In today’s volatile market conditions, it’s important to review your accounts receivable ledger and consider writing off stale, uncollectible accounts. The methods that you’ve used in the past to evaluate bad debts may no longer make sense. Here’s how to keep your allowance up to date.

Know the rules

Under the accrual method of accounting, your company will report accounts receivable on its balance sheet if it extends credit to customers. This asset represents invoices that have been sent to customers but are yet unpaid. Receivables are classified under current assets if a company expects to collect them within a year or the operating cycle, whichever is longer.

Realistically, however, some customers won’t pay their invoices. Companies report bad debts using one of these two methods:

1. Direct write-off method. Companies that don’t follow U.S. Generally Accepted Accounting Principles (GAAP) record write-offs only when a specific account has been deemed uncollectible. This method is prescribed by the federal tax code, plus it’s relatively easy and convenient. However, it fails to match bad debt expense to the period’s sales. It may also overstate the value of accounts receivable on the balance sheet.
2. Allowance method. Companies turn to the allowance method to properly report revenues and the related expenses in the periods that they were earned and incurred. This method conforms to the matching principle under GAAP. The allowance shows up as a contra-asset to offset receivables on the balance sheet and as bad debt expense to offset sales on the income statement.

Review your estimate

Under the allowance method, a company usually estimates uncollectible accounts as a percentage of sales or total outstanding receivables. Some companies also include allowances for returns, unearned discounts and finance charges.

Companies typically base the allowance on such factors as the age of receivables and bad debt write-offs in prior periods. But it’s also critical to consider general economic conditions. Given the current economic stress you may be experiencing, your business might have to update its historical strategies for assessing the collectability of its receivables.

Monitoring changes in your customers’ credit risk can help prevent your business from being blindsided by economic distress in your supply chain. If a customer’s credit rating falls to an unacceptable level, you might decide to stop extending credit and accept only cash payments. This can help minimize write-offs from a particular customer before they spiral out of control.

Think like an auditor

Bad debt allowances are subjective and can be difficult to audit, especially during economic downturns. Auditors use several techniques to assess whether the allowance for doubtful accounts appears reasonable. Management can use similar techniques to self-audit the company’s allowance.

An obvious place to begin is the company’s aging schedule. The older a receivable is, the harder it is to collect. In general, once a receivable is four months overdue, collectability is doubtful. However, that benchmark varies based on the industry, the economy, the company’s credit policy and other risk factors.

If your customers have requested extended payment terms, it could cause an increase in older receivables on your company’s aging schedule. In this situation, if your company’s allowance is based on aging, you may need to consider adjusting your assumptions based on current conditions.

Consider outside assistance

Businesses are facing unprecedented uncertainty as the end of the calendar year approaches. In fact, a recent survey of audit partners published by the Center for Audit Quality, an affiliate of the AICPA, found that 40% were uncertain about the outlook for their primary industries.

Contact us if you’re unsure whether your bad debts allowance is sufficient in today’s uncertain marketplace. We can help evaluate your estimate and, if necessary, adjust it based on your company’s current circumstances. We’ll also explain the tax implications.

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You may have heard that the Inflation Reduction Act (IRA), a remnant of Biden’s build back better plan, was signed into law recently. While experts have varying opinions about whether it will reduce inflation in the near future, it contains, extends and modifies many climate and energy-related tax credits that may be of interest to individuals. The ACT also extends the excess business loss limitation for partnerships and S corporations through 2028.

Nonbusiness energy property

Before the IRA was enacted, you were allowed a personal tax credit for certain nonbusiness energy property expenses. The credit applied only to property placed in service before January 1, 2022. The credit is now extended for energy-efficient property placed in service before January 1, 2033.

The new law also increases the credit for a tax year to an amount equal to 30% of:

• The amount paid or incurred by you for qualified energy efficiency improvements installed during the year, and
• The amount of the residential energy property expenditures paid or incurred during that year.

The credit is further increased for amounts spent for a home energy audit (up to $150).

In addition, the IRA repeals the lifetime credit limitation, and instead limits the credit to $1,200 per taxpayer, per year. There are also annual limits of $600 for credits with respect to residential energy property expenditures, windows, and skylights, and $250 for any exterior door ($500 total for all exterior doors). A $2,000 annual limit applies with respect to amounts paid or incurred for specified heat pumps, heat pump water heaters and biomass stoves/boilers.

The residential clean-energy credit

Prior to the IRA being enacted, you were allowed a personal tax credit, known as the Residential Energy Efficient Property (REEP) Credit, for solar electric, solar hot water, fuel cell, small wind energy, geothermal heat pump and biomass fuel property installed in homes before 2024.

The new law makes the credit available for property installed before 2035. It also makes the credit available for qualified battery storage technology expenses.

New Clean Vehicle Credit

Before the enactment of the law, you could claim a credit for each new qualified plug-in electric drive motor vehicle placed in service during the tax year.

The law renames the credit the Clean Vehicle Credit and eliminates the limitation on the number of vehicles eligible for the credit. Also, final assembly of the vehicle must now take place in North America.

Beginning in 2023, there will be income limitations. No Clean Vehicle Credit is allowed if your modified adjusted gross income (MAGI) for the year of purchase or the preceding year exceeds $300,000 for a married couple filing jointly, $225,000 for a head of household, or $150,000 for others. In addition, no credit is allowed if the manufacturer’s suggested retail price for the vehicle is more than $55,000 ($80,000 for pickups, vans, or SUVs).

Finally, the way the credit is calculated is changing. The rules are complicated, but they place more emphasis on where the battery components (and critical minerals used in the battery) are sourced.

The IRS provides more information about the Clean Vehicle Credit here: https://www.irs.gov/businesses/plug-in-electric-vehicle-credit-irc-30-and-irc-30d

Credit for used clean vehicles

A qualified buyer who acquires and places in service a previously owned clean vehicle after 2022 is allowed a tax credit equal to the lesser of $4,000 or 30% of the vehicle’s sale price. No credit is allowed if your MAGI for the year of purchase or the preceding year exceeds $150,000 for married couples filing jointly, $112,500 for a head of household, or $75,000 for others. In addition, the maximum price per vehicle is $25,000.

Funding for the legislation

To support the large legislative package, the IRS will seek to improve services to close the “tax gap”. The tax gap refers to the difference between what should be collected and what actually is. To close the gap, the IRS will be aggregating time to improve enforcement. The majority of taxpayers won’t experience any direct impact. However, the increased pressure on enforcement suggests audits will be more likely.

We can answer your questions

Contact us if you have questions about taking advantage of these new and revised tax credits.

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The Financial Accounting Standards Board (FASB) could have congressional lobbyists nipping at its heels over a “book minimum tax” rule in the newly enacted Inflation Reduction Act of 2022 (IRA). This would be the first corporate alternative minimum tax based on financial statement book income since the 1980s. And many in the accounting profession are up in arms about it.

Book minimum tax provision

A company’s book income as reported on its income statement may differ significantly from its taxable income for federal income tax purposes. The IRA — a $740 billion package with provisions on health care, climate and tax — will require companies that report over $1 billion in adjusted financial statement income (AFSI) to pay a 15% minimum tax rate on that income. Some of these companies may already be satisfying this requirement. But others with over $1 billion in book income, which may have taken certain credits or deductions that lower their tax rate below 15% of their AFSI, may be subject to additional tax liability under the new law.

Unlike previous calculations of corporate alternative minimum tax that started in taxable income, the minimum tax under the IRA starts with book income. In addition to allowing for the use of net operating losses and foreign tax credits, the calculation of AFSI allows exemptions for such items as general business credits and defined pension benefits. A late modification also allows for the reduction of AFSI by accelerated depreciation under the federal tax code.

FASB mission

The FASB develops U.S. Generally Accepted Accounting Principles (GAAP) for public and private companies and not-for-profit organizations in the United States. This rulemaking body is designed to be independent from influence by corporations and Congress. However, the book minimum tax rule could potentially give the FASB significant influence over some of the revenue the federal government collects — with potentially significant financial implications for U.S. companies.

This provision is effective for tax years beginning after December 31, 2022. It applies to any corporation (other than an S corporation, regulated investment company, or a real estate investment trust) that meets an average annual AFSI test for one or more earlier tax years that end after December 31, 2021. The Joint Committee on Taxation estimates that about 150 corporate taxpayers would be subject to this tax annually. 

“Even though [the IRA] doesn’t directly involve FASB, it does have implications for FASB because it is asking major companies to pay a tax based on financial statement income which is based on GAAP standards set by FASB,” said Andrew Lautz, director of federal policy at National Taxpayers Union.

Changes made to financial accounting rules could have a direct impact on federal tax revenue. As a result, Congress may take more interest in the FASB’s work in the future and lobby for or against certain changes. Accounting standards could become targets for special interests and lobbyists. Any resulting rule changes could extend to all entities that follow GAAP, not just large corporations with more than $1 billion in AFSI.

Accounting industry pushback

“What is concerning at this point is that tying the new minimum tax to financial statement income creates incentives for companies to report lower book income, which may be at odds with the overall purpose of financial statements (and the goal of the FASB) to be a source of information that is useful to current and potential investors and creditors,” said Mary Cowx, Assistant Professor at the W. P. Carey School of Accountancy at Arizona State University.

The Financial Accounting Foundation (FAF), which governs the FASB, recently said tax and public policy matters are outside the FASB’s mission and should be left to Congress and other regulatory agencies. The FAF’s statement is consistent with a letter signed by more than 300 accounting professionals that was sent to Congress when it was considering the Build Back Better (BBB) bill. However, Congress made major changes to the book minimum tax provision from what was proposed under the BBB and what was signed into law under the IRA.

Stay tuned

It’s currently uncertain whether the new law will lead to unintended changes in GAAP. But the FAF is committed to maintaining the FASB’s independence and avoiding any adverse effects on investor confidence and capital markets. Contact us to discuss the status of current FASB projects that could affect income reporting, such as those related to bolstering income tax disclosures and disaggregating expense information on the income statement.

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As businesses and not-for-profit entities increasingly rely on technology, cyberthreats are becoming more sophisticated and aggressive. Auditors must factor these threats into their risk assessments. They can also help you draft cybersecurity disclosures and brainstorm ways to mitigate your risk of an attack.

Increasing risks

How much does a data breach cost? The average has reached an all-time high of $4.35 million, according to the newly released “Cost of a Data Breach Report 2022.” The report, published by independent research group Ponemon Institute, also found that 83% of respondents have experienced more than one data breach.

Another key finding is that the average cost of a data breach increased by roughly 13% during the pandemic. Why? One reason is the increase in remote working arrangements. Many organizations now have sensitive data stored in more places than ever before — including laptops, cloud-based storage, email, portals, mobile devices and flash drives — providing many potential areas for unauthorized access.

Ransomware attacks are also on the rise, in part due to geopolitical instability. According to the study, ransomware attacks were up 41% in 2022 compared to the previous year. These attacks cost organizations an average of $4.54 million per incident in 2022, excluding any ransom paid to the perpetrator. Ransomware attacks generally take longer to detect and contain than other types of data breaches.

Targeted data

Hackers may try to steal valuable information about your organization’s employees and customers. Examples include payment card data, protected health data and personal identifiable information, such as phone numbers, addresses and Social Security numbers.

Another target may be valuable intellectual property, such as customer lists, proprietary software, formulas, strategic business plans and financial data. These intangible assets may be sold or used by competitors to gain market share or competitive advantage.

Risk assessment

As the frequency and severity of cyberattacks have increased, data security has become a critical part of the audit risk assessment. In recent years, the Public Company Accounting Oversight Board (PCAOB) has interviewed auditors of companies that have experienced a cybersecurity breach.

These interviews reveal that audit firms provide varying levels of guidance, both when assessing risk at the start of the engagement and when uncovering a cybersecurity incident that occurred during the period under audit or during audit fieldwork. For example, auditors usually ask management what’s being done to understand, detect and prevent computer system breaches.

Another key finding of the PCAOB research is that the costs associated with cybersecurity breaches may not always be apparent. A major cybersecurity breach can cause more than lost profits; it may also result in a loss of customers, reputational damage and even bankruptcy.

We can help

Though PCAOB’s research focuses on public companies, any organization can be the victim of a cyberattack. And the effects may be even more devastating for those with fewer resources to absorb the losses and assign dedicated staff to respond to breaches. Our firm is atop the latest cybersecurity trends. Our auditors can help your organization assess its cyber risks and improve the effectiveness of internal controls over sensitive data. Contact us for more information.

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Auditors commonly use confirmations to verify such items as cash, accounts receivable, accounts payable, employee benefit plans and pending litigation. Under U.S. Generally Accepted Auditing Standards, an external confirmation is “a direct response to the auditor from a third party either in paper form or by electronic other means, such as through the auditor’s direct access to information held by a third party.”

Some companies may be put off when auditors reach out to customers, lenders and other third parties — and sometimes confirmation recipients fail to respond in a timely, complete manner. But confirmations are an important part of the auditing process that you’ll better appreciate if you learn more about them.

Three formats

The types of confirmations your auditor uses will vary depending on your situation and the nature of your organization’s operations. Confirmations generally come in the following three formats:

1. Positive. Recipients are requested to reply directly to the auditor and make a positive statement about whether they agree or disagree with the information included.

2. Negative. Recipients are requested to reply directly to the auditor only if they disagree with the information presented on the confirmation.

3. Blank. The amount (or other information) isn’t stated on this type of request. Instead, it requests recipients to complete a blank confirmation form.

Confirmation procedures may be performed as of a date that’s on, before or after the balance sheet date. If the procedures aren’t performed as of the balance sheet date, the account balance will need to be rolled forward (or backward) to the balance sheet date.

Mailed vs. electronic forms

In the past, auditors sent out confirmation letters through the U.S. Postal Service. Then, they waited to receive written responses from their audit clients’ customers, suppliers, banks, benefits plan administrators, attorneys and others. This was a cumbersome process. If an auditor failed to receive an adequate level of response, follow-up confirmation letters could be sent, which could lead to delays in the audit process. Alternatively, the auditor could contact nonresponding recipients by phone or in person. Otherwise, the auditor would need to perform alternative procedures.

Although written confirmations are still permitted, auditors routinely use electronic confirmations today. These may be in the form of an email submitted directly to the respondent by the auditor or a request submitted through a designated third-party provider.

Electronic confirmations can be considered reliable audit evidence. Plus, they overcome some of the shortcomings of written confirmations. That is, they’re sent and received instantaneously at no cost, and the electronic confirmation process is generally secure, minimizing the risks of interception or alteration. As a result, some financial institutions no longer respond to paper confirmation requests and will respond only to electronic confirmation requests.

Let’s work together

External confirmations can be a simple and effective audit tool. Contact us if you have questions about how we plan to use confirmations during your next audit or if you have concerns about the efficacy or security of the confirmation process.

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