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Accounting Update and Options

Posted on December 1, 2015 by

Clayton & Mckervey

Clayton & McKervey

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At the September CFO/Controller Roundtable, Timothy J. Hilligoss, CPA, MST, Shareholder – International Accounting, Practice Leader for Asia, and Bryan Powrozek, CPA, CGMA, Senior Accountant – SME, discussed unique financial reporting and tax situations that would impact small to mid-sized entities. The open forum covered four main topics:

Accounting for Income Taxes for Pass-Through Entities

  • Importance of differentiating between tax and non-tax distributions
    • Review bank covenants to determine whether distributions for taxes can be excluded from covenant ratios
  • Best practice: Account for owner taxes (composite/withholdings) within the pass-through entity. Taxes include composite state taxes, non-resident withholding, and federal and state income taxes.  Alternative presentations include:
    • Establishing a payable account
    • Accrue monthly distributions in order to stabilize interim financials
    • Accrue tax distributions in relation to monthly performance (i.e., percentage of net income)
  • Other concerns addressed by participants
    • What is the appropriate tax rate to use?
      • Highest tax rate for any given owner
    • How to account for tax-related distributions on the statement of cash flows?
      • Gross Amount Presentation Method
      • A contra dividend account reflecting dividend accrued but not yet paid
      • Separate dividends for taxes from non-tax dividends

FRF for SMEs

  • An alternative framework intended to be simplified and relevant
  • No GAAP departure needed for variable interest entities (VIEs) under FRF alternative framework
  • Participants questioned whether there would be any additional cost
    • The alternative framework is intended to provide efficient, meaningful financial statements in a cost-effective manner. This is accomplished by alleviating the burden of complex account practices required by US GAAP, originally intended for non-SMEs.

The Use of Normalized Free Cash Flow in Operations and Business Valuation

  • A measure of financial performance which evaluates the availability of cash (EBITDA – Earnings Before Interest, Taxes, Depreciation, and Amortization) after accounting for discretionary items/adjustments (i.e., management fees, bonuses, etc.)
  • Calculation typically not straightforward; requires management to identify discretionary and non-recurring items

IRS and State Audit Areas of Focus

  • Federal Audits
    • Personal use of vehicles
    • Significant meals and entertainment
    • Club expenses and dues
  • State Audits
    • Errors in apportionment calculation
      • Every state has a different method
    • Reviewing all purchases made within a given year for items subject to Use Tax
      • Agent walkthrough with extrapolation for years not reviewed but still open for adjustment based on statute of limitations. No statute of limitations if a return has not been filed.
    • High risk states: Pennsylvania, New York, California, Texas, and Washington
      • Gross receipt and franchise taxes have lower threshold for creating taxability in the respective states

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