Acuity Advisors

Is annual financial reporting enough?

Businesses generally issue year-end financial statements to let investors and lenders evaluate their financial health. But proactive stakeholders — including the company’s CEO and board of directors — may want more than one “snapshot” per year of financial results. Interim statements let stakeholders know how a company is doing each quarter or month, but they also have drawbacks and limitations.

Benefits

Interim reports may provide signals of impending financial turmoil due to, say, the loss of a major customer, significant uncollectible accounts receivable or pilfered inventory. Or they might confirm that a turnaround plan appears successful or that a startup has finally achieved profits. In short, they allow stakeholders to check up on performance, giving them either midyear peace of mind or the opportunity to implement corrective measures early on.

Limitations

But beware: Interim financials usually don’t conform to U.S. Generally Accepted Accounting Principles. Outside accounting firms rarely review or audit interim statements because of the cost to do so. Absent external oversight, internal finance and accounting personnel with bad news to report might be tempted to cook the books to appear more profitable.

Interim numbers may omit many of the adjustments that external accountants make at year end, such as estimates for bad-debt write-offs, accrued expenses, prepaid items, management bonuses or income taxes. In addition, some companies save tedious bookkeeping procedures, such as physical inventory counts and updating depreciation schedules, until year end. So interim account balances might reflect last year’s amounts or be based on historic gross margins.

It’s also important to realize that some companies are seasonal. If there are operating peaks and troughs, for example, you can’t multiply quarterly profits by four to reliably predict year-end performance. For seasonal operations, you may want to benchmark last year’s monthly (or quarterly) results against the current year-to-date numbers.

When the numbers don’t add up

If interim statements reveal irregularities or trigger concerns, consider seeking outside accounting expertise. We can conduct a forensic investigation or agreed-upon procedures that target high-risk account balances or an account that was previously adjusted by auditors. Contact us for more information.

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Tax Return Identity Theft

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Take small-business tax credits where credits are due

Tax credits reduce tax liability dollar-for-dollar, making them particularly valuable. Two available credits are especially for small businesses that provide certain employee benefits. And one of them might not be available after 2017.

1. Small-business health care credit

The Affordable Care Act (ACA) offers a credit to certain small employers that provide employees with health coverage. The maximum credit is 50% of group health coverage premiums paid by the employer, provided it contributes at least 50% of the total premium or of a benchmark premium.

For 2016, the full credit is available for employers with 10 or fewer full-time equivalent employees (FTEs) and average annual wages of $25,000 or less per employee. Partial credits are available on a sliding scale to businesses with fewer than 25 FTEs and average annual wages of less than $52,000.

To qualify for the credit, online enrollment in the Small Business Health Options Program (SHOP) generally is required. In addition, the credit can be claimed for only two years, and they must be consecutive. (Credits claimed before 2014 don’t count, however.)

If you meet the eligibility requirements but have been waiting to claim the credit until a future year when you think it might provide more savings, claiming the credit for 2016 may be a good idea. Why? It’s possible the credit will go away for 2018 because lawmakers in Washington are starting to take steps to repeal or replace the ACA.

Most likely any ACA repeal or replacement wouldn’t go into effect until 2018 (or possibly later). So if you claim the credit for 2016, you may also be able to claim it on your 2017 return next year (provided you again meet the eligibility requirements). That way, you could take full advantage of the credit while it’s available.

2. Retirement plan credit

Small employers (generally those with 100 or fewer employees) that create a retirement plan may be eligible for a $500 credit per year for three years. The credit is limited to 50% of qualified start-up costs.

Of course, you generally can deduct contributions you make to your employees’ accounts under the plan. And your employees enjoy the benefit of tax-advantaged retirement saving.

If you didn’t create a retirement plan in 2016, it might not be too late. Simplified Employee Pensions (SEPs) can be set up as late as the due date of your tax return, including extensions.

Maximize tax savings

Be aware that additional rules apply beyond what we’ve discussed here. We can help you determine whether you’re eligible for these credits. We can also advise you on what other credits you might be eligible for when you file your 2016 return so that you can maximize your tax savings.

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FASB approves one-step impairment test for goodwill

In January, the Financial Accounting Standards Board (FASB) issued updated guidance to simplify goodwill impairment testing for public companies and private companies that haven’t taken advantage of the simplified reporting option for goodwill. Here are the details.

The basics

Goodwill shows up on a company’s balance sheet when it buys another business at a price that’s more than the purchased business’s market value. This premium is considered an intangible asset that generally includes the reputation of the purchased business and its competitive advantage in the market.

Under U.S. Generally Accepted Accounting Principles (GAAP), companies are typically required to test for declines in the value of the goodwill at least once a year. When there’s a drop in the fair value of goodwill, companies must record an impairment. Impairment write-offs may be viewed by stakeholders as a sign that an acquired business isn’t living up to management’s expectations.

Old rules vs. new rules

Under existing GAAP, goodwill impairment testing is a two-step process. The first step is to determine whether an impairment exists and then value it. The second step includes determining the implied fair value of the goodwill and comparing it with its carrying amount on the balance sheet.

Companies have complained for years that the second step requires complex calculations. Further, they told the FASB that investors are more interested in the existence of an impairment than in a precise calculation of its amount.

In 2014, the FASB issued a reprieve for private companies that carry goodwill on the balance sheet: They can elect to forgo annual impairment testing and, instead, amortize goodwill over a 10-year period.

Soon public companies and private companies that still test annually for impairment will also have a simpler route: An update to GAAP scraps the second step of the existing impairment test. So, goodwill impairment will simply equal the excess of the entire reporting unit’s carrying amount over its fair value.

Effective date

The revised standard goes into effect in 2020 for calendar-year public companies that file financial statements with the Securities and Exchange Commission. All other public companies can delay implementation of the update for one year — and private companies that haven’t elected to amortize goodwill can delay implementation for two years. However, because one-step testing is easier than two-step testing, many companies are expected to take advantage of the early adoption option that’s permitted for annual impairment tests conducted after January 1, 2017.

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The “manufacturers’ deduction” isn’t just for manufacturers

The Section 199 deduction is intended to encourage domestic manufacturing. In fact, it’s often referred to as the “manufacturers’ deduction.” But this potentially valuable tax break can be used by many other types of businesses besides manufacturing companies.

Sec. 199 deduction 101

The Sec. 199 deduction, also called the “domestic production activities deduction,” is 9% of the lesser of qualified production activities income or taxable income. The deduction is also limited to 50% of W-2 wages paid by the taxpayer that are allocable to domestic production gross receipts.

Yes, the deduction is available to traditional manufacturers. But businesses engaged in activities such as construction, engineering, architecture, computer software production and agricultural processing also may be eligible.

The deduction isn’t allowed in determining net self-employment earnings and generally can’t reduce net income below zero. But it can be used against the alternative minimum tax.

How income is calculated

To determine a company’s Sec. 199 deduction, its qualified production activities income must be calculated. This is the amount of domestic production gross receipts (DPGR) exceeding the cost of goods sold and other expenses allocable to that DPGR. Most companies will need to allocate receipts between those that qualify as DPGR and those that don’t — unless less than 5% of receipts aren’t attributable to DPGR.

DPGR can come from a number of activities, including the construction of real property in the United States, as well as engineering or architectural services performed stateside to construct real property. It also can result from the lease, rental, licensing or sale of qualifying production property, such as:

Tangible personal property (for example, machinery and office equipment),
Computer software, and
Master copies of sound recordings.

The property must have been manufactured, produced, grown or extracted in whole or “significantly” within the United States. While each situation is assessed on its merits, the IRS has said that, if the labor and overhead incurred in the United States accounted for at least 20% of the total cost of goods sold, the activity typically qualifies.

Contact us to learn whether this potentially powerful deduction could reduce your business’s tax liability when you file your 2016 return.

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