What’s more shocking: HP’s $8.8 billion (yes, billion!) impairment charge recorded in its recently completed fourth quarter, or the fact that it blames the charge on the “accounting improprieties and disclosure failures” of Autonomy, a UK-based company it acquired just last year? Clearly, investors were not pleased, as evinced by the immediate drop in stock price after the announcement was made. What lingers, though, is an aching question that haunts companies contemplating an acquisition: if HP, with its significant M&A experience and multiple Big Four audit teams, failed to see through Autonomy’s misrepresentations, then what hope is there for the rest of us?

Investigations by the Securities and Exchange Commission’s Division of Enforcement and the UK’s Serious Fraud Office are under way to determine whether evidence of fraud exists. I think it’s safe to say that detecting fraud at a target company is not typically engrained in the pre-acquisition due diligence process. However, consider this: what if the “improprieties” weren’t fraud per se, but instead liberal interpretations of principles-based international financial reporting standards?

Drawing focus to areas requiring extensive judgment and assumptions should be an integral part of the due diligence process. Even where the financial statements have already been audited by a reputable firm, focusing on the gray can be exceptionally beneficial: it can highlight areas of financial risk; it can provide greater insights in vetting forecasted financial results; and it can identify areas where the target’s accounting policies differ from your own.

More often than not, the financial due diligence process is focused on quantifying the net assets of the business (aka “scrubbing the balance sheet”) and understanding the assumptions underlying the company’s financial projections. However, attention should also be given to those accounting policies for which judgment and/or material estimates are required. SEC registrants often refer to such policies as “critical accounting estimates” and include required disclosures in the Management Discussion & Analysis section of their periodic filings. Private companies are not required to provide such disclosures, and they may only touch on general accounting policies in the footnotes.

Critical accounting estimates often include areas such as rev rec, asset impairment analysis, contingent liabilities, income taxes and reserve accounting, including warranty provisions, bad debt allowance and reserves for excess and obsolete inventory. Understanding your target’s policies with regard to these areas is critical, not only to assess the judgments applied, but also because certain accounting rules (especially those that are principles based) can provide leniency in interpretation, and different companies arguably have different risk profiles.

So the moral of the story is, no deal is ever black and white. The more time you spend understanding the gray, the better your chances are for understanding and valuing what you’re buying.

For an M&A due diligence checklist, see our report, M&A: Get What You Bargained For.

In my pre–Sarbanes-Oxley days, I worked with companies where it was tough to get audit committee members to attend meetings, and many of those meetings were check-the-box exercises without real value. The Sarbanes-Oxley Act changed the landscape significantly. Among other things, SOX clearly laid the responsibility for overseeing external audits on the shoulders of the audit committee—and now we are seeing increased focus on how the audit committee manages the external auditor.

Two documents recently issued by the SOX-created Public Company Accounting Oversight Board, which oversees the audits of public companies, focus on one aspect of that management: communication. The first, AS 16, Communications with Audit Committees, is aimed at increasing the relevance and quality of communication between audit committees and external audit firms. The second, Release No. 2012-003, Information for Audit Committees about the PCAOB Inspection Process, provides guidance on conversations that audit committees may wish to have with their external auditors.

A little background may be helpful. Each year, the PCAOB conducts inspections of audit firms. These inspections ascertain how the firms under review conducted their audits—in essence, whether their audit opinions were sufficiently supported by the facts. They also determine how committed the firms are to quality control—basically, whether they meet professional standards.

Release No. 2012-003 suggests some questions for an audit committee to ask its external auditor, including the following:

  • Has my audit been selected for a PCAOB review?
  • Have other companies similar to my business been selected for review?
  • What issues did these reviews raise?
  • What were the review findings?
  • If deficiencies were uncovered, how is the audit firm remediating them, and how will those efforts affect our company?

Be skeptical if your external auditor suggests that an issue identified was a documentation problem or a matter of professional judgment. You may find it difficult to imagine that your auditor did not gather sufficient evidence to form an opinion when your management team feels like it’s being audited to death—but perhaps this is an opportunity for some candid discussion. A benefit of talking with your auditor about the PCAOB inspection results is to gain more insight about issues the PCAOB is seeing across the profession, and to learn how you might be impacted by those issues and ways to get a leg up on proactively addressing them.

Audit committees are becoming more proactive in managing relationships with external auditors and in evaluating auditor performance—think quality of services and adequacy of resources. Ensuring the audit firm’s independence, objectivity and professional skepticism hinges on good communication.

Stock options in Silicon Valley are like free drinks in Las Vegas—and accounting for equity-based compensation often gets treated with the breezy inattention of a gambler ordering another round. But eventually some kind of tab will come due. Think company money and time, restatements and increased auditors’ scrutiny.

Our new report, Stock Options: Do You Have a Problem? by Kelley Wall of RoseRyan’s Technical Accounting Group walks you through the issues we see regularly and tells you how to get clean.

Don’t think this applies to you? Equity-related restatements most often stem from honest mistakes—and they’re more common than you might think. Why? Some companies aren’t fully aware of accounting requirements. Others have incomplete or broken internal processes. And some rely on equity systems with parameters and limitations they don’t really understand.

Let’s take one example. Stock-based awards to employees and nonemployees are accounted for differently. No big deal—but the problem we’ve observed is that companies fail to identify nonemployee recipients as nonemployees. Perhaps the stock administrator assumes all the grantees on a list of option grants are employees. Or the equity administrator doesn’t set up the system to identify both the individual and the grant as nonemployee. Or the accounting department doesn’t realize there are nonemployee awards, so it doesn’t ask for nonemployee stock-based compensation expense reports. In each case, the result is an understatement of expense.

You can avoid this and many other costly accounting mistakes by adopting our recommended best practices in the areas of communication, valuation, modifications/special arrangements and forfeiture rate estimation.

Don’t become yet another sobering example of a painful accounting breakdown. Check out our report to ensure that your equity compensation practices are up to snuff.

Let’s face it: whatever the climate for M&As and IPOs, positioning your business for a high valuation can be tricky. What if you could assemble a brain trust to give you the insider perspective on ensuring a big payday?

RoseRyan hears you. We pulled together a roundtable of Silicon Valley’s sharpest minds in accounting, investment analysis, business strategy and the law to answer exactly the questions you’d like to ask. We share the highlights in our new report, Boost Your Business’s Value: What to Do—and What Not to Do—When You Want to Be Worth a Fortune.

Our experts—RoseRyan’s Jim Goldhawk, Adrian Bray of Assay, Jim Chapman of Foley & Lardner and Tony Yeh of SVB Analytics—got deep into a conversation that reveals how complex valuation can be. Financial metrics are only part of the story. Qualitative factors—inflows of top talent and even the background of the founding group—can be predictors of competitiveness. But workforce won’t count as much after the close of deal. That’s when what the workforce has created drives value.

The good news is that even in skeptical times, entrepreneurs can bank against uncertainty to boost valuation. Culture, product positioning, customer mix, business infrastructure—all are within a company’s control. Moving away from commoditization, investing in due diligence, and pursuing what one of our thought leaders calls “organic growth” are a few strategies for preparing to pounce when the time is right.

Our last question: if there was one thing you could say to CEOs who are interested in or worried about their valuation, whether or not they have an exit strategy on the horizon, what would you tell them?

Check out our report to find out how our experts responded!

As inhabitants of Silicon Valley, we’re sure to have been shaken by an earthquake or two. For me, it’s always a reminder of how important it is to have a disaster plan and earthquake preparedness kit ready…for the big one! In the corporate world, there’s also a need to prepare for the inevitable—and that includes the SEC comment letter.

Technically speaking, Section 408 of the Sarbanes-Oxley Act of 2002 requires the Securities and Exchange Commission to review the filings of public registrants at least once every three years. And that review may be sooner if the company has reported a material misstatement, experienced significant volatility in its stock price or been affected by something the SEC deems relevant. Based on its review, the SEC issues a comment letter to start the dialogue with the company. It usually requests supplemental information so that SEC staff can better understand the company’s accounting and disclosures. Depending on the company, its activities and transactions, and the transparency of its disclosures, these letters can include a handful or dozens of comments.

Practically speaking, comment letters are known to hit the CFO’s fax machine just after close of market on an otherwise quiet Friday afternoon. In most cases, the SEC will ask the company to respond to its inquiry within 10 business days.

Instantly unsettled, corporate executives respond frantically (and sometimes in a panic), racking their brains about who they should call and assessing whether voicemails will be returned before the weekend. Then their minds wander to the level of risk inherent in the accounting and disclosures contained in their filings. And finally, they’re left asking, “What now?”

It doesn’t have to be this way. Creating an SEC preparedness plan can save time and money and is scientifically proven to lower stress levels.

Creating your emergency plan

It’s a given that responding to SEC inquiries requires time, resources and efficient project management capabilities.

First, create a SEC review preparedness folder on your company’s intranet—it should include copies of the following documentation:

  • All technical accounting memos, whether written by the company or your auditors
  • Correspondence with your auditors and legal counsel regarding key accounting and disclosure decisions
  • Any materiality assessments that were performed for evaluation of errors, disclosures and the like
  • Documentation regarding key transactions, including impairments, business acquisitions and restructuring activities
  • Restatement documentation (if applicable)

Having reviewed and assisted in the response to hundreds of SEC comments, I’m still amazed by how much time can be spent tracking down the information needed to respond.

Second, create a tactical plan that identifies who should be engaged in the response and how efforts will be coordinated. Comment responses should be both thoughtful and careful—you can’t do that if you’re in panic mode.

Consider the following steps:

  1. Coordinate a call with key accounting members, legal counsel, outside legal advisors and your auditors.
  2. Create a “response team,” which may include both accounting and legal personnel, capable of drafting responses.
  3. Develop a timeline, including when information will be gathered and when responses are due, allowing enough time for review.
  4. Determine who should be engaged in the review. Legal counsel and the auditors are a given, but what about your disclosure committee and board of directors?
  5. Assign a project coordinator to consolidate comments and keep everyone up-to-date and on schedule.

With key information at your fingertips and a tactical plan in hand, you won’t be shaken when the big one arrives.