Financial Statement Audit vs. Collateral Based Field Exam

December 2012       Download PDF      Print

Borrowers inevitably find themselves in situations where they are receiving financial statement audits by their outside CPA firm and field exams by their lender. In these cases, the volume of information requests can be overwhelming. Understanding the differences between a financial statement audit versus a bank's collateral-based field exam can be very helpful in preparing for each process. A financial statement audit will perform certain tests based on the auditors' assessed level of risk and overall materiality specific to the company. Materiality can be determined based on a range of percentages relative to net income (5%), total assets (.3%), total revenue (.5%), or total equity (1%). The audit is not prepared for the sake of validating the default risk and risk of loss a lender may face by financing a company's operating needs using accounts receivable and inventory financing.

Determination of ineligible AR (e.g. affiliate AR, foreign AR, balances >90 days including 'taint rule' application, etc.) Yes, to a limited degree. Related party AR (e.g. unconsolidated affiliates) will be disclosed. Yes, and this tends to be detailed. Foreign AR and specific customer balances over 90 days will be identified. Field exams can also uncover cases where the customer's AR >90 days as a % of the total balance is high (e.g. > 25%) creating concerns with the total balance.
Invoice documentation analysis (e.g. analysis of pre-billing and assignment dates, purchase order (PO) versus shipment activity, etc.) Yes, to a limited degree. The auditors would be concerned when 'bill and hold' activity occurs. This would be heavily focused on revenue recognition criteria to determine if the company can recognize profit upon invoicing or if it should be deferred until shipment. Yes, and this tends to be detailed. In addition to 'bill and hold' sales, field exams will focus on trying to determine 1) if customer PO's were shipped after the PO's were cancelled, 2) if shipments were made before requested dates per customer PO, or 3) if shipments were in excess of amounts requested in customer PO. These are indicators of lower quality receivables or potential ineligibles.
Credit memo analysis (e.g. calculation of total lag days and determination of weighted average lag to be applied to total credit memo dollars) No. Yes, and this tends to be detailed.
Detailed analysis of AR dilution Yes, to a limited degree. Note that if the amount of sales returns and allowances for discounts is not considered by the auditor to be 'material' to the company's business, then no consideration will be given to this form of dilution. Yes, and this tends to be detailed.
Cash application test (e.g. verification of AR turnover ratio in total and for large customers) No. Yes, and this tends to be detailed.
Concentration analysis Yes, to a limited degree. Customers making up >10% of total AR will be accumulated and disclosed in the footnotes to the audited financial statements. Individual customers will not be disclosed. Note that when a consolidated group of companies will be reported, the 10% threshold can increase. Yes, and this tends to be detailed.
Analysis of ineligible inventories (e.g. inventories that are nontrade, out on consignment, over 365 days old, work-in-process, etc.) Yes, to a limited degree. This is generally covered in the reserve for slow moving and obsolete inventory procedures. However it is important to note that this reserve is not broken down by inventory type and in cases where the reserve is not considered 'material', no reserve balance will be disclosed. Yes, and this tends to be detailed. This analysis can break down the inventory reserve by inventory type allowing for more effective borrowing base calculations.
Comparison of custom orders manufactured to existing (PO) No. Yes.
Inventory classification analysis to determine if items are appropriately grouped as raw material, work-in-process and finished goods Yes. This is generally an indirect procedure based on the sample of items that would be selected for price testing or cost build-up. Yes.
Analysis of in-transit inventory Yes. This procedure will have a materiality threshold applied to it to determine if it warrants the auditors' attention. Therefore, if the amount is considered 'immaterial', it would likely not be evaluated. Yes.

Mariner Capital Advisors provides collateral -based field exam and business valuation services to lenders and their borrowers to help evaluate underlying loan collateral and lending decisions.

This document is for informational use only and may be outdated and/or no longer applicable. Nothing in this publication is intended to constitute legal, tax, or investment advice. There is no guarantee that any claims made will come to pass. The information contained herein has been obtained from sources believed to be reliable, but Mariner Capital Advisors does not warrant the accuracy of the information. Consult a financial, tax or legal professional for specific information related to your own situation.