Greencrest, Author at Whalen & Company, CPAs

Evaluating “going concern” concerns

Greencrest on July 29, 2022

Under U.S. Generally Accepted Accounting Principles (GAAP), financial statements are normally prepared based on the assumption that the company will continue normal business operations into the future. When liquidation is imminent, the liquidation basis of accounting may be used instead.

It’s up to the company’s management to decide whether there’s a so-called “going concern” issue and to provide related footnote disclosures. But auditors still must evaluate the appropriateness of management’s assessment. Here are the factors that go into a going concern assessment.

Substantial doubt and potential for mitigation

The responsibility for making a final determination about a company’s continued viability shifted from external auditors to the company’s management under Accounting Standards Update (ASU) No. 2014-15, Presentation of Financial Statements — Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern. The updated guidance requires management to decide whether there are conditions or events that raise substantial doubt about the company’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued, to prevent auditors from holding financial statements for several months after year end to see if the company survives).

Substantial doubt exists when relevant conditions and events, considered in the aggregate, indicate that it’s probable that the company won’t be able to meet its current obligations as they become due. Examples of adverse conditions or events that might cause management to doubt the going concern assumption include:

Recurring operating losses,
Working capital deficiencies,
Loan defaults,
Asset disposals, and
Loss of a key franchise, customer or supplier.

After management identifies that a going concern issue exists, it should consider whether any mitigating plans will alleviate the substantial doubt. Examples of corrective actions include plans to raise equity, borrow money, restructure debt, cut costs, or dispose of an asset or business line.

Aligning the guidance

After the FASB updated its guidance on the going concern assessment, the Auditing Standards Board (ASB) unanimously voted to issue a final going concern standard. The ASB’s Statement on Auditing Standards (SAS) No. 132, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, was designed to promote consistency between the auditing standards and accounting guidance under U.S. GAAP.

The updated guidance requires auditors to obtain sufficient appropriate audit evidence regarding management’s use of the going concern basis of accounting in the preparation of the financial statements. It also addresses uncertainties auditors face when the going concern basis of accounting isn’t applied or may not be relevant.

For example, SAS No. 132 doesn’t apply to audits of single financial statements, such as balance sheets and specific elements, accounts, or items of a financial statement. Some auditors contend that the evaluation of whether there’s substantial doubt about a company’s ability to continue as a going concern can be performed only on a complete set of financial statements at an enterprise level.

Prepare for your next audit

With increased market volatility, rising inflation, supply chain disruptions, labor shortages and skyrocketing interest rates, the going concern assumption can’t be taken for granted. Management must take current and expected market conditions into account when making this call — and be prepared to provide auditors with the appropriate documentation. Contact us before year end if you have concerns about your company’s going concern assessment. We can provide objective market data to help evaluate your situation.

The kiddie tax: Does it affect your family?

Greencrest on July 19, 2022

Many people wonder how they can save taxes by transferring assets into their children’s names. This tax strategy is called income shifting. It seeks to take income out of your higher tax bracket and place it in the lower tax brackets of your children.

While some tax savings are available through this approach, the “kiddie tax” rules impose substantial limitations if:

The child hasn’t reached age 18 before the close of the tax year, or
The child’s earned income doesn’t exceed half of his or her support and the child is age 18 or is a full-time student age 19 to 23.

The kiddie tax rules apply to your children who are under the cutoff age(s) described above, and who have more than a certain amount of unearned (investment) income for the tax year — $2,300 for 2022. While some tax savings on up to this amount can still be achieved by shifting income to children under the cutoff age, the savings aren’t substantial.

If the kiddie tax rules apply to your children and they have over the prescribed amount of unearned income for the tax year ($2,300 for 2022), they’ll be taxed on that excess amount at your (the parents’) tax rates if your rates are higher than the children’s tax rates. This kiddie tax is calculated by computing the “allocable parental tax” and special allocation rules apply if the parents have more than one child subject to the kiddie tax.

Note: Different rules applied for the 2018 and 2019 tax years, when the kiddie tax was computed based on the estates’ and trusts’ ordinary and capital gain rates, instead of the parents’ tax rates.

Be aware that, to transfer income to a child, you must transfer ownership of the asset producing the income. You can’t merely transfer the income itself. Property can be transferred to minor children using custodial accounts under state law.

Possible saving vehicles

The portion of investment income of a child that’s taxed under the kiddie tax rules may be reduced or eliminated if the child invests in vehicles that produce little or no current taxable income. These include:

Securities and mutual funds oriented toward capital growth;
Vacant land expected to appreciate in value;
Stock in a closely held family business, expected to become more valuable as the business expands, but pays little or no cash dividends;
Tax-exempt municipal bonds and bond funds;
U.S. Series EE bonds, for which recognition of income can be deferred until the bonds mature, the bonds are cashed in or an election to recognize income annually is made.

Investments that produce no taxable income — and which therefore aren’t subject to the kiddie tax — also include tax-advantaged savings vehicles such as:

Traditional and Roth IRAs, which can be established or contributed to if the child has earned income;
Qualified tuition programs (also known as “529 plans”); and
Coverdell education savings accounts.

A child’s earned income (as opposed to investment income) is taxed at the child’s regular tax rates, regardless of the amount. Therefore, to save taxes within the family, consider employing the child at your own business and paying reasonable compensation.

If the kiddie tax applies, it’s computed and reported on Form 8615, which is attached to the child’s tax return.

Two reporting options

Parents can elect to include the child’s income on their own return if certain requirements are satisfied. This is done on Form 8814 and avoids the need for a separate return for the child. Contact us if you have questions about the kiddie tax.

Last call for lease accounting

Greencrest on July 11, 2022

The updated lease accounting standard is currently in effect for private companies. After several postponements during the pandemic, the Financial Accounting Standards Board (FASB) voted unanimously to move forward with the changes. That means private companies and private not-for-profit entities that follow U.S. Generally Accepted Accounting Principles (GAAP) must adopt the new standard for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Surprisingly, some organizations still haven’t completed the implementation process, however. (Note: The updated accounting rules for long-term leases took effect for public companies in 2019.)

In a nutshell

Under the updated guidance, organizations must report both operating and finance leases on their balance sheets (with the exception of short-term leases with terms of 12 months or less). Previously, operating leases didn’t have to be recorded on the balance sheet.

This means lessees must now record a “right-to-use” asset and a corresponding liability for lease payments over the expected term. Generally, the asset and liability are based on the present value of minimum payments expected to be made under the lease, with certain adjustments. The updated guidance also requires additional disclosures about the amount, timing and uncertainty of cash flows related to leases.

How will these changes affect your organization’s financial statements? The effects vary, but if you have significant operating leases for buildings, equipment, vehicles, technology and other assets, adopting the updated standard will immediately increase your company’s assets and liabilities, making it appear to be more leveraged than before. This can cause technical violations of loan covenants that limit your debt or require you to maintain certain debt ratios. You might want to forewarn your lenders if you expect major changes to your year-end financial results under the updated guidance.

A major undertaking

Based on our experiences with public companies and other organizations that have already implemented the updated lease standard, the biggest challenge will be to locate all of your leases and extract the data necessary. Leases generally aren’t standardized, so reviewing them and gathering the required data — including lease terms, payment schedules, end-of-term options and incentives — can be a time-consuming, manual task.

Another challenge will be identifying leasing arrangements that must be accounted for under the updated standard but aren’t found in traditional lease agreements. If an agreement gives you the right to control an identified asset for a period of time in exchange for payment, then it may be considered a lease under the updated guidance. For example, leases may be “embedded” in service, supply, transportation or information technology agreements. With embedded leases, you’ll need to separate the contract’s lease and nonlease components for reporting purposes.

Leverage external resources

Organizations with significant leasing arrangements might want to consider purchasing lease accounting software to automate the process of managing and tracking their leases and calculating their lease-related assets and liabilities. If you haven’t yet started the implementation process, we can help you evaluate software options and get your accounting records and systems up to speed. Contact us for more information.

How disability income benefits are taxed

Greencrest on July 6, 2022

If you’ve recently begun receiving disability income, you may wonder how it’s taxed. The answer is: It depends.

The key issue is: Who paid for the benefit? If the income is paid directly to you by your employer, it’s taxable to you just as your ordinary salary would be. (Taxable benefits are also subject to federal income tax withholding. However, depending on the employer’s disability plan, in some cases they aren’t subject to Social Security tax.)

Frequently, the payments aren’t made by an employer but by an insurance company under a policy providing disability coverage. In other cases, they’re made under an arrangement having the effect of accident or health insurance. In these cases, the tax treatment depends on who paid for the insurance coverage. If your employer paid for it, then the income is taxed to you just as if it was paid directly to you by the employer. On the other hand, if it’s a policy you paid for, the payments you receive under it aren’t taxable.

Even if your employer arranges for the coverage (in a policy made available to you at work), the benefits aren’t taxed to you if you (and not your employer) pay the premiums. For these purposes, if the premiums are paid by the employer but the amount paid is included as part of your taxable income from work, the premiums will be treated as paid by you. In these cases, the tax treatment of the benefits received depends on the tax treatment of the premiums paid.

Illustrative example

Let’s say Max’s salary is $1,000 a week ($52,000 a year). Additionally, under a disability insurance arrangement made available to him by his employer, $10 a week ($520 annually) is paid on his behalf by his employer to an insurance company. Max includes $52,520 in income as his wages for the year ($52,000 paid to him plus $520 in disability insurance premiums). Under these facts, the insurance is treated as paid for by Max. If he becomes disabled and receives benefits under the policy, the benefits aren’t taxable income to him.

Now assume that Max includes only $52,000 in income as his wages for the year because the amount paid for the insurance coverage qualifies as excludable under the rules for employer-provided health and accident plans. In this case, the insurance is treated as paid for by the employer. If Max becomes disabled and receives benefits under the policy, the benefits are taxable income to him.

There are special rules if there is a permanent loss (or loss of the use) of a member or function of the body or a permanent disfigurement. In these cases, employer disability payments aren’t taxed, as long as they aren’t computed based on amount of time lost from work.

Social Security disability benefits

This discussion doesn’t cover the tax treatment of Social Security disability benefits. They may be taxed to you under the rules that govern Social Security benefits.

Needed coverage

In deciding how much disability coverage you need to protect yourself and your family, take the tax treatment into consideration. If you’re buying the policy yourself, you only have to replace your “after tax” (take-home) income because your benefits won’t be taxed. On the other hand, if your employer is paying for the benefit, keep in mind that you’ll lose a percentage of it to taxes. If your current coverage is insufficient, you may want to supplement the employer benefit with a policy you take out on your own. Contact us if you’d like to discuss this issue.

Paying tribute to auditor independence

Greencrest on July 5, 2022

In the spirit of Independence Day, it’s a good time to review the rules for auditor independence. If you discover potential issues now, there’s still plenty of time to take corrective action before next year’s audit begins.

Definition of independence

Independence is one of the most important requirements for audit firms. It’s why investors and lenders trust CPAs to provide unbiased opinions about the presentation of a company’s financial results. The AICPA and the Securities and Exchange Commission (SEC) have rules regarding auditor independence. Even the U.S. Department of Labor has issued independence guidance for auditors of employee benefit plans.

The AICPA specifically goes to great lengths to explain how audit firms can maintain their independence from the companies they audit. In short, auditors can’t provide any services for an audit client that would normally fall to the company’s management to complete. Auditors also can’t engage in any relationships with their clients that would 1) compromise their objectivity, 2) require them to audit their own work, or 3) result in self-dealing, a conflict of interest or advocacy.

Independence is a matter of professional judgment, but it’s something that accountants take seriously. A firm that violates the independence rules calls into question the accuracy and integrity of its clients’ financial statements.

Prohibited services

Under Rule 2-01 of Regulation S-X, the SEC specifically prohibits auditors from providing the following nonaudit services to a publicly traded audit client or its affiliates:

Bookkeeping,
Financial information systems design and implementation,
Appraisal or valuation services, fairness opinions or contribution-in-kind reports,
Actuarial services,
Internal audit outsourcing services,
Management functions or human resources,
Broker-dealer, investment advisor or investment banking services, and
Legal services and expert services unrelated to the audit.

This list isn’t exhaustive. Audit committees should consider whether any service provided by the audit firm may impair the firm’s independence in fact or appearance. SEC independence rules also prohibit audit firms and auditors from engaging in financial relationships with their public audit clients, such as contingent fees, banking, insurance, debtor-creditor arrangements, broker-dealer relationships and futures commission merchant accounts.

In the spotlight

In a recent statement, the SEC’s Acting Chief Accountant Paul Munter noted that current market conditions have caused many companies to engage in complex business arrangements, including restructurings and special purpose acquisition companies. “Such arrangements have the potential to undermine auditor independence. The [general standard of independence, Rule 2-01(b)] is the heart of the Commission’s auditor independence rule, it always applies, and the Commission investigates and enforces against violations of the general standard,” said Munter.

Independence is a critical issue for public and private companies alike. Contact your auditor to discuss any questions you may have regarding auditor independence.

Author: Greencrest

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