accounting

The home office deduction: Actual expenses vs. the simplified method

If you run your business from your home or perform certain functions at home that are related to your business, you might be able to claim a home office deduction against your business income on your 2018 income tax return. There are now two methods for claiming this deduction: the actual expenses method and the simplified method.

Basics of the deduction

In general, you’ll qualify for a home office deduction if part of your home is used “regularly and exclusively” as your principal place of business.

If your home isn’t your principal place of business, you may still be able to deduct home office expenses if 1) you physically meet with patients, clients or customers on your premises, or 2) you use a storage area in your home (or a separate free-standing structure, such as a garage) exclusively and regularly for your business.

Actual expenses

Traditionally, taxpayers have deducted actual expenses when they claim a home office deduction. Deductible home office expenses may include:

  • Direct expenses, such as the cost of painting and carpeting a room used exclusively for business,
  • A proportionate share of indirect expenses, such as mortgage interest, property taxes, utilities, repairs and insurance, and
  • A depreciation allowance.

But keeping track of actual expenses can be time consuming.

The simplified method

Fortunately, there’s a simplified method that’s been available since 2013: You can deduct $5 for each square foot of home office space, up to a maximum total of $1,500.

For example, if you’ve converted a 300-square-foot bedroom to an office you use exclusively and regularly for business, you can write off $1,500 under the simplified method (300 square feet x $5). However, if your business is located in a 600-square-foot finished basement, the deduction will still be only $1,500 because of the cap on the deduction under this method.

As you can see, the cap can make the simplified method less beneficial for larger home office spaces. But even for spaces of 300 square feet or less, taxpayers may qualify for a bigger deduction using the actual expense method. So, tracking your actual expenses can be worth the extra hassle.

Flexibility in filing

When claiming the home office deduction, you’re not locked into a particular method. For instance, you might choose the actual expense method on your 2018 return, use the simplified method when you file your 2019 return next year and then switch back to the actual expense method thereafter. The choice is yours.

Unsure whether you qualify for the home office deduction? Or wondering whether you should deduct actual expenses or use the simplified method? Contact us. We can help you determine what’s right for your specific situation.

© 2019

What is and isn’t a financial statement audit?

by Tyler Mosley, CPA

Audit Partner at Atchley & Associates, LLP

 

In the public accounting world, we sometimes assume everyone knows what a financial statement audit is and what it isn’t. However, that is a misconception as the term “audit” can be used to describe a variety of compliance related activities.  For example, an income tax audit performed by the IRS is completely different than a financial statement audit performed by an independent auditor. So…what is a financial statement audit?

A financial statement audit is an examination of an organization’s financial statements by an independent auditor who must be a certified public accountant (CPA).  The examination is performed in accordance with Generally Accepted Auditing Standards (GAAS) and a reporting framework chosen by the party who authorizes the audit engagement.  In most cases, the framework chosen is Generally Accepted Accounting Standards (GAAP) as that is what most third parties who request a financial statement audit require.  However, a financial statement audit can be performed using a variety of reporting frameworks, such as but not limited to income tax basis, modified cash basis, cash basis, or statutory basis.

The independent auditors’ role in the engagement is to provide an opinion on whether or not the financial statements presented are materially correct in all respects related to the reporting framework chosen.  An audit involves the independent auditors obtaining an understanding of your organization’s internal control, assessing fraud risk, substantively testing accounting records through inspection, observation, and third-party confirmation or corroborative inquiry.

Now that we have defined what a financial statement audit is, let’s discuss what it isn’t.  A financial statement audit does not serve the same purpose as a financial statement compilation or review.

A financial statement review provides a conclusion as to whether they believe any material modifications should be made to the presented financial statements based on the reporting framework that has been chosen.  In a review engagement, the CPA is required to understand the industry in which the organization operates including accounting principles that are unique to the industry.  The CPA will also ask questions about your financial activity and perform analytical procedures to identify areas in the financial statements where material misstatements are likely to arise.  The CPA does not obtain an understanding of your organization’s internal controls, assess fraud risk, or substantively test accounting records.  As such, the CPA only provides limited assurance on the financial statements.

A financial statement compilation is a service that does not have to be performed by a CPA or even an independent third party. However, if the person preparing the compilation is not independent they must disclose the fact in the compilation.  The CPA does not provide an opinion on if the financial statements presented are materially correct nor do they provide a conclusion like they would for a review.

We encourage all our clients to inform us of the purpose of the compilation, review, or audit engagement services they are requesting so we can assist in determining what level of service is appropriate for their needs.  The time required to perform the engagement increases as you move from compilation to review to an audit.

Private companies: Have you implemented the new revenue recognition standard?

Private companies that follow U.S. Generally Accepted Accounting Principles (GAAP) must comply with the landmark new revenue recognition standard in 2019. Many private company CFOs and controllers report that they still have significant work to do to meet the demands of the sweeping rules. If you haven’t started the implementation process, it’s time to get the ball rolling.

Lessons from public company peers

Affected private companies must start following Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Accounting Standards Codification Topic 606), the first time they issue financial statements in 2019. For private companies with a fiscal year end or issuing quarterly statements under U.S. GAAP, that could be within the next few months. Other private companies have until the end of the year or even early 2020. No matter what, it’s crunch time.

Public companies, which had to begin following the standard in 2018, reported that, even if the new accounting didn’t radically change the number they reported in the top line of their income statements, it changed the method by which they had to calculate it. They had to comb through contracts and offer paper trails to back up their estimates to auditors. Public companies largely reported that the standard was more work than they anticipated. Private companies can expect the same challenges.

An overview

The revenue recognition standard erases reams of industry-specific revenue guidance in U.S. GAAP and attempts to come up with the following five-step revenue recognition model for most businesses worldwide:

  1. Identify the contracts with a customer.
  2. Identify the performance obligations in the contract.
  3. Determine the transaction price.
  4. Allocate the transaction price to the performance obligations.
  5. Recognize revenue as the entity satisfies a performance obligation.

In many cases, the revenue a company reports under the new guidance won’t differ much from what it reported under old rules. But the timing of when a company can record revenues may be affected, particularly for long-term, multi-part arrangements. Companies also must assess:

  • The extent by which payments could vary due to such terms as bonuses, discounts, rebates and refunds,
  • The extent that collected payments from customers is “probable” and won’t result in a significant reversal in the future, and
  • The time value of money to determine the transaction price.

The result is a process that offers fewer bright-line rules and more judgment calls compared to old U.S. GAAP.

We can help

Our accounting experts can help you avoid a “fire drill” right before your implementation deadline and employ best practices learned from public companies that made the switch in 2018. Contact us for help getting your revenue reporting systems, processes and policies up to speed.

© 2019

6 last-minute tax moves for your business

Tax planning is a year-round activity, but there are still some year-end strategies you can use to lower your 2018 tax bill. Here are six last-minute tax moves business owners should consider:

  1. Postpone invoices. If your business uses the cash method of accounting, and it would benefit from deferring income to next year, wait until early 2019 to send invoices. Accrual-basis businesses can defer recognition of certain advance payments for products to be delivered or services to be provided next year.
  2. Prepay expenses. A cash-basis business may be able to reduce its 2018 taxes by prepaying certain expenses — such as lease payments, insurance premiums, utility bills, office supplies and taxes — before the end of the year. Many expenses can be deducted up to 12 months in advance.
  3. Buy equipment. Take advantage of 100% bonus depreciation and Section 179 expensing to deduct the full cost of qualifying equipment or other fixed assets. Under the Tax Cuts and Jobs Act, bonus depreciation, like Sec. 179 expensing, is now available for both new and used assets. Keep in mind that, to deduct the expense on your 2018 return, the assets must be placed in service — not just purchased — by the end of the year.
  4. Use credit cards. What if you’d like to prepay expenses or buy equipment before the end of the year, but you don’t have the cash? Consider using your business credit card. Generally, expenses paid by credit card are deductible when charged, even if you don’t pay the credit card bill until next year.
  5. Contribute to retirement plans. If you’re self-employed or own a pass-through business — such as a partnership, limited liability company or S corporation — one of the best ways to reduce your 2018 tax bill is to increase deductible contributions to retirement plans. Usually, these contributions must be made by year-end. But certain plans — such as SEP IRAs — allow your business to make 2018 contributions up until its tax return due date (including extensions).
  6. Qualify for the pass-through deduction. If your business is a sole proprietorship or pass-through entity, you may qualify for the new pass-through deduction of up to 20% of qualified business income. But if your taxable income exceeds $157,500 ($315,000 for joint filers), certain limitations kick in that can reduce or even eliminate the deduction. One way to avoid these limitations is to reduce your income below the threshold — for example, by having your business increase its retirement plan contributions.

Most of these strategies are subject to various limitations and restrictions beyond what we’ve covered here, so please consult us before you implement them. We can also offer more ideas for reducing your taxes this year and next.

© 2018

4 steps to auditing AP

At most companies, the accounts payable (AP) department handles an enormous volume of transactions. So, the AP ledger may be prone to errors or used to bury fraudulent journal entries. How do auditors get a handle on AP? They use four key procedures to evaluate whether this account is free from“material misstatement” and compliant with U.S. Generally Accepted Accounting Principles (GAAP).

1. Examination of SOPs

Standard operating procedures (SOPs) are critical to a properly functioning AP department. However, some companies haven’t written formal SOPs— and others don’t always follow the SOPs they’ve created.

If SOPs exist, the audit team reviews them in detail. They also test a sample of transactions to determine whether payables personnel follow them.

If the AP department hasn’t created SOPs — or if existing SOPs don’t reflect what’s happening in the department — the audit team will temporarily stop fieldwork. Auditors will resume testing once the AP department has issued formal SOPs or updated them as needed.

2. Analysis of paper trails

Auditors use the term “vouching” to refer to the process of tracking a transaction from inception to completion. Analyzing this paper trail requires auditors to review original source documents, such as:

  • Purchase orders,
  • Vendor invoices,
  • Journal entries for AP and inventory, and
  • Bank records.

The audit team may select transactions randomly, as well as based on a transaction’s magnitude or frequency. They’ll also ascertain whether the company has complied with invoice terms and received the appropriate discounts.

3. Confirmations

Auditors may send forms to the company’s vendors asking them to “confirm” the balance owed. Confirmations can either:

  • Include the amount due based on the company’s accounting records, or
  • Leave the balance blank and ask the vendor to complete it.

If the amount confirmed by the vendor doesn’t match the amount recorded in the AP ledger, the audit team will note the exception and inquire about the reason. Unresolved discrepancies may require additional testing procedures and could even be cause for a qualified or adverse audit opinion,depending on the size and nature of the discrepancy.

4. Verification of financial statements

Auditors compare the amounts recorded in the company financial statements to the records maintained by the AP department. This includes reviewing the month-end close process to ensure that items are posted in the correct accounting period (the period in which expenses are incurred).

Auditors also review the process for identifying and recording related-party transactions. And they search for vendor invoices paid with cash and unrecorded liabilities involving goods or services received but yet not processed for payment.

Get it right

These four procedures may be conducted as part of a routine financial statement audit — or you may decide to hire an auditor to specifically target the AP department. Either way, your payables personnel can help streamline fieldwork by having the formal SOPs in place and source documents ready when the audit team arrives. Contact us for more information about what to expect during the coming audit season.

© 2018

Beware of unexpected tax liabilities under new accounting and tax rules!

The Tax Cuts and Jobs Act (TCJA) contains a provision that ties revenue recognition for book purposes to income reporting for tax purposes, for tax years starting in 2018. This narrow section of the law could have a major impact on certain industries, especially as companies implement the updated revenue recognition standard under U.S. Generally Accepted Accounting Principles (GAAP).

Recognizing revenue under GAAP

Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, went into effect for public companies this year; it will go into effect for private companies next year. The updated standard requires businesses to all use a single model for calculating the top line in their income statements under GAAP, as opposed to following various industry-specific models.

The standard doesn’t change the underlying economics of a business’s revenue streams. But it may change the timing of when companies record revenue in their financial statements. The standard introduces the concept of “performance obligations” in contracts with customers and allows revenue to be recorded only when these obligations are satisfied. It could mean revenue is recorded right away or in increments over time, depending on the transaction.

The changes will be most apparent for complex, long-term contracts. For example, most software companies expect to record revenues in their financial statements earlier under ASU 2014-09 than under the old accounting rules.

Matching book and tax records

Starting in 2018, the TCJA modifies Section 451 of the Internal Revenue Code so that a business recognizes revenue for tax purposes no later than when it’s recognized for financial reporting purposes. Under Sec. 451(b), taxpayers that use the accrual method of accounting will meet the “all events test” no later than the taxable year in which the item is taken into account as revenue in a taxpayer’s “applicable financial statement.”

The TCJA also added Sec. 451(c), referred to as the “rule for advance payments.” At a high level, the rule can require businesses to recognize taxable income even earlier than when it’s recognized for book purposes if the company receives a so-called “advance payment.”

Some companies delivering complex products, such as an aerospace parts supplier making a custom component, can receive payments from customers years before they build and deliver the product. Under ASU 2014-09, a business can’t recognize revenue until it’s completed its performance obligations in the contract, even if an amount has been paid in advance. However, under Sec. 451(c), companies may be taxed before they recognize revenue on their financial statements from contracts that call for advance payments.

Will the changes affect your business?

Changes in the TCJA, combined with the new revenue recognition rules under GAAP, will cause some companies to recognize taxable income sooner than in the past. In some industries, this could mean significantly accelerated tax bills. However, others won’t experience any noticeable differences. We can help you evaluate how the accounting rule and tax law changes will affect your company, based on its unique circumstances.

© 2018

ASU 2016-14: Information about Liquidity

by Colleen Trombetta

Audit Senior at Atchley & Associates, LLP

 

Do you ever find yourself reading a set of financials statements and asking, “So how are we doing cash-wise?” or “Do we have enough cash to pay all our expenses this month… how about the next six months?” It’s clear that the readers of financial statements are concerned with cash. The FASB Accounting Standards Update (ASU) 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities, is going to address this concern of cash and take it one step further by addressing liquidity, which is more complex than just cash-on-hand.

The financial assets that an organization has available to cover operating expenses consist not only of cash, but also of assets that will turn into cash within the coming year, such as accounts receivable, contributions and grants receivable and short-term investments. On the balance sheet, these assets are presented as “Current Assets.” If there are no donor restrictions or board designations, the current assets would be disclosed in the financial statements notes as assets available to cover operating expenses within one year of the balance sheet date.

ASU 2016-14 will require disclosure of the organization’s policies for managing liquidity. The policies should cover areas such as cash reserves, available lines of credit, and investment of cash in excess of current operating needs.

ASU 2016-14 will also require nonprofits to present, on the face of the financial position, the amount for each of two classes of net assets— net assets with donor restrictions and net assets without donor restrictions— as opposed to three.

ASU 2016-14 is effective for fiscal years beginning after December 15, 2017, with early application permitted.

 

 

References.

https://www.aicpa.org/interestareas/centerforplainenglishaccounting/resources/2016/asu-2016-14.html

https://www.nonprofitaccountingacademy.com/asu-2016-14-nonprofit-liquidity/

Business deductions for meal, vehicle and travel expenses: Document, document, document

Meal, vehicle and travel expenses are common deductions for businesses. But if you don’t properly document these expenses, you could find your deductions denied by the IRS.

A critical requirement

Subject to various rules and limits, business meal (generally 50%), vehicle and travel expenses may be deductible, whether you pay for the expenses directly or reimburse employees for them. Deductibility depends on a variety of factors, but generally the expenses must be “ordinary and necessary” and directly related to the business.

Proper documentation, however, is one of the most critical requirements. And all too often, when the IRS scrutinizes these deductions, taxpayers don’t have the necessary documentation.

What you need to do

Following some simple steps can help ensure you have documentation that will pass muster with the IRS:

Keep receipts or similar documentation. You generally must have receipts, canceled checks or bills that show amounts and dates of business expenses. If you’re deducting vehicle expenses using the standard mileage rate (54.5 cents for 2018), log business miles driven.

Track business purposes. Be sure to record the business purpose of each expense. This is especially important if on the surface an expense could appear to be a personal one. If the business purpose of an expense is clear from the surrounding circumstances, the IRS might not require a written explanation — but it’s probably better to err on the side of caution and document the business purpose anyway.

Require employees to comply. If you reimburse employees for expenses, make sure they provide you with proper documentation. Also be aware that the reimbursements will be treated as taxable compensation to the employee (and subject to income tax and FICA withholding) unless you make them via an “accountable plan.”

Don’t re-create expense logs at year end or when you receive an IRS deficiency notice. Take a moment to record the details in a log or diary at the time of the event or soon after. The IRS considers timely kept records more reliable, plus it’s easier to track expenses as you go than try to re-create a log later. For expense reimbursements, require employees to submit monthly expense reports (which is also generally a requirement for an accountable plan).

Addressing uncertainty

You’ve probably heard that, under the Tax Cuts and Jobs Act, entertainment expenses are no longer deductible. There’s some debate as to whether this includes business meals with actual or prospective clients. Until there’s more certainty on that issue, it’s a good idea to document these expenses. That way you’ll have what you need to deduct them if Congress or the IRS provides clarification that these expenses are indeed still deductible.

For more information about what meal, vehicle and travel expenses are and aren’t deductible — and how to properly document deductible expenses — please contact us.

© 2018

Get ready for the new lease standard

A new accounting rule for reporting leases goes into effect in 2019 for public companies. Although private companies have been granted a one-year reprieve, no business should wait until the last minute to start the implementation process. Some recently revised guidance is intended to ease implementation. Here’s an overview of what’s changing.

Old rules, new rules

Under the existing rules, companies must record lease obligations on their balance sheets only if the arrangements are considered financing transactions. Few arrangements get recorded, because accounting rules give companies leeway to arrange the agreements in a way that they can be treated as simple rentals for financial reporting purposes. If an obligation isn’t recorded on a balance sheet, it makes a business look like it is less leveraged than it really is.

In 2016, the Financial Accounting Standards Board (FASB) issued a new standard that calls for major changes to current accounting practices for leases. In a nutshell, Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), will require companies to recognize on their balance sheets the assets and liabilities associated with rentals.

Most existing arrangements that currently are reported as leases will continue to be reported as leases under the new standard. In addition, the new definition is expected to encompass many more types of arrangements that aren’t reported as leases under current practice.

Revised guidance

Recently, the FASB revised two provisions to make the lease guidance easier to apply:

1. Modified retrospective approach. Upon adoption of the new lease accounting standard, companies may elect to present results using the current lease guidance for prior periods. This will allow management to focus on accounting for current and future transactions under the new rules — rather than looking backward at old leases.

2. Maintenance charges. On March 28, the FASB agreed to give lessors and property managers the option not to separately account for the fees for “common area maintenance” charges, such as security, elevator repairs and snow removal.

In addition, the FASB has provided a practical expedient to utilities, oil-and-gas companies and energy providers that hold rights-of-way to accommodate gas pipelines or electric wires. Under the revised guidance, companies that hold such land easements won’t have to sort through years of old contracts to determine whether they meet the definition of a lease. This practical expedient applies only to existing land easements, however.

Need help?

The lease standard is expected to add more than $1.25 trillion of operating lease obligations to public company balance sheets starting in 2018. How will it affect your business? Contact us to help answer this question and evaluate which of your contracts must be reported as lease obligations under the new rules.

© 2018

For-profit vs. not-for-profit: Compare and contrast financial reporting goals

As the term suggests, for-profit companies are driven primarily by one goal — to maximize profits for their owners. Nonprofits, on the other hand, are generally motivated by a charitable purpose. Here’s how their respective financial statements reflect this difference.

Reporting revenues and expenses

For-profits produce an income statement (also known as a profit and loss statement), listing their revenues, gains, expenses and losses to evaluate financial performance. They report mainly on profitability and increasing assets, which correlate with future dividends and return on investment to owners and shareholders.

By comparison, not-for-profit entities just want revenue to cover the costs of fulfilling their mission now and in the future. They often rely on grants and donations in addition to fees for service income. So they prepare a statement of activities, which lists all revenue less expenses, and classifies the impact on each net asset class.

Many nonprofits currently produce a statement of functional expenses. But a new accounting standard kicks in this year — Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities. It will require organizations to classify expenses by nature (meaning categories such as salaries and wages, rent, employee benefits and utilities) and function (mainly program services and supporting activities). This information will need to be expressed in a grid format that shows the amount of each natural category spent on each function.

Balance sheet considerations

For-profit companies prepare a balance sheet that lists the owner’s or shareholders’ equity, which is based on the company’s assets, liabilities and prior profits. The equity determines the value of a company’s common and preferred stock.

Nonprofits, which have no owners, prepare a statement of financial position. It also looks at assets, liabilities and prior earnings. The resulting net assets historically have been classified as 1) unrestricted, 2) temporarily restricted, or 3) permanently restricted, based on the presence of donor restrictions. Starting in 2018 for most not-for-profits, the new accounting standard will reduce these classes to two: 1) net assets without donor restrictions and 2) net assets with donor restrictions.

Footnote disclosures

Another key difference: Nonprofits tend to focus more on transparency than for-profit businesses do. Thus, their financial statements and footnotes include a lot of disclosures, such as about the nature and amount of donor-imposed restrictions on net assets. Starting in 2018, ASU No. 2016-14 will require more disclosures on the amount, purpose and type of board designations of net assets. Additional disclosures will be required to outline the availability and liquidity of assets to cover operations in the coming year.

Common denominator

Whether operating for a profit or not, all entities have a common need to produce timely financial statements that stakeholders can trust. Contact us for help reporting accurate financial results for your organization.

© 2018