The Value of an Audit
Times are tough and you're looking for ways to reduce your overhead. As
you are scanning your income statement you come to the line item for accounting
services and think to yourself, "This might be a place to trim costs." So
you put in a call to George, your CPA.
The conversation might go something like this:
You: George, I have just been reviewing my financial statements. Man, I didn't know that I paid you so much in fees. What's the deal?
George: I don't know. Let me take a look at your file and give you a call back. As promised, George calls back and the conversation continues:
You: Hi, George. What did you find out?
George: I took a look at your bills over the past few years and it looks as if they've been pretty consistent. In 2007 our fees were $22,625; in 2008 they were $32,000; and in 2009 we billed $24,000. This year our fees were $24,500.
You: How much did you charge for the audit? Can I just have the tax return done and forget about the audit?
George: We charged $22,000 for the audit and $2,500 for your tax return. You can cut the audit and just have us prepare the tax return, but you save the $22,000 because we cut a lot of things in the audit that help us prepare the tax return.
You: Well, can you tell me what I would save?
You find out from George that you could save $20,000 if you drop the audit. You also find out a few other things you did not realize, such as why auditing costs so much and why it is in your best interest to continue doing it; in other words, the true benefits of an audit.
If you are like many business owners, you consider the audit and tax preparation to be costs you would like to avoid. Since what you get for the work is a few pieces of paper, that's understandable. The work that goes into the papers and the potential benefit you reap, however, is considerable.
Audits take time for the client and the auditor. At a minimum, expect your accounting personnel to be busy preparing schedules, answering questions and providing information to the auditors. Some of management will spend time with the auditors, too, though it will not be significant in most instances. Other employees might also be asked to speak with the auditors during the course of the work.
We could go into the details here of just how this process works, but the real value to you isn't in all of the technical details. Instead, the value lies in the auditor's interaction with you and your employees. Aside from obtaining accounting documents, auditors are required to design procedures to obtain reasonable (but not absolute) assurance that your company's financial statements are free from material errors, fraudulent financial reporting and misappropriation of assets. Auditors routinely ask management and employees about the systems used to detect and report fraud, and whether employees and management are aware of any fraud. Even if the interview process does not uncover actual wrongdoing, it can uncover areas of weakness.
Our interaction with management and employees can also yield tangible results for your bottom line. During the audit process, there are multiple opportunities for informal discussions between the auditors and company personnel. Sometimes personnel will tell auditors information they do not feel comfortable passing on to management regarding operational matters. These talks might help the auditor formulate business suggestions for you that extend beyond accounting topics.
For example, you might be keeping all of your funds in a non-interest bearing cash account or earning interest at a very low rate while paying high service charges. This happens a lot; but because of our audit procedures, we notice this when management has not. As a manager, too often you are busy handling day-to-day challenges and probably have little opportunity to focus on such things.
You might be thinking of adding a shift to your current production schedule to meet an unusually high demand, when working overtime for a short period instead will achieve your objectives and save money. A discussion with your auditor will help focus on ways to meet your needs without adding personnel and overhead.
Administrative and business practices are always taken into consideration by auditors because this helps clients - and that is our main goal. An audit can - and often does - yield results beyond meeting third-party reporting needs.
That isn't to say that your CPA does not consider cost savings or revenue raising options for you in the course of preparing your tax return or compiling your financial statements outside of an audit. But since it is a more in-depth engagement, the audit affords a greater opportunity to uncover beneficial ideas.
If your company currently undergoes an audit, talk to your accounting team regarding the additional benefits it can bring your business. If your company is not being audited, give us a call and let's explore how that process will offer benefits to your company's operations.
ESOP: It's Not a Fable
Mention an ESOP and some people might think you are talking about Aesop's fables. Though the two sound the same, it's doubtful the ancient Greeks ever considered selling their businesses through an Employee Stock Ownership Plan. Once this can be explained as a mechanism for doing so, some owners will show a great deal of interest in an ESOP. Perhaps you will, too.
What is an ESOP?
ESOP is short for Employee Stock Ownership Plan. It is a mechanism to vest ownership in a company in its employees.
Why would you want an ESOP?
One of the best reasons to create an ESOP is to provide a market for a departing shareholder's interest in a company. Establishing an ESOP can also be an effective way to reward employees and offer incentives for desired performance. Additionally, ESOPs are a tax-effective way to borrow money for asset acquisition.
How does an ESOP work?
An ESOP is a qualified employee benefit plan under the Employee Retirement Income Security Act of 1974. Typically, a business establishes a trust to obtain company stock. The ESOP can be funded either by the donation of newly issued stock from the company or the cash to purchase existing shares. The ESOP can also purchase shares in the company by issuing debt and acquiring stock with the proceeds. The company would then make periodic contributions to service the debt. Regardless of the method of funding, company contributions are tax deductible, based on certain limitations.
Shares held by the trust are allocated to the individual employee accounts. With some exceptions, all full-time employees over the age of 21 participate in the plan. Allocations to employees are based on a formula established in the plan. Typically, the longer the time of service and the greater the employee's pay, the more shares are allocated to him or her. Ownership does not necessarily vest immediately, but an employee must be fully vested within three to six years.
Upon an employee's termination, he or she receives the stock in his or her account. The company must then repurchase that stock from the employee at its fair market value, as determined by an independent appraisal. However, if the company is a public company, the buyback price is based on publicly traded stock quotes.
Advantages of ESOPs
Using an ESOP can be a cost-effective way to buy out departing shareholders because ownership passes from them to the ESOP trust. The company makes tax deductible contributions to the ESOP to pay for the purchase.
In many cases, the ESOP borrows the funds to buy out a departing owner. In order to repay the loan plus the related interest, the company makes a tax-deductible contribution to the ESOP. This makes both principal and interest tax deductible.
Compare this to a company's direct purchase of stock from a departing stockholder where the cost of the treasury stock is not deductible. A final use of the ESOP is, of course, to offer additional benefits to employees.
Tax Effects
If a company chooses to fund the ESOP with stock, the stock contributions are tax deductible. In effect, the company can issue stock at no cash cost and reduce its taxable income. The resulting tax savings enhances the company's cash flow.
Cash contributions to the ESOP are also tax deductible. The cash need not be immediately used to acquire stock, but it can be retained to meet future repurchase obligations or to purchase stock in the future.
As previously mentioned, by virtue of using tax-deductible contributions to the ESOP to service debt, the after-tax cost of the ESOP is greatly reduced.
Finally, and most significantly for the departing owners, if the ESOP ownership interest in the company is 30 percent or greater, the shareholder can reinvest the sales proceeds in publicly traded securities and defer recognition of the gain until a future period.
If the ESOP is an owner in an S Corporation, its pro-rata share of income is not subject to income tax, although it must still receive distributions proportionate to its ownership interest.
Dividends are tax deductible. Dividends used to repay an ESOP loan, or those that are passed through to employees or reinvested in company stock by employees are tax deductible. The dividends must be reasonable in comparison to dividends paid by other companies.
Employees do not pay tax on contributions to ESOPs. Rather, they pay tax only when they receive a distribution from their accounts.
So, what's the catch?
If all of this sounds too good to be true, it really isn't. However, as with everything in the employee benefit arena, there are stringent rules governing the operation of ESOPs. In addition to typical reporting requirements applicable to other employee benefit plans, the requirement for appraisals of the stock can make the ESOP costly. ESOPs are not available to partnerships and most professional corporations. Additionally, while ESOPs are available to S Corporation shareholders, the gain on the sale of the shares cannot be deferred by reinvesting the funds in another qualifying security.
As with all things, whether an ESOP is a viable alternative for your business or not requires careful evaluation based on your company's circumstances. If you believe your company could benefit from one, give us a call and let's discuss your alternatives.
Update: New Rules Create Grandfathering Conundrum in Healthcare Reform
No one expected the healthcare overhaul to be simple. The new regulatory standards governing employer-sponsored plans that were announced in June could mean that as many as 39 percent to 69 percent of employer-sponsored plans will be subject to the new regulations and will not be eligible for grandfathering (i.e. exemption from the new rules). The new provisions outline the limits on what changes are allowed before a plan becomes subject to the new mandatory requirements starting in 2014. In short, the requirements don't allow for most of the alterations that have become standard as businesses try to find affordable solutions. Small businesses, in particular, are liable to be caught in situations where revising existing plans could jeopardize their eligibility for grandfathered status.
Why worry about grandfathered status?
Many business owners would like to keep their existing plans and have grandfathered status but find the looming premium increases too costly to bear. Major healthcare insurance companies appear to be increasing their prices somewhere between 11 percent and 15 percent. Small businesses are reporting quotes that have increased 17 percent or 18 percent -with some seeing premium hikes of up to 24 percent. Insurers say that these increases are needed to offset spiraling costs for hospital care, prescription medicines and doctors. Switching to cheaper plans could bring the new regulations into the picture, creating substantially higher healthcare costs for employers.
While all the heated rhetoric is under way on Capitol Hill, remember that under the Affordable Care Act firms with less than 50 employees have no employer responsibility requirements - in other words, there is no employer mandate for these small businesses to offer healthcare coverage.
Small Business Healthcare Tax Credit
Many small business owners will qualify for some relief if they are eligible for this new tax credit. The Internal Revenue Service began contacting small businesses by mail in April to encourage them to check their eligibility. To qualify, an employer must cover at least 50 percent of the cost of healthcare coverage for some workers (based on single rate coverage).
Here is an overview of some of the key issues raised by recent developments. How individual business owners respond to the new healthcare insurance regulations will depend on many factors. Seek advice from your tax and finance professionals before making any decisions.
Companies facing
steep increases normally get competitive bids from other insurance providers.
If they change providers, business owners (who are otherwise eligible )
will forfeit grandfathered status for their healthcare plans, and thus be
required under the new laws (effective in 2014) to offer costly additions,
such as yearly physical exams and extending coverage to include adult children
up to 26 years old.
Plans that increase
the amount patients must pay out-of-pocket (co-insurance) could also be
liable to governance under the new healthcare act. The law offers some flexibility
in response to rising costs - deductibles may be increased in line with
medical inflation.
Tax credits of up
to 35 percent of premium costs for 2010 are designed to help small businesses
with 25 or fewer full-time workers (business with fewer than 50 half-time
employees might be eligible) to offset rising costs. In January 2014, this
rate increases to 50 percent.
All is not lost if you make a mistake. There will be a grace period during which time employers can undo changes that unwittingly may have triggered forfeiture of grandfathering. The White House Office of Health Reform has indicated it will acknowledge attempts to comply that may have slightly missed the mark. Nevertheless, you can avoid headaches later by consulting with your tax and legal experts now.
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