The Ins and Outs of Materiality

Materiality is a core concept that shapes the entire financial reporting process. In simple terms, materiality helps determine which financial information is significant enough to influence decisions — and which details likely won’t affect the overall picture. Understanding how experienced certified public accountants (CPAs) evaluate materiality can help you prepare reliable financial reports and avoid surprises when working with external advisors.

Materiality defined

Under U.S. accounting standards, financial information is “material” if omitting or misstating it could influence users’ decisions based on the financial statements. Auditing standards apply the same principle, focusing on whether misstatements — individually or in the aggregate — could reasonably influence users’ economic decisions.

Although wording varies slightly across reporting frameworks, the underlying principle remains consistent: Materiality is user-focused and requires professional judgment informed by both quantitative and qualitative factors. It’s not a mechanical percentage test.

How auditors set and apply materiality thresholds

An audit provides reasonable assurance that the financial statements are free from material misstatement. External auditors rely on their professional judgment to determine what’s material for each company, based on such factors as:

• Size,

• Industry,

• Internal controls, and

• Financial performance.

When planning an audit, the auditor establishes overall materiality for the financial statements as a whole, often using a benchmark such as a percentage of pretax income, revenue or total assets. The auditor also sets “performance materiality,” a lower threshold used to reduce the risk that undetected misstatements, in aggregate, exceed overall materiality. In some cases, auditors establish separate materiality thresholds for particular high-risk accounts or disclosures.

During fieldwork, materiality affects the nature, timing and extent of audit procedures. It influences sample sizes, risk assessments and which accounts receive more scrutiny. Auditors also evaluate significant year-over-year fluctuations and unexpected trends. For example, if shipping or direct labor costs increased by 30% in 2025, it may raise a red flag, especially if it didn’t correlate with an increase in revenue. Businesses should be ready to explain why costs increased and provide supporting documents (such as invoices or payroll records) for auditors to review.

Auditors may need to reassess materiality if circumstances change from year to year — or even during an engagement. Moreover, auditors must apply significant judgment when evaluating materiality. For instance, a relatively small misstatement may still be material if it masks a trend, affects compliance with loan covenants, triggers management bonuses or involves fraud.

Beyond audits

Materiality also plays a role in other types of accounting engagements. In a financial statement review, the CPA provides limited assurance that financial statements are free from material misstatement. The CPA performs inquiry and analytical procedures and reports whether anything came to his or her attention suggesting the financial statements may be materially misstated. Unlike an audit, a review doesn’t involve detailed testing of transactions or internal controls. However, materiality still plays an important role in designing review procedures and evaluating unusual fluctuations, significant estimates and financial statement disclosures.

In a financial statement compilation, the CPA provides no assurance. The accountant presents financial information in the proper format but doesn’t verify its accuracy. Professional standards require the CPA to consider whether the financial statements appear materially misstated or misleading. If information is incomplete, inconsistent or obviously incorrect, the CPA may need to request revisions — or, in some cases, withdraw from the engagement.

Why it matters

The concept of materiality also has strategic implications for business owners and their internal finance and accounting teams. Not every minor bookkeeping error requires immediate correction, and not every fluctuation deserves the same level of attention. Understanding materiality helps you focus attention where it matters most — on the accounts, estimates and risks that could meaningfully affect profitability, cash flow, debt covenant compliance and overall business value.

Rather than striving for perfection in every minor detail, management can use materiality as a decision-making filter. It supports smarter allocation of accounting resources, more effective internal controls and clearer financial reporting. A shared understanding of what’s truly material also strengthens discussions with lenders, investors and other stakeholders by keeping the focus on the issues that influence business outcomes.

Putting materiality to work for you

Materiality is more than an accounting concept — it’s a practical tool for better financial decision-making. Proactively evaluating significant changes in your financial statements and understanding what matters most to your stakeholders can strengthen your reporting. Contact FMD to learn more.

Does Your Estate Plan include a Living Will?

A comprehensive estate plan does more than simply distribute your assets after your death — it also protects your voice, your values and your loved ones during a difficult moment. One critical yet often overlooked component of an estate plan is a living will.

Living will vs. last will and testament

Many people confuse a living will with a last will and testament, but they aren’t the same. These separate documents serve different but vital purposes.

A last will and testament is what you probably think of when you hear the term “will.” This document details how your assets will be distributed upon your death. A living will (sometimes referred to as a “health care directive”) details your preferences for how life-sustaining medical treatment decisions should be made if you become incapacitated and unable to communicate them yourself.

While many people focus on wills and trusts to manage property after death, a living will addresses critical decisions during your lifetime. Including one as part of your estate plan offers significant personal and financial benefits, such as:

Easing emotional stress on family members. Few situations are more emotionally taxing than making end-of-life medical decisions for a family member. When loved ones are forced to make choices without clear guidance, feelings of guilt and doubt can arise.

A living will can provide clarity and reassurance. It relieves your family of the burden of guessing what you would have wanted. Instead of debating difficult choices, they can focus on supporting one another.

Helping to avoid family disputes. Unfortunately, disagreements over medical treatment can strain even the closest families. Different personal beliefs, religious views or interpretations of “quality of life” can lead to conflict.

By documenting your wishes in advance, you reduce the risk of disputes. Health care providers and family members can rely on a legally recognized document rather than differing opinions. This can help preserve family harmony.

Reducing unnecessary medical costs. End-of-life medical care can be expensive. While financial considerations shouldn’t drive medical decisions, unwanted or prolonged treatments can significantly impact your estate and your family’s financial security.

A living will helps ensure that you receive only the type of care you want — no more and no less. This clarity can prevent costly interventions that don’t align with your preferences, helping to protect the assets you’ve worked hard to build.

Don’t forget powers of attorney

Often, a living will is drafted in conjunction with two other documents: a durable power of attorney for property and a health care power of attorney. In the State of Michigan, the Living Will language is included in the Designation of Patient Advocate which is also referred to as the Health Care Power of Attorney, thus requiring only one document.  Many states will separate the two, requiring two documents for health care.

A durable power of attorney identifies someone who can handle your financial affairs, such as paying bills and undertaking other routine tasks, should you become incapacitated. A health care power of attorney becomes effective if you’re incapacitated but not terminal or in a vegetative state. Your designee can make medical decisions on your behalf — for example, agreeing to a surgical procedure recommended by your physician — if you’re unable to do so. But this person can’t officially make life-sustaining choices. That requires a living will, except in a state like Michigan which combines the Living Will and Health Care Power into one.

Seek professional help

Because laws governing living wills vary by state, it’s important to work with qualified professionals in your area to ensure your documents are properly drafted and integrated into your broader estate planning strategy. FMD can explain how a living will fits within your overall financial and legacy goals. Be sure to turn to your attorney to draft your living will.

Selling your Business? You might benefit from Presale Financial Due Diligence

If you’re contemplating a sale of your business, you probably know that any serious buyer will scrutinize your financial statements, operations, assets and legal agreements. Conducting your own due diligence now can smooth the buyer review process and ease deal negotiations. Working with financial and legal advisors, you’ll have the opportunity to fix any problems before your business goes on the market.

Anticipate buyer scrutiny

The primary goal of presale due diligence is to evaluate the quality and sustainability of earnings, identify risks, and normalize financial results before giving prospective buyers access to the company’s books. Financial advisors look for anything that could be considered negative or inconsistent by a prospective buyer and, thus, potentially cause the buyer to reduce the offering price — or even terminate the deal.

Presale due diligence generally focuses on financial performance, tax exposure and other matters that buyers might scrutinize. So, your financial advisor may:

• Analyze the last three years of financial statements to assess revenue recognition policies, margin trends and earnings before interest, taxes, depreciation and amortization (EBITDA),

• Evaluate inventory accounting methods, costing practices and obsolescence risks,

• Look for any “off-balance-sheet” liabilities,

• Assess compliance with federal and state regulations, such as those related to environmental protection and employee-related taxes,

• Review customer and vendor concentrations, related-party transactions, and key contracts,

• Evaluate the strength of confidentiality and nondisclosure agreements, and internal control policies, and

• Identify any outstanding lawsuits.

Addressing these issues now can reduce seller and buyer uncertainty later.

Evaluating IP issues

Presale due diligence also may require your attorney to assess ownership of key intellectual property (IP) such as patents, trademarks, logos and proprietary software. And your financial advisor may review IP documentation to identify gaps or inconsistencies that could affect asset values.

Such verification is critical to a company’s value, especially in industries such as technology, pharmaceuticals and manufacturing. If, say, your business has only a tenuous claim on an internally developed product, it’s better to learn — and possibly fix — this before a prospective buyer finds out.

Start early

The earlier you start planning and preparing for a sale, the better. Ideally, you should engage a professional with merger and acquisition experience to perform presale due diligence on your business at least six months before going to market. If you’d like to make major changes before selling, such as divesting noncore operations or significantly reducing your company’s debt, give yourself even more time. Contact FMD with questions.

Turn your Income Statement into a Profit-boosting Playbook

When your financial statements arrive, it’s tempting to glance at the bottom line and move on. After all, you’ve got customers to serve and employees to manage. But your income statement is more than a report card. It can be a strategic tool to help you spot growth opportunities, tighten your execution and make smarter decisions that move your business forward.

Measure what matters

The income statement is a good starting point for analyzing your financials and identifying inefficiencies and anomalies. The following ratios are commonly used to gauge profitability:

Gross profit margin. This is gross profit (revenue minus cost of goods sold) divided by revenue. It’s a good ratio to compare with industry statistics because it’s typically calculated on a consistent basis, though the definition of cost of goods sold can vary between companies.

Net profit margin. This is calculated by dividing net income by revenue. If the margin is rising, the company is generally doing something right. Often, this ratio is computed on a pretax basis to accommodate differing tax rates.

Return on assets. This is net income divided by the company’s total assets. The return shows how efficiently management is using its assets.

Return on equity. This is calculated by dividing net income by shareholders’ equity. The resulting figure shows how well the shareholders’ investment is performing compared to competing investments. However, private companies should use this ratio with caution because their equity levels can fluctuate due to owner withdrawals or tax strategies.

You can use these profitability ratios to compare your company’s performance over time and against industry norms.

Dig deeper into the details

If your company’s profitability ratios have deteriorated compared to last year or industry norms, it’s important to find the cause. If the whole industry is suffering, the decline is likely part of a macroeconomic trend. If the industry is healthy but your company’s margins are falling, it’s time to identify internal factors and take corrective measures.

Depending on the source of the problem, you might need to cut costs, reevaluate staffing levels, automate certain business functions, eliminate unprofitable segments or product lines, raise prices or possibly conduct a forensic accounting investigation. For instance, a hypothetical manufacturer might discover that its gross margin fell due to rising labor costs from excessive overtime or because supplier prices rose faster than the company adjusted its pricing.

Build a winning game plan

In today’s volatile economy, it’s easy to blame shrinking profit margins on external pressures. But assumptions can be costly. Your income statement provides insight into your team’s performance, from your operational efficiency to pricing and spending. A careful review of your income statement — including revenue trends, cost drivers and operating expenses — often uncovers actionable opportunities for improvement. FMD can help you develop strategies to boost profitability and keep your business competing at the highest level.

April 15 isn’t only the Income Tax Return Filing Deadline, it’s also the Gift Tax Return Filing Deadline

If you made large gifts to family members or heirs last year, you may need to file a 2025 gift return by April 15. So, it’s important to understand whether you’re required to file a federal gift tax return — and when it might be beneficial to file one even if not required.

When filing a return is required

Generally, you must file a gift tax return (Form 709) if, during the 2025 tax year, you made gifts (other than to your U.S. citizen spouse) that exceeded the $19,000-per-recipient annual gift tax exclusion. If you split gifts with your spouse to take advantage of your combined $38,000 annual exclusion, both you and your spouse must file separate gift tax returns.

You also need to file a gift tax return if you made gifts to a Section 529 college savings plan and wish to accelerate up to five years’ worth of annual exclusions ($95,000) into 2025. Other times filing is required include when you made gifts:

• That exceeded the $190,000 annual exclusion amount (for 2025) for gifts to a noncitizen spouse,

• Of future interests (such as remainder interests in a trust), regardless of the amount, or

• Of community property.

Keep in mind that you’ll owe gift tax only to the extent that an exclusion doesn’t apply and you’ve used up your lifetime gift and estate tax exemption ($13.99 million for 2025). As you can see, some gifts require filing a return even if you don’t owe tax.

When filing a return isn’t required

Generally, no gift tax return is required if you:

• Paid qualifying education or medical expenses on behalf of someone else directly to the educational institution or health care provider,

• Made gifts of present interests that fell within the annual exclusion amount,

• Made outright gifts, in any amount, to a spouse who’s a U.S. citizen, including gifts to marital trusts that meet certain requirements, or

• Made charitable gifts and aren’t otherwise required to file Form 709 — if a return is required, charitable gifts should also be reported.

If you gifted hard-to-value property, such as artwork or interests in a family-owned business, consider filing a gift tax return even if you’re not required to. Adequate disclosure of the gift on a return triggers the statute of limitations, generally preventing the IRS from challenging your valuation more than three years after you file.

In some cases, it’s even advisable to file a gift tax return to report nongifts. For example, suppose you sold assets to a family member or a trust. Again, filing a return triggers the statute of limitations and prevents the IRS from claiming, more than three years after you filed the return, that the assets were undervalued and, therefore, are partially taxable.

Questions? We can help

Gift and estate tax rules are complex. Determining whether you must file a gift return (or whether you should file one even if not required) isn’t always easy. If you need help, please contact FMD.

ABCs of Customer Profitability

Some customers naturally require more time and resources than others. But when certain relationships consistently consume more of your and your employees’ time than they generate in profit, it may be time to reassess. Taking a closer look at customer‑level profitability can help you understand where resources are going and ensure that high‑value relationships receive the attention they deserve.

Estimate their value to your business

Before you do anything else, determine individual customer profitability. If your business software tracks customer purchases and your accounting system has adequate cost-accounting or decision-support capabilities, this process will be easier. Even if you don’t maintain cost data, you can sort the good from the bad by reviewing customer purchase volume and average sale price. Often, such data can be supplemented by general knowledge of the relative profitability of different products or services.

Don’t ignore indirect costs. High marketing, handling, service or billing costs for individual customers or customer segments can significantly affect their profitability even if they purchase high-margin products.

Give them a grade

After you’ve assigned profitability levels to customers or customer categories, sort them into the following groups:

Group A. These customers are highly profitable. To further increase their value to your business, spend time learning what motivates them. Your proprietary products? Your prices? Your customer care? Developing a good understanding of this group will help you grow these relationships and provide insight into attracting similar customers.

Group B. Customers in this group may not be extremely profitable, but they positively contribute to your bottom line. There’s a good chance that, with the right mix of product, service and marketing resources, you can turn some of them into A customers. But be sure to monitor them closely to prevent them from slipping into the C group.

Group C. These customers tend to be unprofitable. They may also be difficult to work with and perpetually dissatisfied. They may expect special pricing or services, or pay invoices late. Fortunately, eliminating C customers probably won’t require a formal breakup. You can start by reducing the level of attention they receive. Remove them from marketing lists and tell your salespeople to stop contacting them. After a while, most C customers who are ignored will leave on their own.

When a strategic overhaul is warranted

It’s normal for businesses to have a mix of highly and less profitable customers. The key is making intentional decisions about where to invest your time and resources. Reallocating attention away from consistently unprofitable customer relationships — and toward your A and B groups — can boost your company’s financial performance. However, if C customers make up a large portion of your customer base, you may need to consider broader strategic changes. These could include reviewing pricing, refining service offerings, adjusting processes or rethinking which markets and customer segments you want to serve. Contact FMD to learn more.

Play it Smart by Naming Co-executors

Choosing an executor is one of the most important decisions in the estate planning process. This person (or institution) will be responsible for carrying out your wishes, managing assets, paying debts and taxes, distributing property to beneficiaries and more.

Your first instinct may be to name your spouse, adult child or other close family member as executor. While that decision may feel natural, it’s not always the best choice. Co-appointing a professional advisor alongside a trusted family member can provide a more effective and balanced solution.

An executor’s duties

Your executor has a variety of important duties, including:

• Arranging for probate of your will and obtaining court approval to administer your estate (if necessary),

• Taking inventory of — and collecting, recovering or maintaining — your assets, including life insurance proceeds and retirement plan benefits,

• Obtaining valuations of your assets where required,

• Preparing a schedule of assets and liabilities,

• Arranging for the safekeeping of personal property,

• Contacting your beneficiaries to advise them of their entitlements under your will,

• Paying any debts incurred by you or your estate and handling creditors’ claims,

• Defending your will in the event of litigation,

• Filing tax returns on behalf of your estate, and

• Distributing your assets among your beneficiaries according to the terms of your will.

For someone without financial, legal or tax expertise, these responsibilities can feel overwhelming — especially while grieving. Even highly capable family members may lack the time or experience needed to administer an estate efficiently.

Mistakes can result in delays, disputes or even personal liability. Executors are legally responsible for acting in the best interests of the estate and its beneficiaries. If errors occur — such as missed tax deadlines or improper distributions — the executor may be held accountable.

Emotional dynamics can complicate matters

When a family member serves as sole executor, emotional tensions can arise. Sibling rivalries, blended family dynamics or disagreements about asset values can quickly escalate.

Even when everyone has good intentions, beneficiaries may question decisions about timing, asset sales or expense payments. The executor may feel caught between honoring the deceased’s wishes and preserving family harmony. Needless to say, these situations can strain relationships, sometimes permanently.

Two can be better than one

A practical alternative is to name both a trusted family member and a professional advisor, such as a CPA, estate planning attorney or corporate fiduciary, as co-executors. This structure can offer several key benefits, such as:

Technical expertise. A professional advisor can bring knowledge of tax law, probate procedures, accounting requirements and regulatory compliance. This reduces the risk of costly mistakes and helps ensure deadlines are met.

Objectivity. A neutral third party can help mediate disagreements and make decisions based on fiduciary standards rather than emotions. This can protect family relationships and minimize conflict.

Shared responsibility. Administering an estate can be time consuming. Dividing responsibilities allows the family member to focus on personal matters while the professional handles technical and administrative tasks.

Continuity and stability. If a family member becomes overwhelmed, ill or otherwise unavailable, a professional co-executor can provide continuity. Estates often take months — or even years — to settle.

A balanced approach

Co-appointing a professional doesn’t mean excluding family involvement. In fact, it often enhances it. The family member remains involved in decision-making and ensures that your personal wishes and family values are honored. Meanwhile, the professional ensures that legal and financial matters are handled efficiently and correctly.

For larger or more complex estates — such as those involving business ownership, multiple properties or significant investments — this collaborative model can be especially valuable. Contact FMD if you have questions about having co-executors or choosing them.

Pay Equity can Benefit Employees and Businesses

Pay equity is the philosophy and practice of “equal pay for equal work.” Employers known for fair pay practices stand out in today’s competitive labor market. Fostering pay equity can also help reduce the risk of employment law litigation. But what does pay equity mean in practice?

What it does and doesn’t mean

First and foremost, pay equity doesn’t mean all employees receive the same amount of compensation. Instead, companies that embrace pay equity make compensation decisions free of unjust biases related to protected characteristics such as age, race, gender, disability, national origin and sexual orientation. Employees’ pay, both when workers are hired and when they receive raises, is determined according to objective, job-related factors, including:

• Education and training,

• Experience,

• Skills,

• Responsibilities,

• Performance, and

• Tenure.

Determining whether pay inequities currently exist within your business requires a careful, honest assessment. Many companies conduct a formal pay equity audit. This is a thorough statistical analysis of compensation history, policies and structure. The audit’s objective is to identify any inconsistencies, gaps and incongruities that can’t be explained rationally.

Consider these policies

If you discover signs of pay inequity in your company, put in place policies to help eliminate them. For example, you might want to use only initials or random ID numbers during early screenings of job candidates, such as resumé reviews. This practice minimizes the chance that hiring managers will distinguish candidates by ethnicity, gender or other protected identities.

Also, during candidate interviews, refrain from asking about pay history. Many states and municipalities prohibit such questions, so ask your attorney what applies in your situation. (You might also want to take that opportunity to ensure you understand all antidiscrimination laws that affect hiring decisions.) But even if your state or local law doesn’t forbid past salary questions, it’s a well-established best practice to avoid them. Women and people of color are more likely to have been paid less in their previous positions. By using historical compensation to set their current salaries, you risk compounding pay disparities.

More ideas

Here are some other ideas that can help your organization achieve pay equity:

Set standard pay ranges. Generate objective criteria for recruiting, hiring, compensating, evaluating and promoting employees. Then set standard pay ranges that reflect each position’s value to the business.

Avoid individual decision-making. Limit managers’ ability to single-handedly adjust pay for specific employees. These decisions can lead to pay inequities and other problems, such as accusations of favoritism.

Provide training. To help managers and supervisors understand pay equity, conduct information sessions. Such training will help them recognize potential issues and discuss compensation with their reports.

Prioritize transparency. Let staffers know how you set compensation. Also, reassure them that they can discuss pay with their supervisors without fear of retaliation.

Fair work culture

The best talent is typically drawn to companies that prioritize employee well-being and cultivate a fair, transparent work culture. Pay equity can help communicate such principles to potential job candidates. Contact FMD if you’d like help analyzing compensation data or coordinating with legal counsel on a pay equity audit.

When Should You Update Your Estate Plan?

Many people think of estate planning as a “one-and-done” task — something you complete and file away. But an estate plan should evolve as your life and finances and relevant laws change. An outdated plan can create confusion, unintended tax consequences or outcomes that no longer reflect your wishes.

The higher federal gift and estate tax exemption that was made permanent by last year’s One Big Beautiful Bill Act is one reason to review your estate plan now. But you should also review your plan whenever something significant changes in your life. Let’s take a look at common situations that signal the need to revisit your will, trusts, powers of attorney or other estate planning documents.

Major life events

Life transitions are the most common reasons estate plans need attention. Marriage or remarriage is a big one, especially if you have children from a prior relationship. Divorce is equally important. Failing to update your documents could leave an ex-spouse in control of your assets or medical decisions.

The birth or adoption of a child or grandchild should also trigger a review. You’ll want to name a guardian or adjust beneficiary designations to reflect your growing family. Similarly, the death or incapacity of a spouse, beneficiary, trustee or executor means your plan may no longer function as intended.

Financial changes matter, too

Your estate plan should reflect your current financial situation. If your net worth has increased significantly — through business growth, inheritance, real estate appreciation or investment success — your existing plan may not adequately address tax planning or asset protection.

Starting, buying or selling a business is another major reason to update your estate plan. Business ownership often requires specific provisions for succession planning, valuation and continuity. Retirement also can prompt changes, as income sources shift and distribution strategies evolve.

Don’t forget supporting documents

Updating an estate plan isn’t just about your will or trusts. Beneficiary designations on retirement accounts and life insurance policies should be reviewed regularly, as they generally override what’s stated in your will.

Powers of attorney and health care directives are also critical to review. Make sure they continue to reflect your wishes and that those you’re providing with decision-making authority are still people you trust and who are able to serve.

The bottom line

An estate plan is only effective if it reflects your current wishes and circumstances, as well as current law. Regular reviews help ensure your assets are distributed as intended, your loved ones are protected, and unnecessary taxes or legal complications are avoided.

Because estate planning intersects with taxes, financial planning and your long-term goals, it’s wise to review your plan with qualified professionals. FMD can help you identify when updates may be needed and coordinate with your legal and financial advisors to keep your plan on track.

Where Should You Hold Your Company Retreat?

As remote and hybrid work have become more common, corporate retreats have surged in recent years. Some or all of your employees may now work from home and experience little in-person interaction with coworkers. A retreat can foster collegial relationships and, ultimately, greater productivity. But the first decision you’ll likely need to make is whether your retreat will be a smaller-scale affair held in your office or an off-site retreat. There are ways to make either one affordable.

Your office

Staying on your company’s premises can keep out-of-pocket costs in check. The most obvious is that you won’t need to rent meeting rooms. And, assuming employees live in the area, you won’t have transportation and lodging expenses. You’ll also likely spend less on food and beverages. A local restaurant can cater your meals and snacks, and you could buy beverages in bulk.

On the downside, employees tend to view on-site retreats as just another day at the office. This can hamper creative thinking and team building and limit possible activities. Worse, employees may be distracted if they can frequently run back to their desks to check email and voicemail.

Off-site locations

In general, workers are better able to focus on a retreat agenda at an off-site location. They’re in a new, “special” environment with no visual cues to trigger workday routines. So, even though you’ll incur greater costs than if you’d stayed in your office, you may get a better return on investment.

The fact is, hotels and other facilities that host company retreats need and want your business! Many things may be negotiable, and you might be able to snag discounts by booking or paying early. Get several quotes and compare prices and services. You’ll have more leverage if you avoid scheduling your retreat during seasonal peaks when local venues tend to be busy with weddings, trade shows and industry conferences.

Hotels earn their biggest margins on food, beverages and meeting setup fees, so they may be willing to provide complimentary or discounted rooms for guest speakers and out-of-town employees. Also, try to negotiate a flat food-and-beverage price for the entire retreat, rather than a per-person or per-event rate.

Possible tax relief

Here’s another way to save: Some of your company retreat expenses may be tax-deductible. They need to meet IRS criteria as “ordinary and necessary” business expenses and can’t be extravagant or include expenditures for employees’ spouses. In general, business meals are only 50% deductible, and entertainment costs are nondeductible. Contact FMD to learn more about tax-deductible costs and the IRS’s documentation requirements.

Beware: Accounting Missteps can Trip up New Businesses

Launching a start-up comes with no shortage of big decisions and fast-moving priorities. In the rush to grow, financial fundamentals can sometimes take a back seat — often with costly consequences. Some common accounting missteps that new business owners should avoid include:

Overlooking day-to-day spending. Starting a new business is exciting, and it’s natural to focus on generating revenue and building business relationships. But it’s essential to keep detailed, timely records of expenses, including receipts and invoices. This will help you properly allocate costs, price products and services, assess and improve financial performance, and claim tax deductions.

Skipping regular account reviews. Reconciling accounts involves comparing your records to your bank and credit card statements to identify and correct any discrepancies. Account reconciliation helps ensure your business pays close attention to expenses and available cash. It can also help prevent and detect fraud by third parties and employees.

Blurring the line between personal and company finances. When you own a business, you need to keep personal and business matters separate for financial reporting, tax and legal purposes. Maintaining separate bank and credit card accounts and clearly distinguishing between personal and business activities will help avoid confusion. These practices also make it easier to track business expenses and support accurate budgeting and forecasting.

Getting worker status wrong. How much control do you exercise over the people who work for your business? Are your workers an integral part of your operations? Misclassifying employees as independent contractors can have serious legal and financial consequences. Make sure you understand the differences between employees and contractors and categorize them appropriately. If you don’t follow the rules, the IRS, the U.S. Department of Labor and a state tax agency might challenge the status of your workers. Some state rules may be stricter than the federal ones.

Being unprepared for tax obligations. Because many start-ups run at a loss, at least initially, some owners forget to set aside money for taxes. This can lead to cash shortages and other financial difficulties when tax time rolls around. Failure to make timely federal and state tax payments can result in penalties and interest charges. And don’t forget about payroll, sales and property tax obligations. Even if your business operates at a loss, these taxes may still be due.

Neglecting formal accounting systems and controls. Entrepreneurs must select and consistently apply an accounting method that best fits their business needs. Many fledgling businesses start off using cash- or tax-basis accounting, then graduate to accrual-basis reporting as they mature. But lenders, franchisors and investors sometimes require accrual-basis financial reporting from the get-go. Working with an experienced accountant can help you evaluate these requirements, select affordable, user-friendly bookkeeping software and establish consistent processes for recording business transactions.

It also pays to invest upfront in simple internal controls — such as locks on file cabinets, regular software updates, network backups and antivirus programs — to help prevent theft and fraud. Start-ups with valuable intellectual property, such as patents, secret recipes and proprietary software, should consider protecting these assets by implementing network security policies, filing appropriate legal protections, and requiring employees and contractors to sign noncompete agreements, where legally permitted. Additional internal control measures can be implemented as your business matures.

Fortunately, these common accounting missteps are preventable if you take proactive measures to avoid them. Building a strong financial foundation begins with seeking guidance from experienced bookkeeping and accounting professionals. In addition to helping you design and implement sound financial systems and controls, FMD offer interim CFO and bookkeeping services to support your business while you recruit and onboard the right talent for your finance and accounting department. Contact us to learn more.

Increase Estate Planning Flexibility by Decanting an Irrevocable Trust

Irrevocable trusts provide various estate planning benefits, such as reducing estate taxes and helping to ensure assets are distributed as you wish. But estate planning isn’t a “set it and forget it” process. Families, tax laws and financial circumstances can change. A major downside of irrevocable trusts is that they’re difficult to update once they’ve been signed and funded. That’s where trust decanting can help.

What does it mean to “decant” a trust?

The term decanting comes from pouring wine from one bottle to another. In estate planning, it means transferring assets from an existing trust to a new trust that can better achieve your goals.

Depending on the trust’s language and the provisions of applicable state law, decanting may allow a trustee to:

• Correct errors or clarify trust language,

• Move the trust to a state with more favorable tax or asset protection laws,

• Take advantage of new tax laws,

• Remove beneficiaries,

• Change the number of trustees or alter their powers,

• Add or enhance spendthrift language to protect the trust assets from creditors’ claims, or

• Move funds to a special needs trust for a disabled beneficiary.

Unlike assets transferred at death, assets that are transferred to a trust don’t receive a step-up in basis. As a result, they can subject the beneficiaries to capital gains tax on any appreciation in value. One potential solution is to use decanting.

Decanting can authorize the trustee to confer a general power of appointment over the assets to the trust’s grantor. This would cause the assets to be included in the grantor’s estate and, therefore, to be eligible for a step-up in basis. Depending on the size of the estate, this might make sense given today’s high gift and estate tax exemption ($15 million in 2026).

Beware of your state’s laws

Many states have decanting statutes, and in some states, decanting is authorized by common law. Either way, it’s critical to understand your state’s requirements. For example, in certain states, the trustee must notify the beneficiaries or even obtain their consent to decant.

Even if decanting is permitted, there may be limitations on its uses. Some states, for example, prohibit the use of decanting to eliminate beneficiaries or add a power of appointment. And most states won’t allow the addition of a new beneficiary. If your state doesn’t authorize decanting, or if its decanting laws don’t allow you to accomplish your objectives, it may be possible to move the trust to a state whose laws meet your needs.

Don’t forget about potential tax implications

One of the risks associated with decanting is uncertainty over its tax implications. For example, let’s say a beneficiary’s interest is reduced. Has he or she made a taxable gift? Does it depend on whether the beneficiary has consented to the decanting? If the trust’s language authorizes decanting, must it be treated as a grantor trust? Does such language jeopardize the trust’s eligibility for the marital deduction? Does distribution of assets from one trust to another trigger capital gains or other income tax consequences to the trust or its beneficiaries?

If you have tax-related questions, please contact FMD. We’d be pleased to help you better understand the pros and cons of decanting a trust.

How to get Inventory Under Control

Uncertainty regarding inflation, demand and foreign tariffs has made inventory management even harder for businesses than it was previously. Although there are many unknowns right now, one thing is generally certain: Carrying excess inventory is expensive. If you’d like to trim your buffer stock and maximize profitability, there are effective ways to do it without risking customer service.

Count and compare

Inventory management starts with a physical inventory count. Accuracy is essential for knowing your cost of goods sold and for identifying and resolving discrepancies between your physical count and perpetual inventory records. An external accountant can bring objectivity to the counting process and help minimize errors.

The next step is to compare your inventory costs to those of your peers. Trade associations often publish benchmarks for gross margin [(revenue - cost of sales) / revenue], net profit margin (net income / revenue) and days in inventory (average inventory / annual cost of goods sold × 365 days).

Your company should strive to meet — or beat — industry standards. For a retailer or wholesaler, inventory is simply purchased from the manufacturer. But the inventory account is more complicated for manufacturers and construction firms where it’s a function of raw materials, labor and overhead costs.

Guide to cutting

The composition of your company’s cost of goods will guide you on where to cut. You may be able to reduce inventory expenses by renegotiating prices with your suppliers or seeking new vendors. And don’t forget the carrying costs of inventory, such as storage, insurance, obsolescence and pilferage. Brainstorm ways to mitigate such threats and improve margins. For example, you might negotiate a net lease for your warehouse, install antitheft devices or opt for less expensive insurance coverage.

To lower your days-in-inventory ratio, compute product-by-product margins. You might stock more products with high margins and high demand — and less of everything else. Whenever possible, return excess supplies of slow-moving materials or products to your suppliers.

To help prevent lost sales due to lean inventory, make sure your product mix is sufficiently broad and in tune with consumer needs. Before cutting back on inventory, negotiate speedier delivery from suppliers or consider giving suppliers access to your perpetual inventory system.

Reality check

Right now, many businesses are sitting on strategic stockpiles they purchased to combat marketplace uncertainty. If this is true of your business and you haven’t been able to move goods fast enough, you may want to consider new inventory management methods. FMD can advise you on such challenges as using software to accurately forecast inventory needs, pricing goods to increase profitability without alienating customers, and modeling the cost impacts of tariffs and other economic variables.

Remote Auditing is Here to Stay: How it’s Changing the Audit Process

Once considered a temporary workaround, remote auditing is now a permanent part of how audits are planned and performed. Technological advances and evolving workforce expectations have pushed audit firms to rethink traditional, fully on-site approaches. The question isn’t whether remote auditing will continue (it will), but how firms and clients can use it effectively while maintaining audit quality.

How remote auditing gained momentum

The concept of remote auditing didn’t emerge overnight. Even before remote work became commonplace during the COVID-19 pandemic, accounting firms were gradually expanding the use of off-site audit procedures. Many firms invested in staff training and technology — such as cloud computing, secure remote access and videoconferencing tools — to work off-site. Moreover, advanced analytics software and continuous auditing tools enabled real-time testing, reducing reliance on certain traditional manual testing procedures.

These efforts were driven largely by a desire to reduce business disruptions and costs while improving flexibility for both auditors and clients. The pandemic served as a catalyst for the widespread adoption of remote auditing techniques. As firms became more comfortable with these tools, they found that some procedures could be completed just as effectively, if not more so, outside the traditional on-site model.

Why hybrid audits are the new standard

Even with well-established remote capabilities, certain audit areas still benefit significantly from being conducted in person. Auditing standards emphasize that auditors must obtain sufficient appropriate evidence, whether collected on-site or off-site. Your auditor’s risk assessment dictates how and where procedures are performed.

Today, most auditors use a hybrid approach. By combining off-site and in-person procedures, they can balance efficiency with effectiveness. Some examples include:

Internal control testing. Auditors must evaluate whether controls are properly designed and implemented, and if they’re operating effectively. Gaining a full understanding of a company’s control environment can be challenging through virtual meetings alone. In addition, auditors often need to reassess how transactions are processed when employees work remotely or in hybrid settings. Controls that were effective in prior periods may need to be updated or supplemented, and in-person observation can provide critical context.

Fraud-related inquiries. Auditing standards emphasize that inquiries of management and those charged with governance regarding fraud are most effective when conducted face-to-face. On-site discussions allow auditors to observe body language, assess tone and evaluate interpersonal dynamics — insights that are harder to capture through a screen.

Inventory observations. Auditors are required to obtain sufficient appropriate evidence that inventory exists and is in good condition. While technology, such as live video feeds, drones and security cameras, can support this process, these tools have limitations. Observing inventory counts in person, at least for a sample of locations, often remains necessary to verify accuracy and completeness.

Companies that are unwilling to allow in-person procedures in these areas may raise concerns about audit risk. And when auditors decide to use remote procedures, they must apply heightened professional skepticism and be well-trained in using technology effectively.

Remote auditing, together

The future of auditing is flexible, adaptable and often remote. However, maintaining audit quality requires using the right tools in the right situations. The optimal mix of remote and on-site procedures will vary based on a company’s size, industry, systems and risk profile. Contact FMD to discuss what makes sense for your organization. We’ll work closely with your internal finance and accounting team to design an audit approach that streamlines the process while upholding audit quality.

Owning Real Estate in Multiple States can Negatively Affect Beneficiaries

A vacation home, rental property or future retirement residence may play an important role in your long-term plans. However, if you hold properties across multiple states, it can create estate planning issues that can be easily overlooked. If not addressed properly, these issues can have consequences for your heirs.

Multiple properties can result in multiple probate proceedings

Probate is a court-supervised administration of your estate. If real estate is titled in your name, that property generally must go through probate in the state where it’s located.

If probate proceedings are required in multiple states, the process can become expensive. For example, your representative will need to engage a probate lawyer in each state, file certain documents in each state and comply with other redundant administrative requirements.

Beyond cost and inconvenience, multiple probate proceedings can slow the transfer of property. This can create uncertainty for beneficiaries who need access to or control over the real estate.

A revocable trust can help avoid probate

A common strategy to avoid probate — especially for individuals with property in multiple states — is to transfer property to a revocable trust (sometimes called a “living trust”). When it comes to real estate, this generally involves preparing a deed transferring each property to the trust and recording the deed in the county where the property is located.

Property held in a revocable trust generally doesn’t have to go through probate. The reason is that the trust owns the property, not you. Your trustee manages or distributes the property according to the terms of the trust, without court involvement. A single revocable trust can hold real estate located in multiple states, potentially eliminating the need for separate probate proceedings in each jurisdiction.

Planning ahead makes a difference

While a revocable trust can be an effective solution, it must be structured and maintained correctly to achieve the intended results. Titling, state-specific rules and coordination with the rest of your estate plan all matter.

For example, will transferring a residence to a trust affect your eligibility for homestead exemptions from property taxes or other tax breaks? Will the transfer affect any mortgages on the property? Will it be subject to any real property transfer taxes? It’s also important to consider whether transferring title to property will affect the extent to which it’s shielded from the claims of creditors.

Review your properties and your estate plan

If you own — or are considering purchasing — real estate in another state, be sure to review how that property fits into your overall estate plan. FMD can assess the financial and tax implications and work with your legal advisors to help ensure your plan supports your long-term goals and protects your family.

Advisory Boards Provide Family Businesses with Independent Perspectives

Does your family business keep its strategic decisions within the family? It’s common for family businesses to assign relatives to positions of authority and require other employees to defer to them. But “common” doesn’t necessarily mean “good.” Not only is outside input recommended, but it can help reduce the risk of certain problems (such as unaccountability and fraud) and promote long-term financial health. Here’s how your family business might benefit from an advisory board made up primarily of nonfamily members.

A consulting body

An advisory board serves only in a consulting capacity. So it doesn’t carry the fiduciary responsibilities or legal authority of a formal board of directors. Small business advisory boards generally are less formal and enjoy greater freedom to develop creative solutions and suggest new business opportunities.

Advisory boards can also act as mediators. Board members may provide perspective and potential solutions for family disagreements over:

• Your company’s strategic direction,

• Growth and expansion opportunities,

• Mergers and acquisitions,

• Loans and other financing initiatives,

• Compensation and promotion decisions,

• Interpersonal conflicts, and

• Succession plans.

Depending on your board’s composition, it may also be qualified to offer opinions on legal, regulatory and complicated financial issues.

Building the base

You’ll want a mix of professionals from varying fields, demographics and backgrounds on your board. One effective way to recruit advisory board members is to network with business, industry, community, academic and philanthropic organizations. You may also want to involve professional advisors, such as your CPA, banker, insurance agent, estate planner or legal counsel. These advisors will likely already be familiar with your company’s goals, issues and operations.

Specify the mix of traits and qualifications — leadership skills, experience, competencies, education, affiliations and achievements — needed in members to fulfill your board’s purpose. Ensure these individuals are willing to make candid observations and provide constructive advice. They must also maintain confidentiality and exercise discretion regarding sensitive business and family matters.

It may be practical for you or another family member to serve as the advisory board’s chair. But as your business grows in size and complexity and the demands on your time increase, consider delegating this responsibility to a board member.

Nail down the details

Other details to work out include the frequency of advisory board meetings. Meeting at least monthly initially will help the group build rapport and become relevant to your business. Once the board is established, quarterly meetings may suffice. However, emergency meetings scheduled on short notice may become necessary at certain points.

Your business should cover advisory board members’ travel costs and pay them for their time. Cash compensation makes sense for family businesses that intend to remain closely held. However, companies planning to go public often issue stock or equity-based compensation (subject to legal and tax considerations).

Impartial perspectives

If your family business doesn’t already have one, consider creating an independent advisory board to provide impartial perspectives on your company’s pressing challenges and opportunities. Contact FMD to discuss how we can help you design an effective advisory board — or participate as an independent financial advisor to support governance and long-term planning.

Preparing Your F&A Team for Leadership Changes

At the start of the new year, your finance and accounting (F&A) department is under a microscope. Budgets, forecasts and strategic plans are top of mind, and internal staff may be working with your CPA to finalize year-end financial statements. This heightened attention often raises an important question: What would happen if your CFO suddenly left?

For many organizations, leadership change in the F&A department would be highly disruptive. Proactively planning for a CFO’s departure — whether expected or unexpected — can help stabilize your team and reduce key-person risk. It also creates a valuable opportunity to reassess your organization’s financial reporting and strategic planning needs. Here are four practical steps to consider as you plan for 2026.

1. Update the job description

During the current CFO’s tenure, your organization’s needs may have changed. Take time to review the existing job description and assess whether it still reflects the skills and experience your organization requires today.

For example, if you’ve recently taken on debt and must comply with lending covenants, make sure those responsibilities are clearly defined in the job description. Also, if you’ve expanded substantially, you may have outgrown the current role’s scope or structure. For instance, you might need to replace a bookkeeper with a CPA who has the experience and skills to manage a larger F&A team.

2. Evaluate your department’s performance

The F&A department is critical to your success. It should provide accurate, relevant financial information on a timely basis. Objectively assess whether reporting delays, recurring errors or limited financial insight have been holding your business back.

If your organization’s goals demand a higher level of performance, this may signal a need for structural improvements — such as enhanced training, new team members, clearer accountability, and more formalized policies and procedures. Strong internal controls help reduce fraud risk and lessen reliance on any single individual.

3. Ensure your accounting technology is keeping pace

Leveraging modern accounting software can help your F&A team operate more efficiently, reduce manual data entry and minimize errors that often arise from spreadsheet-driven processes. Well-configured systems can also improve consistency in reporting, strengthen internal controls and create clearer audit trails.

In addition, automation can free up internal staff to focus on higher-level activities, such as financial analysis, forecasting and strategic decision-making. As part of your planning, assess whether your current system is up to date, industry-appropriate and properly configured to support your organization’s size, complexity and growth plans. If the system relies heavily on manual workarounds or undocumented processes, it may expose your organization to unnecessary risk during a leadership transition.

Also consider whether you’re maximizing the functionality of your current accounting software. Set up a meeting with a vendor rep to discuss what’s working and what’s not, and see how they respond. A worthy provider will address issues, provide training and offer ongoing customer support. If your vendor doesn’t provide adequate support, we can conduct a comprehensive assessment of the effectiveness of your accounting system and how you’re using it.

4. Plan for change

In-house personnel will need to manage new challenges as your organization grows and evolves. For example, if you’re dealing with a complex matter — such as a merger, restructuring or private equity transaction — your CFO should have sufficient knowledge to support the effort.

Thinking in terms of succession, scalability and adaptability can help ensure your finance function remains effective over time. Streamlined processes and documented procedures also make transitions smoother when change does occur.

Be proactive, not reactive

A CFO’s departure doesn’t have to derail your organization’s momentum. With a clear action plan in place, you can turn a potential disruption into a strategic reset. Taking these steps before a transition occurs can help ensure your F&A team remains stable, effective and aligned with your organization’s goals in 2026 and beyond. Contact FMD for more information.

Are You and Your Spouse Considering Splitting Gifts?

The gift tax annual exclusion allows you to transfer up to $19,000 (for 2026) per beneficiary gift-tax-free, without tapping your $15 million (for 2026) lifetime gift and estate tax exemption. You can double the exclusion amount if you elect to split the gifts with your spouse.

Gift-splitting in a nutshell

Gift-splitting allows married couples to treat a gift made by one spouse as if it were made equally by both spouses. This election can reduce future estate tax exposure and provide greater flexibility in passing wealth to the next generation.

For example, let’s say that you have two adult children and four grandchildren. You can gift each family member up to $19,000 tax-free by year end, for a total of $114,000 ($19,000 × 6). If you’re married and your spouse consents to a joint gift (or a “split gift”), the exclusion amount is effectively doubled to $38,000 per recipient, for a total of $228,000.

Avoid common mistakes

It’s important to understand the rules surrounding gift-splitting to avoid these common mistakes:

Misunderstanding IRS reporting responsibilities. Split gifts and large gifts trigger IRS reporting responsibilities. A gift tax return is required if you exceed the annual exclusion amount or give joint gifts with your spouse. Unfortunately, you can’t file a “joint” gift tax return. In other words, each spouse must file an individual gift tax return for the year in which you both make gifts.

Gift-splitting with a noncitizen spouse. To be eligible for gift-splitting, both spouses must be U.S. citizens.

Divorcing and remarrying. To split gifts, you must be married at the time of the gift. You’re ineligible for gift-splitting if you divorce and either spouse remarries during the calendar year in which the gift was made.

Gifting a future interest. Only present-interest gifts qualify for the annual exclusion. So gift-splitting can be used only for present interests. A gift in trust qualifies only if the beneficiary receives a present interest — for example, by providing the beneficiary with so-called Crummeywithdrawal rights.

Benefiting your spouse. Gift-splitting is ineffective if you make the gift to your spouse, rather than a third party; if you give your spouse a general power of appointment over the gifted property; or if your spouse is a potential beneficiary of the gift. For example, if you make a gift to a trust of which your spouse is a beneficiary, gift-splitting is prohibited unless the chances your spouse will benefit are extremely remote.

Be aware that, if you die within three years of splitting a gift, some of the tax benefits may be lost.

Proper planning required

Whether gift-splitting is right for you and your spouse depends on your estate size and long-term objectives, among other factors. Because the election involves technical requirements and potential implications for future planning, it’s important to carefully evaluate the strategy. FMD can help ensure that your split gifts comply with federal tax laws.

Is Your Business Vulnerable to Payroll Fraud?

Payroll fraud schemes can be costly — and for small businesses, devastating. The Association of Certified Fraud Examiners (ACFE) has found that the median loss from payroll fraud schemes is $50,000. However, some long-term payroll frauds, particularly when perpetrated by upper management, have produced losses in the millions of dollars. Can your company afford that? Probably not.

Payroll fraud incidents can also result in bad publicity, weakened employee morale and, potentially, an IRS investigation. It’s critical that your business take steps to protect its payroll function.

Illegal self-enrichment

There are several ways for fraud perpetrators to illegally manipulate payroll to enrich themselves. For example, cybercriminals often target payroll functions. They might use phishing emails to trick your workers into providing sensitive information, such as bank login credentials. This becomes a form of payroll fraud if they divert payroll direct deposits to accounts they control. Criminals might also target you and accounting department managers by sending fake emails from “employees” requesting changes to their direct deposit instructions.

Also watch out for occupational payroll fraud. In the absence of appropriate internal controls, crooked accounting staffers could add invented “ghost” employees to the payroll. The wages of those ghost employees might then be deposited in accounts controlled by the fraudsters.

And any employee who files for expense reimbursement may inflate expenses, submit multiple receipts for the same expense or claim fictitious expenses. This is considered payroll fraud because reimbursements are often added to paychecks. By the same token, workers eligible for overtime who artificially inflate their work hours are also generally considered payroll fraud perpetrators.

Effective internal controls

To prevent payroll fraud — and uncover it quickly if it occurs — implement and enforce strong internal controls. For instance, require two or more employees to make payroll changes, such as increasing pay rates or adding or removing employees. Payroll staffers should be alert for excessive or unusual pay rates, hours or expenses. And if they receive a request to change an employee’s direct deposit information, they should verify the request with the worker before proceeding.

For their part, department managers must closely monitor employee expense reimbursement requests. They should ask employees to explain discrepancies, such as totals that don’t add up or expense claims that lack receipts.

Other effective controls include:

Audits. Regularly conduct payroll audits to detect anomalies. Also audit automatic payroll withdrawals to confirm proper transfers are made.

Training. Educate employees about payroll schemes, phishing attacks and the importance of not sharing sensitive information.

Confidential hotlines. Offer an anonymous hotline or web portal to employees, customers and vendors to report fraud suspicions. Be sure to investigate every report.

Tax responsibilities

Finally, a scheme that’s most often perpetrated by business owners and executives is deliberately failing to pay required payroll tax. Ensure that upper management and payroll department employees understand their tax responsibilities and that no one individual has the ability to divert funds intended for payroll tax to a personal account. Contact FMD for more information and assistance with internal controls.

How Auditors Evaluate Accounting Estimates

Financial statements aren’t built solely on fixed numbers and historical facts. Many reported amounts rely on accounting estimates — management’s best judgments about uncertain future outcomes. Estimates are inherently subjective and can significantly affect reported results. How do external auditors evaluate whether amounts reported on financial statements seem reasonable?

Understanding management’s assumptions and data

External auditors pay close attention to accounting estimates during audit fieldwork. They review the methods and models used to create estimates, along with supporting documentation, to ensure they’re appropriate for the specific accounting requirements. In addition, auditors examine the company’s internal controls over the estimation process to ensure they’re robust and designed to prevent errors or manipulation.

For instance, they may inquire about the underlying assumptions (or inputs) used to make estimates to determine whether the inputs seem complete, accurate and relevant. Estimates based on objective inputs, such as published interest rates or percentages observed in previous reporting periods, are generally less susceptible to bias than those based on speculative, unobservable inputs. This is especially true if management lacks experience making similar estimates.

Challenging estimates and assessing bias

When testing inputs, auditors assess the accuracy, reliability and relevance of the data used. Whenever possible, auditors try to recreate management’s estimate using the same assumptions (or their own). If an auditor’s independent estimate differs substantially from what’s reported on the financial statements, the auditor will ask management to explain the discrepancy. In some cases, an external specialist, such as an appraiser or engineer, may be called in to estimate complex items.

Auditors also may conduct a “sensitivity analysis” to see if management’s estimate is reasonable. A sensitivity analysis shows how changes in key assumptions affect an estimate, helping to evaluate the risk of material misstatement.

In addition, auditors watch for signs of management bias, such as overly optimistic or conservative assumptions that could distort the financial statements. They also consider the objectivity of those involved in the estimation process, ensuring there’s no undue influence or pressure that could affect the estimate’s outcome.

Auditors also may compare past estimates to what happened after the financial statement date. The outcome of an estimate is often different from management’s preliminary estimate. Possible explanations include errors, unforeseeable subsequent events and management bias. If management’s estimates are consistently similar to actual outcomes, it adds credibility to management’s prior estimates. But if significant differences are found, the auditor may be more skeptical of management’s current estimates, necessitating the use of additional audit procedures.

Why estimates matter

Accounting estimates are a key focus area for auditors because small changes in management’s assumptions can have material effects on a company’s financial statements. Through rigorous testing, professional skepticism and independent analysis, auditors can help promote accurate, reliable financial reporting.

As audit season gets underway for calendar-year businesses, now’s a good time to review significant accounting estimates and address gaps in documentation. Taking these proactive measures can help streamline the audit process and reduce the risk of unnecessary delays. Contact FMD with questions or for assistance preparing for your audit.