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Overview of inventory reporting methods

It’s critical to report inventory using the optimal method. There are several legitimate options for reporting inventory — but take heed: The method you choose ultimately affects how much inventory and profit you’ll show and how much tax you’ll owe.

The basics

Inventory is generally recorded when it’s received and title transfers to the company. Then, it moves to cost of goods sold when the product ships and title transfers to the customer. But you can apply different inventory methods that will affect the value of inventory on your company’s balance sheet.

FIFO vs. LIFO

Under the first-in, first-out (FIFO) method, the first units entered into inventory are the first ones presumed sold. Conversely, under the last-in, first-out (LIFO) method, the last units entered are the first presumed sold.

In an inflationary environment, companies that report inventory using FIFO report higher inventory values, lower cost of sales and higher pretax earnings than otherwise identical companies that use LIFO. So, in an increasing-cost market, companies that use FIFO appear stronger — on the surface.

But LIFO can be an effective way to defer taxes and, therefore, improve cash flow. Using LIFO causes the low-cost items to remain in inventory. Higher cost of sales generates lower pretax earnings as long as inventory keeps growing. To keep inventory growing and avoid expensing old cost layers, however, some companies may feel compelled to produce or purchase excessive amounts of inventory. This can be an inefficient use of resources.

Specific identification

When a company’s inventory is one of a kind, such as artwork or custom jewelry, it may be appropriate to use the specific-identification method. Here, each item is reported at historic cost and that amount is generally carried on the books until the specific item is sold. But a write-off may be required if an item’s market value falls below its carrying value.

Weighing your options

Each inventory reporting method has pros and cons — and what worked when you started your business may not be the right choice today. As you prepare for year end, consider whether your method is still optimal, given your current size and business operations, expected market conditions, and today’s tax laws and accounting rules. Not sure what’s right? We can help you evaluate the options.

© 2016

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Combining business and vacation travel: What can you deduct?

If you go on a business trip within the United States and tack on some vacation days, you can deduct some of your expenses. But exactly what can you write off?

Transportation expenses

Transportation costs to and from the location of your business activity are 100% deductible as long as the primary reason for the trip is business rather than pleasure. On the other hand, if vacation is the primary reason for your travel, then generally none of your transportation expenses are deductible.

What costs can be included? Travel to and from your departure airport, airfare, baggage fees, tips, cabs, and so forth. Costs for rail travel or driving your personal car are also eligible.

Business days vs. pleasure days

The number of days spent on business vs. pleasure is the key factor in determining if the primary reason for domestic travel is business. Your travel days count as business days, as do weekends and holidays if they fall between days devoted to business, and it would be impractical to return home.

Standby days (days when your physical presence is required) also count as business days, even if you aren’t called upon to work those days. Any other day principally devoted to business activities during normal business hours also counts as a business day, and so are days when you intended to work, but couldn’t due to reasons beyond your control (such as local transportation difficulties).

You should be able to claim business was the primary reason for a domestic trip if business days exceed personal days. Be sure to accumulate proof and keep it with your tax records. For example, if your trip is made to attend client meetings, log everything on your daily planner and copy the pages for your tax file. If you attend a convention or training seminar, keep the program and take notes to show you attended the sessions.

Once at the destination, your out-of-pocket expenses for business days are fully deductible. These expenses include lodging, hotel tips, meals (subject to the 50% disallowance rule), seminar and convention fees, and cab fare. Expenses for personal days are nondeductible.

We can help

Questions? Contact us if you want more information about business travel deductions.

© 2016

Government official stealing money from taxpayers

Beware of accounts deceivable

More than half of financial statement frauds involve sales and accounts receivable, according to the Committee of Sponsoring Organizations of the Treadway Commission. (COSO is a joint initiative of five private sector organizations that develops frameworks and guidance on enterprise risk management, internal control and fraud deterrence.) But why do fraudsters tend to target accounts receivable?

For accrual-basis entities, accounts receivable is typically one of the most active accounts in the general ledger. It’s where companies report contract revenue and any other sales that are invoiced to the customer (rather than paid directly in cash). The sheer volume of transactions flowing through this account helps hide a variety of scams. Here are some examples.

Fictitious sales

Sometimes fraudsters book phony sales — and receivables — to make their company’s performance appear rosier than reality. Increased sales assure stakeholders that the company is growing and building market share. They also increase profits artificially, because bogus sales generate no costs. And, overstated receivables inflate the collateral base, allowing the company to secure additional financing.

Timing differences

Unscrupulous owners or employees might manipulate cutoffs to boost sales and receivables in the current accounting period. For example, a salesperson could prematurely report a large contract sale even though material uncertainties exist. A retail chain CFO could hold the accounting period open a few extra days to boost year-end sales. Or a contractor might use aggressive percentage-of-completion estimates to boost revenues.

Lapping

Some employees divert customer payments for their personal use. Then, the fraudster applies a subsequent payment from another customer to the customer whose funds were stolen. The second customer’s account is credited by a third customer’s payment, and so on. Delayed payments continue until the fraudster repays the money, makes an adjusting journal entry or gets caught.

Know the red flags

Accounts receivable fraud can be hard to unearth. Fortunately, experienced forensic accountants know to look for such anomalies as:

  • Dramatically increased accounts receivable compared to sales or total assets,
  • Revenues increasing without a proportionate increase in cost of sales or shipping costs,
  • Deteriorating collections, and
  • Significant write-offs and returns in subsequent periods.

If something seems awry with your accounts receivable, we can help verify your outstanding balances and find holes in your internal controls system to safeguard against future scams.

© 2016

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To deduct business losses, you may have to prove “material participation”

You can only deduct losses from an S corporation, partnership or LLC if you “materially participate” in the business. If you don’t, your losses are generally “passive” and can only be used to offset income from other passive activities. Any excess passive loss is suspended and must be carried forward to future years.

Material participation is determined based on the time you spend in a business activity. For most business owners, the issue rarely arises — you probably spend more than 40 hours working on your enterprise. However, there are situations when the IRS questions participation.

Several tests

To materially participate, you must spend time on an activity on a regular, continuous and substantial basis.

You must also generally meet one of the tests for material participation. For example, a taxpayer must:

  1. Work 500 hours or more during the year in the activity,
  2. Participate in the activity for more than 100 hours during the year, with no one else working more than the taxpayer, or
  3. Materially participate in the activity for any five taxable years during the 10 tax years immediately preceding the taxable year. This can apply to a business owner in the early years of retirement.

There are other situations in which you can qualify for material participation. For example, you can qualify if the business is a personal service activity (such as medicine or law). There are also situations, such as rental businesses, where it is more difficult to claim material participation. In those trades or businesses, you must work more hours and meet additional tests.

Proving your involvement

In some cases, a taxpayer does materially participate, but can’t prove it to the IRS. That’s where good recordkeeping comes in. A good, contemporaneous diary or log can forestall an IRS challenge. Log visits to customers or vendors and trips to sites and banks, as well as time spent doing Internet research. Indicate the time spent. If you’re audited, it will generally occur several years from now. Without good records, you’ll have trouble remembering everything you did.

Passive activity losses are a complicated area of the tax code. Consult with your tax adviser for more information on your situation.

© 2016

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Related-party transactions: Think like an auditor

Issues between related parties played a prominent role in the scandals that surfaced more than a decade ago at Enron, Tyco International and Refco. Similar problems have arisen in more recent financial reporting fraud cases, prompting the Public Company Accounting Oversight Board (PCAOB) to unanimously approve a tougher audit standard on related-party transactions and financial relationships. To prevent your company from issuing financial statements with undisclosed or misleading information about these relationships, think like an auditor.

It’s all relative

Under PCAOB Auditing Standard No. 18 (AS 18), Related Parties, Amendments to Certain PCAOB Auditing Standards Regarding Significant Unusual Transactions, and Other Amendments to PCAOB Auditing Standards, related parties include the company’s directors, executives and their family members.

Ultimately, companies are responsible for the preparation of their financial statements, including the identification of these related parties. However, auditors are on the lookout for undisclosed related parties and unusual transactions.

Where to look

Certain types of questionable transactions also might signal that a company is engaged in related-party transactions. Examples include contracts for below-market goods or services, bill-and-hold arrangements, uncollateralized loans and subsequent repurchase of goods sold.

Where can you find evidence of undisclosed related parties? Auditors are trained to consider these types of source materials:

  • Proxy statements,
  • Disclosures contained on the company’s website,
  • Confirmation responses, correspondence and invoices from the company’s attorneys,
  • Tax filings,
  • Life insurance policies purchased by the company,
  • Contracts or other agreements, and
  • Corporate organization charts.

Auditors also scrutinize compensation arrangements and other financial relationships with executives that may create incentives to engage in fraud to meet financial targets.

Leave no stone unturned

AS 18 requires public company auditors to obtain a more in-depth understanding of every related-party financial relationship and transaction, including its nature, terms and business purpose (or lack thereof). Moreover, it requires auditors to communicate with the audit committee throughout the audit process about related-party transactions — not just at the end of the engagement.

Related parties present risks to all kinds of entities, not just public companies. Smaller companies and start-ups also tend to engage in numerous related-party transactions, such as rental and compensation arrangements. These arrangements increase the risks of fraud and legal violations, warranting increased attention for companies of all sizes.

© 2016

NOLbrief

Will your business have a net operating loss? Make the most of it

When the deductible expenses of a business exceed its income, a net operating loss (NOL) generally occurs. If you’re planning ahead or filing your income tax return after an extension request and you find that your business has a qualifying NOL, there’s some good news: The loss may generate some tax benefits.

Carrying back or forward

The specific rules and exact computations to figure an NOL can be complex. But when a business incurs a qualifying NOL, the loss can be carried back up to two years, and any remaining amount can be carried forward up to 20 years. The carryback can generate an immediate tax refund, boosting cash flow during a time when you need it.

However, there’s an alternative: The business can elect instead to carry the entire loss forward. If cash flow is fairly strong, carrying the loss forward may be more beneficial, such as if the business’s income increases substantially, pushing it into a higher tax bracket — or if tax rates increase. In both scenarios, the carryforward can save more taxes than the carryback because deductions are more powerful when higher tax rates apply.

Your situation is unique

Your business may want to opt for a carryforward if its alternative minimum tax liability in previous years makes the carryback less beneficial. In the case of flow-through entities, owners might be able to reap individual tax benefits from the NOL. Also note that there are different NOL rules for farming businesses.

Please contact us if you’d like more information on the NOL rules and how you can maximize the tax benefits of an NOL.

© 2016

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The basics of pushdown accounting

Both public and private companies can elect to use “pushdown” accounting when there’s a merger, acquisition or other change-in-control event. What does this mean — and when might this alternative reporting method be advantageous?

Understanding your options

Pushdown accounting refers to the practice of adjusting an acquired company’s standalone financial statements to reflect the acquirer’s accounting basis rather than the target’s historical costs. Typically, this means stepping up the target’s net assets to fair value and, to the extent the purchase price exceeds fair value, recognizing the excess as goodwill.

In 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-17, Business Combinations (Topic 805): Pushdown Accounting (a consensus of the FASB Emerging Issues Task Force). The updated guidance made pushdown accounting optional for all companies.

Reporting post-M&A performance

Whether pushdown accounting is appropriate depends on a company’s particular circumstances. For some companies, there may be advantages to reporting assets and liabilities at fair value and adopting consistent accounting policies for both the parent and subsidiary. Other companies may prefer not to apply pushdown accounting to avoid the negative impact on earnings, often associated with a step-up to fair value.

Previously, U.S. Generally Accepted Accounting Principles (GAAP) provided little guidance on when pushdown accounting might be appropriate. For public companies, SEC guidance generally prohibited pushdown accounting unless the acquirer obtained at least an 80% interest in the target, and it generally required pushdown accounting when the acquirer’s interest reached 95%. The SEC has rescinded portions of its pushdown accounting guidance, bringing it in line with the FASB’s new standard.

Weighing your options

For each individual change-in-control event, acquired companies must evaluate the option to apply pushdown accounting. And once pushdown accounting is applied, the election is irrevocable. Acquired companies that apply pushdown accounting in their standalone financial statements are required to include disclosures in the current reporting period to help users evaluate its effects. Contact our A&A specialists for help deciding whether to elect this reporting option.

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Can you claim a home office deduction for business use?

You might be able to claim a deduction for the business use of a home office. If you qualify, you can deduct a portion of expenses, including rent or mortgage interest, depreciation, utilities, insurance, and repairs. The exact amount that can be deducted depends on how much of your home is used for business.

Basic rules for claiming deductions

The part of your home claimed for business use must be used:

  • Exclusively and regularly as your principal place of business,
  • As a place where you meet or deal with patients, clients, or customers in the normal course of business,
  • In connection with your trade or business in the case of a separate structure that’s not attached to your home, and
  • On a regular basis for the storage of inventory or samples.

A strict interpretation

The words “exclusively” and “regularly” are strictly interpreted by the IRS. Regularly means on a consistent basis. You can’t qualify a room in your home as an office if you use it only a couple of times a year to meet with customers. Exclusively means the specific area is used solely for business. The area can be a room or other separately identifiable space. A room that’s used for both business and personal purposes doesn’t meet the test.

The exclusive use rule doesn’t apply to a daycare facility in your home.

What if you’re audited?

Home office deductions can be an audit target. If you’re audited by the IRS, it shouldn’t result in additional taxes if you follow the rules, keep records of expenses and file an accurate, complete tax return. If you do have a home office, take pictures of the setup in case you sell the house or discontinue the use of the office while the tax return is still open to audit.

There are more rules than can be covered here. Contact us about how your business use of a home affects your tax situation now and in the future. Also be aware that deductions for a home office may affect the tax results when you eventually sell your home.

© 2016

celebrateIT

Let’s Celebrate IT!

LianaEllison - Copy.jpg By Liana Ellison, CPA

Tax/Accounting Services Supervisor at Atchley & Associates, LLP

 

What is “IT”, you ask? Well, at Atchley & Associates, LLP, “IT” can be anything, such as a new client, a birthday, a volunteer team or a sponsored event. We love to celebrate. In our business, people mean everything to us including our clients, our community, our employees and our families so any time we can celebrate these folks, we do it. Atchley & Associates, LLP strives to celebrate the wins, the accomplishments and the successes right alongside these people, because when we do, we know it shifts our focus and changes our culture for the better.

I have been with Atchley & Associates, LLP since September of 2015 and in ten short months I have been amazed at the ways we choose to celebrate. We are known for providing outstanding technical services, and I believe that I work among the smartest people in our industry. I especially love that we do so much to honor, recognize, validate and celebrate with our “people”.

Below are some examples of the “IT”s we have celebrated in those ten short months:

Community and Client Celebrations

  • Our Community Task Force volunteers for Umlauf Sculpture Garden, Settlement Home Garage Sale, Safe Place Christmas sponsor and It’s My Park Day
  • We are a sponsor for the Austin Forum on Technology and Society
  • We partnered with Mission Capital Party for Good Sponsor
  • We provided a scholarship to a Lanier High School
  • We were an event sponsor for the Austin Child Guidance Center
  • We were a sponsor and recipient of the Ethics in Business and Community award
  • We were an event sponsor for the Austin CPA Chapter awards banquet
  • At our annual retreat, our entire firm volunteered at Central Texas Food Bank
  • We held a discover session meeting with Digital Union to tie our profits to purpose
  • We celebrated each new client
  • We provided pro-bono work for some smaller non-profits

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Employee Celebrations

  • We give Kudos at monthly staff meetings
  • We have an “Employee Spotlight of the Month”
  • We toasted to an awesome New Year, passing of CPA Exams, birthdays, weddings, and new babies
  • We celebrated the end of tax season with a happy hour, a bowling tournament in the spring and ping pong tournament in the fall
  • We loved dressing up and celebrating Halloween together
  • We celebrated our families and invited them to work for a day for Thanksgiving
  • We celebrated together with a lovely meal for a Holiday luncheon
  • We celebrated Karen Atchley on being a finalist for the 2016 Women’s Way Awards
  • We celebrated the year-over-year growth and milestones at our Annual Retreat
  • We even celebrated National Beer Day!

It’s hard to pinpoint a sole celebration that made the biggest impact on me, but recently we celebrated the fact that we provided a scholarship to a young high school student, who will be the first person in her family (meaning parents, grandparents and anyone else before her) to attend college.  She will attend nursing school this fall at The University of Texas in Austin. I celebrate that this contribution by Atchley & Associates, LLP will pay dividends in her life for years to come.

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Celebrating these “ITs” is in our DNA—it is part of our culture and makes us who we are. This commitment to celebrating keeps our employees engaged and proud to be part of a firm that understands the value in celebrating.   You might ask, is it too much? And my response would be an overwhelming “No!”  If you want a successful organization, recognize, reward, honor, value and celebrate with your “people.” Celebrate what you want to see more of.  It will change the way you connect with the people in your life in a positive and meaningful way.

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Fraud Awareness and the Small Business 2016

By Frank Stover, CPA/CFF/CGMA, CFE

Audit Manager at Atchley & Associates, LLP

The Association of Certified Fraud Examiners has released the biennial Report To The Nations on Occupational Fraud and Abuse, a 2016 Global Fraud Study.

For small business the fraud that owners will most often see committed against them or their company is “occupational fraud”.  The Association of Certified Fraud Examiners defines occupational fraud “as the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets.”  Occupational fraud can manifest itself in many ways.  Nor is it limited by gender.

Based upon the statistics and information contained in the “Report to the Nations on Occupational Fraud and Abuse”, 2016 Global Fraud Study, approximately two thirds of the reported cases targeted privately and publicly held companies.  Private companies suffered median losses of $180,000. The median losses suffered by small organizations (those with less than 100 employees) was the same as those of the largest organizations, but the impact upon smaller organizations would be much greater.  The total losses caused by the cases studied exceeded $6.3 billion. It is estimated that fraud costs organizations 5% of revenues each year, applying this percentage to the Gross World Product of $74.16 trillion results in a potential total fraud loss worldwide of $3.7 trillion.  Constant vigilance to prevent fraudulent activity is something that small business owners must practice every day.

Generally, occupational fraud categorized as financial statement fraud, misappropriation of assets, or corruption.  Asset misappropriation was the most common form of fraud reported in more than 83% of the cases studied.  Financial statement fraud will typically involve falsification of an organization’s financial statements or some form of regulatory or financial report. Examples include overstating assets and revenues, or understating liabilities or expenses to achieve personal gain.  Misappropriation of assets is the theft or misuse of an organization’s assets, such as skimming revenues, stealing inventory or committing payroll fraud.  Corruption involves fraudsters wrongfully use their influence in a business transaction to procure some benefit for themselves or another person(s), contradicting their duty to their employer or the rights of another, for instance by accepting kickbacks or engaging in conflicts of interest.

94.5% of the cases studied involved the perpetrator making efforts to conceal their fraud by creating or altering physical documentation.

For Small businesses cash, inventory, payroll and misuse of organization assets are the most common areas of fraud occurrence.  Cash is the most often pilfered from small business but because of its nature and importance to small businesses it is usually discovered within one month.  Inventory fraud is usually not discovered until later because small organizations will be more focused on operation measures (for example, revenues run rates, billing cycle  and accounts receivable information) in the short term and inventory will not be counted or reconciled against purchases and jobs in progress until quarter or year end.  Payroll fraud is usually committed by persons who have some form of operational control and authorization such that they can add phantom employees to the payroll or in collusion with others falsified time records submitted to the payroll department, this type of fraud is most usually discovered when there is turnover in personnel, a “falling out” between conspirators, or some form of periodic management review and reconciliation of historical project costs against approved budgets.  Misuse of organization assets many times occurs when a service company employee uses their employer’s assets on the weekend and holidays to run another business on the side, discovery of this type of fraud will usually occur when a disgruntled customer of the employee’s side business complains regarding defective work or makes a warranty claim, control of physical access to company operating assets during no business hours and mileage logs reconciliations are several ways to prevent or detect such abuse.

The most common detection methods in the cases studied were tips (39.1%).  Organizations that had reporting hotlines were much more likely to detect fraud through tips.

There are fraud policies and controls which can assist small businesses in deterring bad behavior.  Some of these include having a clearly written and communicated fraud policy which describes how and who handles fraud matters and investigations within the organization, what actions the organization considers to constitute fraud, reporting procedures (anonymous tip lines, a designated official, etc.), and what consequences the organization will take for such activity and the dedication to follow through with those stated consequences.

Atchley & Associates, LLP is a group of dedicated professionals, which include Certified Fraud Examiners, who can review, assess and make recommendations regarding small business systems of internal controls to decrease the likelihood of fraud being committed.