Accounting Update and Options

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
• The AICPA’s recently issued Financial Reporting Framework for Small- to Mid-Sized Entities (“FRF for SMEs”)
• The use of normalized free cash flow in operations and business valuation
• IRS and state audit areas of focus

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