On March 27, 2023, the Financial Accounting Standards Board (FASB) published narrowly drawn amendments to the lease accounting rules. The updated guidance clarifies issues that are relevant to rental agreements between businesses that have the same owner.

Written vs. verbal leases

Accounting Standards Update (ASU) No. 2023-01, Leases (Topic 842) Common Control Arrangements, explains how related business entities that are controlled by the same owner determine whether a lease exists. Specifically, it provides an optional practical expedient to private companies and not-for-profit organizations that aren’t conduit bond obligors. (A practical expedient is an accounting workaround that allows a company to use a simpler route to get to the same outcome.) The guidance settles questions about how to approach verbal common control leases and whether legal counsel is required to determine the terms and conditions of a lease.
The practical expedient is applicable only for written leases. Under the updated guidance, a private company electing the practical expedient must use the written terms and conditions of a common control arrangement to determine whether a lease exists and, if so, how to account for it. In the case of a lease agreement that’s verbal — as is often the case between private entities under common control — the company must document the existing unwritten terms before applying the lease accounting rules.

The lessee isn’t required to determine whether written terms and conditions are enforceable when applying the practical expedient. In addition, companies are allowed to apply the practical expedient on an arrangement-by-arrangement basis.

Leasehold improvements

The accounting rules related to certain leasehold improvements have also changed for both public and private organizations under ASU 2023-01. Examples of leasehold improvements include installing carpet, painting and building out the space for the lessee’s needs. For example, a salon might install sinks and plumbing fixtures, a chemical manufacturer might need ventilation for its production process and an eco-friendly restaurant might design a rooftop garden to attract patrons.
The amendments require lessees to amortize leasehold improvements over the improvements’ useful lives to the common control group — regardless of the lease term. When the lessee no longer controls that underlying asset, the transfer of those improvements must be accounted for through equity or net asset. The improvements remain subject to the impairment requirements of Accounting Standards Codification (ASC) Topic 360, Property, Plant and Equipment.

Implementation guidance

ASU No. 2023-01 is an amendment to ASC Topic 842, Leases, which was issued in 2016. This standard requires the full effect of entities’ long-term lease obligations to be reported on the balance sheet. It went into effect for public entities in 2019 and for private entities in 2022.

The new-and-improved rules will be effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted for both interim and annual financial statements that haven’t yet been made available for issuance. If a company adopts the amendments in an interim period, the company must adopt them as of the beginning of the fiscal year that includes that interim period.

If your company decides to adopt ASU 2023-01 concurrently with the adoption of Topic 842, you should use the same transition approach as that standard. If your company adopts the rules in a subsequent period, you can do so either retrospectively or prospectively.

For more information

Does your company rent property from a related party? We can help you report these arrangements in accordance with the updated guidance. Our accounting pros understand how to determine whether a common control lease exists and how to report leasehold improvements and other fixes that have been made to rented property. Contact Us!

© 2023

What do you do with your financial statements after your CPA delivers them? If you’re like most business owners and managers, you breathe a sigh of relief that they’re finished, file them away, and go back to running the business. But financial statements can be a useful tool to help improve business operations in the future.

 

Eye on profitability

The income statement is a good starting point for using your financials to analyze performance and remedy inefficiencies and anomalies. Here are four ratios you can compute from income statement data:

1. Gross profit. This is profit after cost of goods sold divided by revenue. It’s a good ratio to compare to industry statistics because it tends to be calculated on a consistent basis.

2. Net profit margin. This is calculated by dividing net income by revenue. If the margin is rising, the company must be doing something right. Often, this ratio is computed on a pretax basis to accommodate for differences in tax rates.

3. Return on assets. This is calculated by dividing net income by the company’s total assets. The return shows how efficiently management is using its assets.

4. Return on equity. This is calculated by dividing net profits by shareholders’ equity. The resulting figure tells how well the shareholders’ investment is performing compared to competing investment vehicles.

Profitability ratios can be used to compare your company’s performance over time and against industry norms.

 

Connecting the dots

If your company’s profitability ratios have deteriorated compared to last year or industry norms, it’s important to find the cause. If the whole industry is suffering, the decline is likely part of a macroeconomic trend. If the industry is healthy, yet your company’s margins are falling, it’s time to determine the cause and then take corrective measures.

Depending on the source of the problem, you might need to cut costs, lay off unproductive workers, automate certain business functions, eliminate unprofitable segments or product lines, raise prices — or possibly even investigate for fraud. For instance, a hypothetical manufacturer might discover that the reason its gross margin has fallen is rising materials costs because its procurement manager is colluding with a supplier in a kickback scam.

 

Contact us

Today’s uncertain, inflationary markets are putting the squeeze on profits in many sectors. But don’t accept that excuse without first investigating further. Your income statement provides critical clues into what’s happening at your company.

Examine the main components — gross revenue, cost of sales, and selling and administrative costs — to assess if specific line items have fallen due to company-specific or industrywide trends. Also, monitor comparable public companies, trade publications, and the internet for information. We can help you determine possible causes and brainstorm ways to unplug your profit drains.

© 2023

Deferred taxes are a confusing topic — and the accounting rules for reporting these items often seem to defy the logic of real-world economics. Here’s a brief overview to help clarify matters.

 

What are deferred taxes?

Companies pay income tax on IRS-defined taxable income. On their Generally Accepted Accounting Principles (GAAP) financial statements, however, companies record income tax expense based on accounting “pretax net income.” In a given year, taxable income (for federal income tax purposes) and pretax income (as reported on your GAAP income statement) may substantially differ. A common reason for this temporary difference is depreciation expense.

For income taxes, the IRS allows companies to use accelerated depreciation methods to lower the taxes paid in the early years of an asset’s useful life. Some companies also may elect to claim Section 179 deductions and bonus depreciation in the year an asset is placed in service. Alternatively, for GAAP reporting purposes, companies frequently use straight-line depreciation. Early in an asset’s useful life, this divergent treatment usually causes taxable income to be significantly lower than GAAP pretax income. However, as the asset ages, the temporary difference in depreciation expense reverses itself.

The use of different depreciation methods for book and tax purposes causes a company to report deferred tax liabilities. That is, by claiming higher depreciation expense for tax purposes than for accounting purposes, the company has temporarily lowered its tax bill — but it will make up the difference in future tax years. Deferred tax assets may come from other sources, such as capital loss carryforwards, operating loss carryforwards, and tax credit carryforwards.

 

How are deferred taxes reported on the financials?

If a company’s pretax income and its taxable income differ, it must record deferred taxes on its balance sheet. The company records a deferred tax asset for the future benefit it will receive if it pays the IRS more tax than an income statement reflects. If the opposite is true, the company records a deferred tax liability for the additional future amount it will owe.

Like other assets and liabilities, deferred taxes are classified as either current or long-term. Regardless of their classification, deferred taxes are recorded at their cash value (that is, no consideration of the time value of money). Deferred taxes are also based on current income tax rates. If tax rates change, the company may revise its balance sheet, and the change flows through to the income statement.

While deferred tax liabilities are recorded at their full amount, deferred tax assets are offset by a valuation allowance that reflects the possibility the asset will expire before the company can use it. Deciding how much-deferred tax valuation allowance to book is highly subjective and left to management’s discretion. Any changes to the allowance flow through to the company’s income statement.

 

Now or later?

Financial statement users can’t afford to lose sight of deferred taxes. All else being equal, a company with significant deferred tax assets may be able to lower its future tax bill and preserve its cash on hand by claiming deferred tax breaks. Conversely, a company with significant deferred tax liabilities has already tapped into tax breaks and may need additional cash on hand to pay Uncle Sam in future tax years. Contact us for more information.

© 2023

Are Your Employees Engaged? Does it Matter?

 

Most small business owners know the frustration of hiring the wrong person for the job. Regardless of endless efforts to engage the apathetic employee in the work tasks or the company culture, this outlier will not meet the group’s expectations. The cost of poor employee engagement is more than monetary. The failed hire can ignite controversy and complaints among other productive team members or create a host of client complaints.

 

In business, anything that affects the organization’s operations affects its profits. Still, according to Matt Tenney (n.d.), “… employee engagement is probably the factor that has the biggest impact on an organization’s profitability and, by extension, its future success.” Employers must devote time and attention to employee engagement because the stakes are high.

 

What Is Employee Engagement?

Employee engagement is an employee’s cognitive, emotional, and behavioral state directed toward the desired outcomes of the work organization (Shuck & Wollard, 2010). It is an active psychological state related to the experience of work. It encompasses the current task, the job, the team, and the dynamic working experience (Shuck et al., 2017). It is distinct from job satisfaction in that satisfaction can be felt by an employee who is content with their position but needs to be more actively motivated. Job satisfaction indicates how fulfilled or satiated an employee feels with their position rather than how engaged they are in work and culture (Macey & Schneider, 2008; Shuck et al., 2017).

 

It is valuable to look at each engagement component in more detail.

 

Cognitive Engagement

Cognitive engagement is evidenced in the employee’s proportioned attentiveness, focus, and concentration while using mental energy directed at work-related activities (Shuck et al., 2017). It is a proportional effort because it does not sacrifice one aspect of cognition to serve another. For example, the employee is actively working on the task at hand while remaining aware and effortful toward their role’s requirements and their inclusion in the culture and direction of the organization.

 

Emotional Engagement

Employees exemplify emotional engagement when they positively associate with the organization, resulting in a willingness to exert their energy toward supporting the organization’s purpose. These feelings manifest as pride in being a member of the team and a personal identification with the organization as a whole (Macey & Schneider, 2008). These team members might express that they believe in the organization’s purpose or feel that the organization holds personal meaning to them (Shuck et al., 2017).

 

Behavioral Engagement

Behavioral engagement manifests as observable behavior in the work setting and exhibits through innovation, initiative, proactive contributions, and going beyond what is typically required (Macey & Schneider, 2008). These engagement behaviors typified as “going beyond” include patterns of action that characterize organizational citizenship behavior (conscientiousness, support of other team members, support for the organization) but also encompass the employee’s desire to expand their role beyond what is required. This desire denotes a psychological state that will drive behavior even before the behavior materializes into an action (Macey & Schneider, 2008); Shuck et al., 2017). This pre-action bent of the employee toward behavior distinguishes behavioral engagement from performance (Shuck et al., 2017).

 

A Simple Definition of Employee Engagement

When we consider the cognitive, emotional, and behavioral characteristics of engaged employees, we can define employee engagement as the bent of an employee to exert their self-directedness toward a full and enthusiastic involvement with their work and workplace.

 

How Engaged Are Employees?

According to Gallup’s State of the Global Workplace: 2022 Report, 33% of employees in the U.S. are engaged at work. Worldwide, that statistic drops drastically to 21%. Further, the Gallup research indicates that 49% of people are not engaged, and 18% are actively disengaged.

Notably, the Gallup (2022) study found that employee engagement was rising globally in the pre-pandemic world. Engagement rose in the U.S. by 1% in 2021 but has yet to rebound to the pre-pandemic levels.

 

According to Gallup.com (2022), employees (49%) classified as not engaged are psychologically unattached to their work or company. In the workplace, these employees back down from intense or high-profile opportunities, preferring to exist in the realm of duty. These unengaged workers put in the time but need more energy or passion.

 

Actively disengaged employees (18%) are unhappy or unfulfilled at work. They feel resentment that their needs remain unmet. These workers make their unhappiness the focal point of everyone’s day, usually undermining the potential of the engaged workers and soliciting the unengaged workers into their club of discontent (Gallup.com, 2022).

 

By contrast, engaged employees are motivated and enthusiastic about their work and the workplace’s mission. This group is psychologically invested (think ownership) in their job and workplace outcomes. These workers generate innovation and act as catalysts in the high performance of a company (Gallup.com, 2022).

 

What Drives Employees to be Engaged?

Research in the area of employee engagement seeks to understand why employees choose to engage or disengage in the work and workplace. Kahn (1990) found that meaningfulness, safety, and availability were three conditions that shaped how people “inhabited” their organizational roles.

 

Meaningfulness has the strongest correlation to engagement. Meaningfulness is wrapped up in the enrichment provided by the job and the work role fit (May et al., 2004), while safety depends on co-worker relations and supervisor support. Availability encompasses the worker’s motivation to use their physical, emotional, and cognitive resources to perform and invest in work (May et al., 2004).

 

Things that undermine engagement are self-consciousness of how others perceive the employee or their work, a co-worker’s acceptance of the employee regarding attitudes or behaviors, and the energy drain of multiple outside activities brought on by membership in other organizations or participating in other commitments. Strikingly, external involvement in the family can positively influence employee engagement.

 

Perception and personality also affect how individuals react and shape their engagement at work. Cultural nuances, values, political and economic influences, and management styles may also influence employee motivation toward engagement, a caveat potentially impacting multinational corporations and the culturally diverse workplace (Kular et al., 2008).

 

One final twist in the employee engagement plot is that researchers have found an inverse relationship between the length of service and employee engagement. Brim (2002) found that an employee’s most engaged year is their first year of service, suggesting a continuum of employee engagement over time. Therefore, organizations must keep engagement flourishing (Kular et al., 2008).

 

The High Stakes of Engagement

Gallup (2022) has developed a method to measure employee engagement. The Q12® is a survey tool used to frame and improve employee engagement. Analyses of engagement from this survey tool indicate many positive effects of engagement. Engaged teams exhibited the following:

• 81% decrease in absenteeism
• 18% increase in productivity measured as sales
• 23% increase in profitability
• 10% increase in customer loyalty or customer engagement
• Decreases in employee turnover
  • 18% decrease in high-turnover organizations (more than 40% annualized turnover)
  • 43% decrease in low-turnover organizations (with 40% or lower annualized turnover)
• 28% decrease in theft
• 64% decrease in safety incidents (accidents)
• 41% decrease in quality defects
• 58% decrease in patient safety incidents (mortality and falls) in healthcare services

 

Other researchers have found that engaged employees are nearly three times more likely to feel that their work positively affected their physical health compared to disengaged employees (Kular et al., 2008).

 

Successful companies must refrain from harboring unengaged or actively disengaged employees. Below are some simple steps to improving engagement for employees.

 

Ways to Improve Employee Engagement

Engagement is a dance between the elements of the workplace and the characteristics of the worker mediated by an organization’s leadership. Gallup.com (2022) reports that the manager determines 70% of a team’s engagement potential, placing employee engagement in a leader’s responsibilities. Leadership teams must exemplify engagement as a model to the employees they serve. Successful managers can set the workplace’s tone, communicate meaningfully without micromanaging employees, and foster motivation. With careful planning, employee engagement can be an achievable and sustainable goal.

 

Communicating within the group forms the cornerstone of engagement. For example, Gallup.com (2022) reports that employees who receive feedback daily are three times more likely to be engaged than those that receive feedback once a year or less. Consequently, only evaluating employees in once yearly job reviews may be detrimental to employee engagement. Kular and colleagues (2008) add that employees denied the opportunity to communicate and be involved in appropriate decision-making are a root cause of employee disengagement. Brim (2002) recommends that successful engagement is more likely when leaders focus on an employee’s strengths instead of fixing shortcomings.

 

Some simple steps leaders can take to improve engagement are as follows:

• Ensure employees have a clear purpose regarding their role and its relationship to the company’s goals.
• Help employees find their niche in the company and emphasize their unique contributions to the assigned tasks and projects.
• Actively care about the employee holistically. Do not just emphasize their work or performance; become a safe and caring influence by encouraging work-life balance, healthy lifestyles, and strong relationships.
• Help employees become their best selves by encouraging skill set development and training.
• Communicate with employees through performance feedback. Inform them of relevant changes in industry trends, office policies, training initiatives, and employee perks.
• Listen to employee concerns with responsiveness, respect, and interest.
• Do not focus on one aspect of working to evaluate engagement. Instead, weave engagement throughout the employee’s service and experience.
• Focus on engagement during all time frames of the employee’s association. Consider engagement during the hiring and onboarding process. Build engagement opportunities into job performance and development initiatives. Finally, remember to engage departing employees who have served well (Gallup.com, 2022).

 

Summary 

Employee engagement is an ongoing pursuit of capturing the motivation of the individual employees on a team. As in all of life, communication through words and actions is the pivot point of engagement. Leadership is accountable for 70% of the engagement process, which means they must also remain engaged in the company goals, performance, and culture over the long haul. Employees engage at three levels: cognitively, emotionally, and behaviorally. Since employee engagement remains low, leaders will find that about two-thirds of their employees will be under-engaged, resulting in safety, quality, theft, turnover, productivity, profitability, absenteeism, and customer satisfaction problems. Under-engaged employees, therefore, result in a high cost to a company. Improve engagement by identifying an employee’s strengths. Encourage communication by being attentive to employee concerns and providing actionable feedback frequently. Think about employee engagement for all employees throughout their time of service.

 

While every employee will not respond with an engaged attitude, many will sense the care and respect that the leadership has toward the team and want to become a part of the thriving culture. Let employee engagement become the ‘secret sauce’ that drives strong and loyal employees to your business, keeps them actively motivated, and who, in turn, excellently serve your customers.

 

By Laurie Morgan, M.S, D.D.S., M.Ed

Healthcare & Dental Services Consultant

 

References

Brim, B. (2002). The longer workers stay in their jobs, the more disheartened they become. Gallup Management Journal, March. http://www.gallupjournal.com/GM/Jarchive/issue5/2002315c.asp

 

Gallup (2022). State of the workplace 2022 report. Gallup.com. gallup.com/workplace/349484/state-of-the-global-workplace-2022-report

 

Gallup.com (2022). Workplace/285674/improve-employee-engagement-workplace.

 

Kahn, W. A. (1990). Psychological conditions of personal engagement and disengagement at work. Academy of Management Journal, 33(4), 692–724.

 

Kular, S., Gatenby, M., Rees, C., Soane, E., & Truss, K. (2008). Employee engagement: A literature review. Kingston Business School Working Paper Series, 19.

 

Macey, W. H., & Schneider, B. (2008). The meaning of employee engagement. Industrial and Organizational Psychology, 1, 3-30).

 

May, D. R., Gilson, R. L., & Harter, L. M. (2004). The psychological conditions of meaningfulness, safety and availability and the engagement of the human spirit at work. Journal of Occupational Psychology, 77, 11–37.

 

Shuck, B., & Wollard, K. (2010). Employee engagement and HRD: A seminal review of the foundations. Human Resources Development Review, 9(1), 89-110.

 

Shuck, B., Adelson, J. L., & Reio Jr., T. G. (2017). The employee engagement scale: initial evidence for construct validity and implications for theory and practice. Human Resources Management, 56(6), 953-977.

Tenney, M. (n.d.). How employee engagement affects profitability. Business Leadership Today. https://businessleadershiptoday.com/how-employee-engagement-affects-profitability/