes in processes or personnel at year-end.

• Invest in training: Your accounting and finance teams should stay current on new standards and audit requirements to reduce the risk of misapplication.

• Leverage technology thoughtfully: Use financial close and compliance tools to streamline workflows, manage documentation, and maintain audit trails.

• Conduct a pre-audit walkthrough: Reviewing key areas of risk, estimates, and controls ahead of time enables your company to address issues before auditors arrive.

• Foster collaboration: Create open channels of communication between auditors, internal accounting functions, IT, operational departments, and the audit committee to minimize misalignment. Collaboration between external auditors and the internal audit team can also be beneficial. However, under the Public Company Accounting Oversight Board’s new QC 1000 standards, internal auditors are considered “other participants” in the audit, which may affect how their work is evaluated and used. Companies should understand the implications of this designation and ensure internal audit activities are properly documented and aligned with audit objectives.

Be Proactive to Prevent Audit Mistakes Before They Happen

A successful audit is more than a compliance milestone. It’s a sign of sound corporate governance. By recognizing common mistakes and addressing them proactively, you can support more accurate and timely financial statements, reduce audit fatigue in your team, and build trust with stakeholders and regulators.

How MGO Can Help

Our Audit and Assurance team supports public companies through every stage of the audit lifecycle — from preparing internal controls documentation to navigating complex accounting standards and responding to auditor inquiries. Our professionals bring deep industry experience to help clients identify risks and streamline financial reporting processes. If you’re approaching audit season or facing challenges with audit readiness, reach out for guidance tailored to your specific needs.

The post 10 Common Public Audit Mistakes That Could Delay Your Timeline appeared first on MGO CPA | Tax, Audit, and Consulting Services.

• Expanding through contract manufacturing opens opportunities for your cannabis or hemp brand — but also brings complex financial and regulatory challenges.

• Stay ahead of tax risks by aligning your operations with both federal and state compliance rules.

• Strengthen your contracts and tracking systems to keep royalty payments accurate and transparent.

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Contract manufacturing arrangements can accelerate brand growth for cannabis and hemp companies, but they present complex tax, accounting, and compliance challenges. To protect financial integrity and valuation, companies must:

• Recognize and present revenue in a manner consistent with accounting standards and investor expectations. 

• Structure operations to preserve favorable tax status — especially for cannabis intellectual property (IP) entities avoiding Internal Revenue Code (IRC) §280E. 

• Monitor multi-jurisdictional tax nexus triggered by licensing activity. 

• Implement clear, enforceable, and regularly reconciled royalty calculation methods.

1. Revenue Recognition and Financial Presentation

Accounting Considerations

In contract manufacturing models, brand owners typically license IP to local manufacturers, who produce and distribute products under the brand name in exchange for royalty payments. Under U.S. generally accepted accounting principles (GAAP), this licensing arrangement should be accounted for as royalty income — distinct from product sales revenue recorded by manufacturers.

• Licensed operators: Recognize product sales with corresponding inventory and cost of goods sold (COGS).

• IP companies: Recognize only royalty income, without inventory or COGS.

For both cannabis and hemp operators, proper classification ensures financial statements reflect contractual entitlements — not hypothetical retail values — which can withstand both audit and investor due diligence.

Investor and Valuation Impact

Royalty-based models often report lower top-line revenue than direct sales, potentially influencing valuation multiples in capital raises. Your company can mitigate this perception by:

• Presenting retail market performance data as supplemental (non-GAAP) information.

• Demonstrating brand market share, pricing strength, and geographic expansion.

• Maintaining accounting integrity by ensuring GAAP statements reconcile with contractual royalty terms.

Sophisticated investors prioritize accuracy and contractual consistency over inflated revenue optics.

2. Tax Positioning and Regulatory Compliance

Cannabis: Preserving Non-280E Status

Cannabis IP holding companies that do not sell THC products directly and operate as an independent trade or business are generally not subject to IRC §280E and enjoy a significantly lower federal tax burden than state-licensed cannabis operators. However, maintaining this advantage depends on operational alignment between a company’s tax position and accounting presentation.

• Revenue must be recorded as royalty income, not product sales.

• General ledger (GL) accounts and financial statement categories must reflect licensing activity, not manufacturing operations.

Misalignment — such as recording product sales revenue while claiming 280E exemption — can trigger IRS scrutiny.

Hemp: Avoiding Misclassification

While hemp companies are generally outside §280E due to the 2018 Farm Bill, misclassification of revenue streams can still lead to incorrect tax filings, higher tax liabilities, or state compliance issues.

Proactive Compliance Measures

• Regular review of GL account descriptions and revenue categories.

• Documentation that ties reported revenue directly to licensing contracts.

• Periodic confirmation that financial presentation supports intended tax treatment.

For cannabis brands, this is critical to preserving 280E protection; for hemp, it safeguards proper business classification and tax outcomes.

3. State Tax Nexus and Multi-Jurisdictional Compliance

Income Tax Nexus

Licensing IP can create state income tax nexus without physical presence. States differ in sourcing rules — some focus on where products are consumed, others on where IP is exploited. Cannabis companies must navigate cannabis-specific rules layered over general sourcing provisions, while hemp companies contend with varied CBD/hemp regulations.

Sales Tax Considerations

Licensing arrangements may create sales tax obligations or require exemption certificate documentation. Hemp brands selling directly to consumers are typically subject to standard sales tax rules in each state.

Risk Mitigation

• Conduct nexus analysis regularly across all jurisdictions where products are sold.

• File returns in nexus states even if no tax is due.

• Document exemptions and monitor legislative changes.

Factor in marketing, contractor activity, and promotional events in nexus determinations.

4. Royalty Calculation and Documentation

Common Dispute Areas

Royalty disagreements often arise over:

• Gross versus net sales bases.

• Treatment of COGS, taxes, and regulatory fees.

• Allocation of shared costs (utilities, equipment, marketing).

• Returns, discounts, and promotional allowances.

Industry-Specific Nuances

• Cannabis: Must incorporate jurisdiction-specific excise taxes and licensing fees into formulas.

• Hemp: May face cost allocation issues related to compliance testing and certification.

Best Practices

• Include pro forma royalty calculations in contracts, tested with realistic production and pricing scenarios.

• Obtain written acknowledgment of the agreed methodology.

• Specify all potential chargebacks, shared costs, and allocation rules.

• Maintain separate royalty tracking systems.

• Perform periodic reconciliations between contractual formulas and actual payments to identify discrepancies early — an emerging industry best practice.

• Consider independent accounting reviews to validate partner-reported figures.

• If the manufacturer and the IP company are related parties, contracts should be reviewed in relation to tax transfer pricing rules that require arm’s length and market rate terms.

Position Your Brand for Contract Manufacturing Success

Contract manufacturing can offer compelling growth opportunities for your cannabis or hemp brand. The key to sustainable success lies in disciplined revenue presentation, strong tax positioning, proactive compliance, and robust royalty oversight.

By aligning accounting standards with tax objectives, maintaining transparent investor communications, and reconciling royalties regularly, your company can position itself to expand with confidence while minimizing regulatory and financial risk.

How MGO Can Help

We help cannabis companies across the U.S. to navigate complex accounting and tax challenges — including contract manufacturing arrangements. Whether you’re structuring royalty agreements, managing state tax compliance, or preparing for a potential audit, our dedicated Cannabis practice can help you grow smarter. Reach out to our team today to learn how we can support your goals.

The post 4 Critical Tax and Accounting Considerations for Cannabis and Hemp Contract Manufacturing Arrangements appeared first on MGO CPA | Tax, Audit, and Consulting Services.

• Accurate accounting helps startups attract investors, access credit, and make informed business decisions. 

• Implementing a scalable accounting system early supports growth and compliance. 

• Outsourcing accounting can save time, reduce risk, and provide strategic financial advice as your startup grows. 

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Starting a business is exciting, but it’s easy for accounting to fall to the bottom of the to-do list in the rush to develop products and build a customer base. 

Laying a strong financial foundation early on is crucial for long-term viability and growth. Whether your startup is bootstrapped or venture-backed, sound accounting practices help you track performance, attract investors, access credit, and comply with tax rules. 

Why Accounting for a Startup Company Is Necessary

Startups face a unique set of financial pressures. Many operate with limited resources while attempting to scale quickly. In these circumstances, accurate and timely financial reports are critical for making informed decisions, managing cash flow, and demonstrating fiscal responsibility to potential lenders or investors. 

Investors may require financial statements if you’re looking for venture capital or preparing for Series A and beyond. Investors want to see a clear picture of burn rate, runway, margins, and revenue growth. Banks and other lenders typically require financial statements to underwrite loans or lines of credit. 

Beyond external stakeholders, accounting helps internal teams understand what is working and what isn’t. It shows your true customer acquisition cost (CAC), identifies where you can improve margins, and helps uncover early signs of inefficiency and waste. 

How to Set Up Accounting for Your Startup

Follow these steps to establish a solid accounting foundation for your startup’s financial health:

Step 1: Choose an Accounting Method 

One of the first decisions you need to make is whether to use cash basis or accrual basis accounting. 

• Cash accounting records income when you receive cash and expenses when you pay them. This method is simple and often suitable for early-stage startups with minimal inventory or accounts receivable. However, it can give a misleading picture of profitability — especially if there are large timing differences between revenue and expenses. 

• Accrual accounting records income when you earn it and expenses when you incur them, regardless of when cash changes hands. This approach provides a more accurate view of financial performance, and investors generally prefer it. 

Many startups begin using cash basis accounting but switch to accrual accounting as they mature. Whichever method you choose, consistency supports comparability and compliance. 

Step 2: Open Business Bank Accounts 

One important yet often overlooked step in setting up an accounting system is opening separate business bank accounts and credit cards.  

Mixing business and personal transactions in the same account makes it tough to track income and expenses. Using a separate bank account simplifies bookkeeping and streamlines monthly reconciliations. 

Using a business bank account to pay vendors, receive payments, and manage cash flow conveys professionalism to clients, suppliers, and financial institutions. It also provides a clearer audit trail when getting audited financial statements for investors, lenders, and regulators. 

Similarly, a dedicated business credit card can help establish a credit history for your company, help you track expenses by category, and potentially earn rewards while keeping personal spending separate. 

Taking this step early lays the groundwork for organized and transparent financial management. 

Step 3: Use an Accounting System 

Implementing reliable accounting software early on helps you avoid costly errors and inefficiencies down the road. Your accounting software should support basic accounting tasks such as: 

• Recording financial transactions — including sales, purchases, payroll, etc. 

• Reconciling bank accounts 

• Paying bills 

• Managing accounts payable and receivable 

• Expense tracking by category or project 

• Generating financial reports — including a balance sheet, profit and loss (P&L) statement, and cash flow statement 

For most startups, cloud-based accounting software is the logical choice. Platforms such as QuickBooks Online, Xero, or Sage Intacct offer scalability, automation, and access for remote teams. They also integrate with other tools —, including payroll, customer relationship management (CRM) systems, inventory management, and e-commerce platforms. 

Also, consider who will be responsible for entering data, approving payments, and reviewing reconciliation and other financial reports. Even with automation, you need oversight to maintain accuracy and prevent fraud. 

Step 4: Plan for Tax Preparation 

Taxes are often an afterthought for startups, but early planning prevents surprises and supports smoother compliance. 

Here are a few areas to address early on: 

• Business structure: The choice between sole proprietorship, LLC, partnership, S corporation, or C corporation impacts how you pay taxes. It also affects eligibility for certain deductions and credits. 

• Sales tax nexus: Startups selling goods or services across state lines may have sales tax obligations in multiple jurisdictions. It’s crucial to understand where and when to collect and remit sales taxes. 

• Payroll taxes: Hiring employees triggers payroll tax filing and remittance requirements. Misclassifying employees as independent workers or missing deadlines can result in penalties. 

• Estimated taxes: You need to start making quarterly estimated tax payments as soon as the business starts generating profits. 

• Tax deductions and credits: Startups involved in product development may be eligible for incentives, such as the research and development (R&D) tax credit. This credit can offset federal and state income taxes and, in some cases, payroll tax liabilities. However, it’s important to document qualifying activities and costs to claim these benefits. 

Should Your Startups Outsource Accounting? 

While many business owners attempt to handle bookkeeping themselves in the early stages, outsourcing is a strategic decision that saves time and reduces risk. 

Outsourced accounting services range from recording transactions and preparing monthly reconciliations to controller or CFO-level oversight. For startups with limited staff, this approach provides access to financial guidance without the cost of building an in-house team. 

Outsourcing is especially valuable when: 

• Founders are unfamiliar with generally accepted accounting principles (GAAP) or financial reporting 

• The business has multiple revenue streams or international transactions 

• Investors or lenders require formal financial statements 

• Compliance and tax filing deadlines are approaching 

Before engaging an external accounting services provider, evaluate their process, technology stack, and service model. Look for a professional who is experienced with early-stage companies in your industry and one who can scale services as your needs evolve. 

How MGO Can Help 

Accounting is the foundation for making strategic decisions and building financial credibility. Startups that invest early in solid accounting practices are better equipped to manage growth, appeal to investors, and handle their tax obligations. 

MGO helps founders build a strong accounting foundation — from selecting an accounting method and accounting software to managing outsourced accounting functions and preparing for tax obligations. Our team understands the unique challenges startups face and provides practical, reliable support to help you reach your business goals. 

Reach out today to learn how we can support your business’s financial health from day one. 

The post Accounting Tips for Startups: Setting Up Financial Systems for Success  appeared first on MGO CPA | Tax, Audit, and Consulting Services.

• Financial statements offer insight into a company’s operations, performance, and position.

• There are four main types of financial statements — balance sheet, income statement, cash flow statement, and equity statement — and each serves a unique purpose.

• Interpreting financial statements requires an understanding of basic accounting principles and financial ratios.

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Understanding financial statements is a fundamental skill for business owners, investors, and anyone who wants to make informed financial decisions about a company or organization. These reports provide an overview of an entity’s financial health and help stakeholders measure profitability, liquidity, cash flow, and long-term viability.

Whether you’re running a small business or deciding where to invest, knowing how to read and analyze financial statements can help you evaluate performance and make smarter choices. This guide covers the essential components of financial statements and how to interpret them.

What Is a Financial Statement?

Financial statements are standardized reports that provide a snapshot of an entity’s financial position, performance, and cash flows. They offer insight into how the company generates revenue, spends money, and manages its resources.

Several different stakeholders use financial statements — including business owners and executives, investors and lenders, government agencies, employees and unions, and financial analysts and advisors.

There are several methods for preparing financial statements. In the United States, most large companies follow Generally Accepted Accounting Principles (GAAP), while large companies in other countries follow International Financial Reporting Standards (IFRS).

For smaller companies, GAAP and IFRS may be overly complex and expensive to implement and maintain. Fortunately, there are simpler alternatives. These are known as “other comprehensive basis of accounting“, or OCBOA.

OCBOA includes:

• Cash or modified cash basis

• Income tax basis

• Regulatory basis

Types of Financial Statements

There are four primary types of financial statements, each serving a distinct purpose. Let’s look at each of these four statements in more detail:

Balance Sheet

The balance sheet, also known as “the statement of financial position”, provides a summary of a company’s financial position at a specific point in time. It follows the fundamental accounting equation:

Assets = Liabilities + Equity

Assets are the things a company owns — including cash, inventory, and property. Liabilities are what it owes to others — including accounts payable and loans. Equity is the value belonging to the company’s owners after subtracting the book value of liabilities from assets.

A healthy balance sheet demonstrates strong liquidity, indicating the ability to meet short-term obligations and manage debt.

Income Statement

The income statement is also called a profit and loss statement (P&L). It shows the company’s revenues and expenses over a specific period — typically monthly, quarterly, or annually. The basic formula of the income statement is:

Net Income = Revenue – Expenses

This financial statement highlights the revenue a company earns, expenses like cost of goods sold (COGS) and operating expenses, and shows the company’s net income or net loss.

This report helps assess profitability and performance over time.

Cash Flow Statement

The cash flow statement tracks the inflow and outflow of cash in three main areas:

1. Operating activities: Cash from sales and payments to suppliers

2. Investing activities: Buying equipment, selling assets

3. Financing activities: Taking out loans, repaying debt

Unlike the income statement, which can include non-cash items like depreciation, the cash flow statement focuses solely on cash coming into and going out of the business. Understanding the amount of cash on hand can help you assess liquidity and solvency.

Statement of Changes in Equity

The statement of changes in equity (also known as the statement of owners’ equity or statement of shareholders’ equity) explains changes in the company’s equity over a reporting period.

The general formula for this financial statement is:

Beginning Equity + Net Income – Dividends +/- Other Changes = Ending Equity

While people tend to overlook the statement of changes in equity, it provides valuable insights into how the company retains or distributes profits.

How to Read Financial Statements

Reading financial statements effectively means looking beyond the numbers. Here’s a step-by-step breakdown of how to read these reports:

Step 1: Start with the Income Statement

The income statement is often the best starting point because it shows how much money the company brought in and how much it spent over a given period.

Begin by looking at total revenue. Has it grown or declined compared to previous periods? Next, review the major expense categories — including cost of goods sold (COGS), operating expenses, and interest. See how they impact profitability.

Net income, located at the bottom of the statement, indicates whether the business ended the period in the black (i.e., it generated a profit) or in the red (i.e., it incurred a loss).

For additional insight, calculate profitability margins — like gross margin or net profit margin — to understand how efficiently the company converts revenue into profit.

Step 2: Review the Balance Sheet

Next, take a look at the balance sheet — which offers a snapshot of assets, liabilities, and equity at a specific point in time.

Begin by examining current assets and current liabilities to assess the company’s liquidity. Does the company have enough resources to cover short-term obligations? Next, look at long-term liabilities and total equity to understand the business’s capital structure.

A strong balance sheet has a healthy ratio of assets to liabilities, manageable debt levels, and a solid base of retained earnings or shareholder equity.

Step 3: Analyze the Cash Flow Statement

The cash flow statement shows how cash actually moves through the business — critical information for assessing liquidity and solvency.

Focus first on cash from operating activities. Ideally, it should be positive and sufficient to sustain day-to-day operations. Next, review cash from investing activities to understand how the company allocates cash for growth — such as purchasing equipment or investing in new ventures. Finally, consider financing activities to know how the business manages debt, issues stock, or pays dividends.

Even profitable companies can face financial trouble if their cash flow is weak.

Step 4: Review the Statement of Changes in Equity

For the statement of changes in equity, look at how different equity accounts changed over the accounting period. Did equity grow from net income or did the owners have to contribute more capital or issue additional stock to make ends meet?

Does the company keep profits in retained earnings, or pay them out to owners in the form of dividend distributions? Tracking changes in retained earnings reveals whether the business is reinvesting profits or returning value to shareholders.

Step 5: Use Ratios for Deeper Insight

After reviewing the individual statements, use financial ratios to compare performance over time or against industry benchmarks.

Some useful financial ratios include:

• Current Ratio = Current Assets / Current Liabilities (measures liquidity)

• Debt-to-Equity Ratio = Total Liabilities / Shareholder Equity (measures how leveraged the company is)

• Net Profit Margin = Net Income / Revenue (measures profitability)

Compare these ratios across periods and against industry benchmarks. You can find benchmarks for your industry through industry associations or peer networks, online resources such as BizStats, or by consulting with an advisor.

How MGO Can Help

Whether you’re leading a business, evaluating stock market investments, or managing your personal finances, understanding financial statements helps you make more informed financial decisions.

However, compiling and interpreting the numbers isn’t always straightforward. That’s where MGO comes in. Our professionals work closely with business owners and leaders to prepare financial statements and interpret the financial data in context. We can help you connect the dots between reporting and real-world decisions.

If you’re ready to get more from your financial statements or just need help making sense of what you’re seeing, reach out to our team today.

The post Understanding Financial Statements: The Complete Guide for Businesses and Individuals appeared first on MGO CPA | Tax, Audit, and Consulting Services.

• A new Accounting Standards Update requires public companies to provide more detailed expense disclosures in their financial statements.

• Implementing these changes may require modifications to the chart of accounts and adjustments to financial reporting systems.

• Companies should get a head start assessing whether current accounting systems can support the required disclosures and make necessary upgrades.

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In response to persistent calls from investors for enhanced transparency in financial reporting, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2024-03, Income Statement – Reporting Comprehensive Income – Expense Disaggregation Disclosures (Subtopic 220-40): Disaggregation of Income Statement Expenses (DISE). This update introduces a new layer of financial statement disclosures, requiring companies to adjust how they collect and report financial data.

Subtopic 220-40’s New Disclosure Requirements

The finalized ASU requires public companies to provide additional details about specific expense categories in financial statement disclosures.

Currently, companies can consolidate several expense line items into broad categories on income statements. For example, line items like “cost of goods sold,” “cost of sales,” and “selling, general, and administrative expenses” can comprise various direct and indirect costs of producing and selling a company’s goods and services, as well as overhead and administrative costs unrelated to production and sales. This lack of transparency makes it harder for investors, lenders, and other financial statement users to assess the company’s performance.

Subtopic 220-40 requires organizations to disclose (in a tabular format) amounts recognized in each of the following relevant expense captions:

• Purchases of inventory using the expense or cost-incurred approach

• Employee compensation

• Depreciation

• Intangible asset amortization

• Depreciation, depletion, and amortization (DD&A) recognized from oil and gas-producing activities

In addition, companies must provide additional details about inventory and manufacturing expenses, including:

• Inventory purchased

• Employee compensation related to manufacturing

• Depreciation and amortization of manufacturing assets

• Costs capitalized to inventory and manufacturing expenses

• Changes in inventory balances

• Other items used to reconcile costs incurred to expenses recognized

• How the company defines “other manufacturing expenses”

Practical Implications for Public Companies

At first glance, providing more details on expenses might seem simple. However, implementing these changes can become complicated quickly. You may need to reconsider how you categorize expenses, modify your chart of accounts, and evaluate whether your financial systems can extract and present the necessary information.

Some considerations include:

• Accounting system capabilities: Your current systems may not be configured to capture expense details at the required level of granularity. Evaluate whether your general ledger software and reporting tools can generate the necessary disclosures or if they’ll need modifications.

• Adjustments to reporting packages: Review whether your existing financial reporting packages can accommodate these new requirements.

• Audit readiness: The enhanced level of detail required in financial disclosures means auditors will focus on total expense amounts and how those expenses are disaggregated. Make sure you allow enough time to align your internal reporting with the new requirements so your internal and external audits will go smoothly.

• Training and internal processes: Team members responsible for financial reporting will need training on new data collection and reporting processes.

• Industry-specific considerations: The requirements apply broadly to all public companies, but the impact varies by industry. Your company should analyze which line items are relevant to your operations and adjust reporting accordingly.

ASU 2024-03’s Scope and Effective Date

The updated requirements apply to all public companies, although some expense categories may not be relevant depending on your industry. ASU 2024-03 is effective for fiscal years beginning after December 15, 2026, and interim periods beginning after December 15, 2027. Early adoption is permitted.

Because the new disclosures are required for annual and interim reporting periods, you cannot simply address these disclosures at year-end. You need to ensure your accounting systems can support the level of detail required for these disclosures throughout the year.

Preparing for Implementation

Adapting to the new reporting standards requires advance planning and preparation. Begin by conducting a gap analysis to determine whether your current financial systems can support the new disclosures. Reach out to your IT team and other advisors as soon as possible if you need modifications to facilitate a seamless transition.

Other steps you may need to take include:

• Review the detailed FASB guidance to determine the specific disclosures required.

• Assess internal data collection processes to make sure you’re capturing all necessary expense details.

• Engage with internal and external auditors to discuss expectations and potential challenges.

• Test reporting changes in advance to identify and resolve issues before compliance deadlines.

• Monitor ongoing compliance to ensure you’re prepared to meet interim reporting obligations.

How MGO Can Help

The changes introduced by the FASB’s finalized ASU will improve financial statement transparency, but they also present challenges for companies that are unprepared. Begin your implementation efforts now with planning, system updates, training, and allowing time to make adjustments and avoid last-minute compliance struggles. By proactively addressing these changes, you can minimize disruptions and keep your financial statements clear, accurate, and compliant.

If you have questions about Subtopic 220-40, contact us today to connect with professionals who can help.

The post FASB ASU: Disaggregating Income Statement Expenses appeared first on MGO CPA | Tax, Audit, and Consulting Services.

Much like a traditional CPA firm can provide different types of services related to an entity’s financial statements, i.e., audit, review, or compilation, based on need, when government agencies are considering an independent evaluation of performance of their programs or operations, the CPA firm’s advisory or consulting arm can step in and offer a number of engagement types based on the agency’s unique needs: consulting services engagements, attestation engagements (e.g., agreed-upon procedures), and performance audits. It all depends on if, and at what level, assurance is needed. The primary driver of what type of product should be considered is typically based on, for instance, issue complexity, taxpayer concerns or expectations, statute requirements, or increased need for transparency on the efficiency and effectiveness of operations. While the driver of the engagement may differ, time constraints and budget are also determining factors.

The primary focus of this article is to discuss the differences of the three aforementioned types of engagements — consulting services, agreed-upon procedures, and performance audits — and to provide guidance when a performance audit might be an option.

It is important to identify the differences between (1) performance audits, (2) consulting services engagements, and (3) agreed-upon procedures attestation engagements. On numerous occasions throughout my government service career and also while serving clients, questions have come up regarding the objectives sought, the scope of the engagement, and the engagement type when considering an evaluation of performance for a particular program or area of operations. Each of these engagements differ in purpose and reporting requirements, as well as potential cost, as shown below in Figure 1.0. These engagements are governed by different standards, formal reports are not always required for each, and independence is not always required (i.e., consulting services).

Performance Audits Defined

Performance audits are defined as engagements that provide objective analysis, findings, and conclusions to assist management and those charged with governance and oversight to, among other things, improve program performance and operations, reduce costs, facilitate decision making by parties with responsibility to oversee or initiate corrective action, and contribute to public accountability. *1

Furthermore, GAGAS states that management and officials of government programs are responsible for providing reliable, useful, and timely information for transparency and accountability of these programs and their operations. Legislators, oversight bodies, those charged with governance, and the public need to know whether (1) management and officials manage government resources and use their authority properly and in compliance with laws and regulations; (2) government programs are achieving their objectives and desired outcomes; and (3) government services are provided effectively, efficiently, economically, ethically, and equitably. *2

Agreed-Upon Procedures (AUP)

Based on my experience, it usually comes down to identifying a few factors that determine the engagement. First, the agency must determine the purpose and scope of the work, specifically what questions they would like to have answered. These questions can be broad or very narrow. For example, in an AUP, management may make an assertion about whether a subject matter is in accordance with, or based on, established criteria that is the responsibility of a third party and hires a CPA to add credibility to that assertion by performing specific procedures to test compliance with the criteria. If an agency needs to know something very specific and wants an independent party to perform specific procedures and tell them what was found, then an AUP is appropriate. However, an AUP report does not provide recommendations, an opinion, or conclusion about whether the subject matter is in accordance with, or based on, the criteria, or state whether the assertion is fairly stated. While the agency may want to use an AUP, some key steps that are taken in consulting engagements and performance auditing, such as planning, are not required in an AUP engagement. Also, risk is not assessed in developing the scope, nor does the auditor use a risk-based approach, which is required in a performance audit. Finally, in an AUP, auditors do not perform sufficient work to be able to develop elements of a finding or provide recommendations.

1 See Paragraph 1.21 of GAGAS.
2 See Paragraph 1.02 of GAGAS.

Consulting Services Engagement vs. Performance Audit

For a consulting services engagement or performance audit, the initial questions are then turned into the objectives of the engagement. If the agency wants an objective review of operations or a program to assist them in making decisions, for example, to assess the management of specific funds, and wants findings and recommendations to improve operations, then the agency should discuss the options of a consulting services engagement or a performance audit. From here, the decisions are truncated. The agency needs to consider whether the report is for an internal audience, such as governing officials, management, or staff, or an external audience, e.g., a regulatory agency or the public. If the communication is intended for internal use, then a consulting services engagement with observations and recommendations may suffice. For these engagements, findings, recommendations, and a conclusion is provided to assist management in decision making. Or, an independent third party, such as a CPA or an internal auditor, may be asked to answer the engagement’s objectives to an external audience, in which case a performance audit may be more appropriate due to the need for an independent, objective report that can withstand scrutiny and is subject to peer review. Sometimes there isn’t a choice; some agencies are bound by the government code or local ordinance to conduct audits under GAGAS.

Performance audits are typically the more costly engagement type of the three, given the amount of work required to conduct an audit and adhere to stringent standards. As we’ll explore in later articles, performance audits conducted under GAGAS provide the highest level of assurance among the three options, based on the level of work required. These audits involve developing the required elements of a finding and the documentary evidence required for planning, fieldwork, and reporting. The amount of work involved is much greater than in consulting services engagements, where observations and recommendations will suffice. Consulting services engagements are not audits and, therefore, offer no assurance. Similarly, in attestation engagements, where only specific procedures are performed, no assurance is provided. *3

Conclusion

Having been on both sides of deciding what engagement to recommend, either for an agency I worked at or to a client, it’s important to discuss the level of work required for each engagement type, the number of hours required to do the work under the appropriate standard within a reasonable time period, and the available budget. Finally, and most importantly, clients should understand that performance audits and consulting services engagements each have their place and serve unique purposes. A performance audit offers independence and objectivity at a step above a consulting services engagement, and might be the best option if a rigorous audit of a program or agency is needed. This is where the consideration of the agency’s need is paramount. There may not always be the budget or time available to conduct a comprehensive performance audit, nor a need for an in-depth evaluation or a legislative requirement to do so. In these instances, a consulting services engagement is a good option, especially when time and budget are factors. A consulting services engagement can provide a sufficient report with recommendations and advice. However, it’s important to make the agency aware of the limitations of non-audit services. In addition, the audience of the final report product and any regulatory requirements should strongly influence the decision-making process.

Forthcoming articles in this series will drill down and focus in more detail on the professional standards associated with performance audits as compared to other types of engagements, “why” an agency would want a performance audit instead of a consulting engagement or an agreed-upon procedures engagement, when a performance audit would be recommended, what key factors should be considered, and what are the expectations of the audience of the report. The third article in this series will focus on the reporting elements of a performance audit and a sample performance audit report.

*3  Attestation engagement standards are covered in GAGAS Chapter 7, and include agreed-upon-procedures, reviews, and examination engagements. Attestation examinations have the highest level of assurance, as an opinion is given; not so for the others. Auditors may use GAGAS in conjunction with other professional standards such as American Institute of Certified Public Accountants (AICPA), International Auditing and Assurance Standards Board (IAASB), or Public Company Accounting Oversight Board (PCAOB) standards. For financial audits and attestation engagements, GAGAS incorporates by reference for AICPA Statements on Auditing Standards and Statements on Standards for Attestation Engagements. In addition, the AICPA promulgates the consulting standards. AICPA standard committees have taken the position that only the U.S. Government Accountability Office (GAO) sets performance audit standards.

Sources of Information and Documentation Considered:

• Government Auditing Standards, issued by the Comptroller General of the United States
  – July 2018 Revision (effective for performance audits beginning on or after July 1, 2019; effective for attestation engagements for periods ending on or after June 30, 2020; early implementation is not permitted)
• United States General Accounting Office. Best Practices Methodology – A New Approach for Improving Government Operations. May 1995

Disclaimer: The views expressed in this article are those of the author and do not reflect the official policy or position of the GAO, AICPA, or Macias Gini & O’Connell LLP.

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