As I prepare myself for a presentation on the “Basics of Accounting for Lawyers” for the Practicing Law Institute in San Francisco in July, I am debating on how much detail to include in the talk. I suppose that if the attorneys know why and how we as accountants rely on their work, they would better understand our requests for information and its urgency during our audits.
Clearly, there are the more obvious and commonly prepared documents by attorneys that we request from our clients such as company bylaws, articles of incorporation, minutes to board meetings, leases, stock option plans, shareholder agreements etc. But beyond that, there are instances where we need to communicate directly with the attorneys during an audit.
Claims and Assessments
One such instance is when we need a written legal representation regarding all pending litigation against the company in the form of claims and assessments that could potentially have a financial statement impact. Oftentimes, claims can result in an unfavorable outcome for the company, and attorneys are requested to evaluate the likelihood of such an outcome and estimate the amount of the potential loss. Once it is determined that the loss is probable (a concept that I can only do justice to with another post – keep an eye out for such a post) and can be reasonably estimated, then the management of the company has to recognize this loss contingency in its financials and make appropriate disclosures of the circumstances.
Another instance where significant attorney involvement is likely is the area of equity ownership of the company and the preparation of its capitalization table. The ownership of an entity is one of the most important areas in an audit and it is imperative to have a clear picture of who owns how much to avoid legal issues in the future. In order to gain this understanding of the equity ownership, CPAs may request the company’s attorneys, who also act as their stock transfer agent, to provide a detailed capitalization table and to confirm the various forms of securities issued by the company (common stock, preferred stock, warrants etc.), as well as the options outstanding and available to be issued under the company’s stock option plan. All of this information is summarized for presentation in the CPA prepared financials, so the readers are aware of the equity structure of the company and the rights and privileges of the stockholders.
Clearly, effective communication between a company’s trusted advisors is important. So I’m hoping that my presentation, as well as this post, will help reinforce that relationship.