IRS is on YouTube

For those of you looking for quick answers, the IRS has quite a few videos on YouTube at
https://www.youtube.com/user/irsvideos

They also have some pretty good articles written for anyone just starting a business at
http://www.irs.gov/Businesses

As has been mentioned many times in this community, it's best to start out on the right foot & the proper organization of your business can mean a great deal of difference in how and when your taxes are due!

Ready to sell your baby?

Preparing Your Business for Sale

Article written by EricBank

You've determined that it's time to sell your small business and you want to earn the highest possible price for it. This requires you to spruce things up a bit: streamline operations, lower debt, create business plans and in general give the financial statements a thorough review. A makeover can add value to your company and actually improve the quality of your firm. The better the management of the company, the quicker it will sell. So ask yourself, what do buyers want to see in order to evaluate your company?

Financial Buyers

A financial buyer will be looking to finance most of the purchase price of the company, using the company's cash flow to repay the financing. You therefore want to maximize your cash flows. These buyers will put a three- to six-times multiple on earnings before interest and taxes (EBITA) after adjusting for expenses that will not continue with the new management. They subtract from this figure any interest-bearing debt they will assume with the company, so you may want to get rid of your debt before putting your firm up for sale. Of course, the downside of paying down debt is that it soaks up cash that you might otherwise use to generate profits -- for instance, by buying inventory. A sudden drop in revenues stemming from an inability to purchase merchandise for sale can hurt your firm's selling price, so you must evaluate debt reduction in this light.

Strategic Buyers

On the other hand, a strategic buyer will want to combine your business with others and achieve certain synergies. The buyer may be a competitor that already knows the industry and wants access to your confidential information. For instance, you may keep a secret list of sales leads that can be very valuable to a competitor. Therefore, you must be cautious dealing with a strategic buyer and make sure not to give away any proprietary information before the sale is complete. In the worst-case scenario, the bidder will extract valuable information from an eager seller and then suddenly withdraw the bid, or in the case of public corporations, attempt a hostile takeover at a lower price.

Accounting and Auditing

Of course, all your financial statements must be use proper accounting techniques and must be audited if you want to appear credible to a buyer. Bankers will not finance a deal without high quality, audited financial statements. However, if you are a very small business, it's likely you don't have audited statements, so if your buyer insists on them, use a reputable accounting firm that specializes in small businesses. In all cases, you want statements going back at least three years (assuming you've been in business that long) that reveal all pertinent information regarding sales, profits, depreciation, expenses, inventory, receivables, and all other important financial aspects.

Finally, make sure that you have a management team in place that can run the company without you. The new owner may or may not want to replace them, but having a team there will reassure the buyer that your company can survive the loss of you.

Intercompany Transactions

Unrealized Gross Profit Equity Method

Article written by EricBank

The equity method describes how an investing company (the investor) accounts for its stake in another company, the investee. Normally, the investor must own between 20 percent and 50 percent of the investee's voting shares to qualify for equity-method accounting. The unrealized gross profit equity method, or UGPEM, permits the investor to defer revenues generated from certain inter-company transactions with the investee. These include inventory sales between the two companies and the sale of depreciable assets.

Equity Method

According to the equity method, an investment in an investee company is booked by the investor as a long-term asset. To acknowledge the investor's share of investee profits and losses, it adjusts the investment's book value whenever earnings are announced by the investee. For example, suppose Medium Corporation buys 20 percent of Tiny Corp for $2 million. Medium's accountant would book the $2 million as a debit to its Tiny Corp long-term asset account and as a credit to cash. When Tiny Corp next announces quarterly results, it reports net income of $100,000. Medium's 20 percent share amounts to $20,000, which it debits to the Tiny Corp asset account and credits to an income account, with a name like "Tiny Corp Investment Income."

Unrealized Gross Profit

Under the investor-investee relationship of UGPEM, the inventory seller maintains partial ownership of the goods until the buyer sells them all. Until the buyer uses up or sells the inventory, the gross profit accompanying the sale of the inventory between investee and investor is not realized. This applies when the investee sells the inventory to the investor -- an upstream transfer -- and also when the investor is the seller, a downstream transfer.

Downstream Transfer Example

Let's imagine that Medium Corp sells inventory to Tiny that it paid $35,000 to acquire. Medium sell the goods for a 30 percent profit of $15,000, making the sale price $50,000. As of the end of the year, Tiny has sold 80 percent of the inventory -- $40,000 of its cost-- leaving another $10,000 in Tiny's ending inventory. When Tiny finally unloads the remaining inventory, Medium will garner 30 percent, or $3,000, of the profit. However, since Medium owns only 20 percent of Tiny, its unrealized gross profit will be $600, which is $3,000 times 20 percent. At year-end, Medium postpones the unrealized gross profit by booking $600 as a debit to investment income and as a credit to the long-term asset account. After Tiny sells the remaining inventory, Medium enters a reversal transaction and recognizes the $600 gross profit.

Upstream Transfer Example

Upstream sales also receive UGPEM treatment. For example, if Tiny sell Medium inventory costing $40,000 for $60,000, then $20,000 is the gross profit. From Medium's perspective, the $20,000 represents a 33.3 percent gross profit ratio. Now suppose $15,000 of the inventory is still owned by Medium at year's end. This means that 33.3 percent of $15,000, or $5,000, is still tied up in unsold goods. Multiplying this amount by the 20 percent ownership percentage yields an unrealized gross profit of $1,000. Therefore, Medium books the $1,000 deferral as a debit to the investment income account and a credit to the long-term asset at year-end. After disposing of the remaining goods, Medium reverses the deferral.

Who's in the cross hairs for an IRS audit in 2014 & 2015?

Here's really long, boring read, if you're looking for materials to put you to sleep!

<http://westerncpe.us2.list-manage.com/track/click?u=48c9757cae1cfd246a6cbcb02&id=cf426f160c&e=fc6aeb5bdb>  

However, it has some very valuable information about who and why the IRS will be narrowing down their audits and what the new areas of focus (red flags) will be for the upcoming audit season.

Here are a couple of highlights:
*  Of course the high-income taxpayers will always be a target audience.  They are the most likely to just pay to have the problem go away, then waste their time on pulling the documents necessary to prove their positions on the returns.  Also, these could lead to extension of the audit if there are flow-through entities involved in the personal audit.

*  Developers and real estate investors will be a target audience.  With partnership returns on the rise, the IRS has done some special training to target this growing target base.

*  Employers are always a target.  Specifically whether or not you have your employees properly classified (versus independent contractors), your form 1099 compliance and reasonable compensation for S Corporate officers.

*  Cash basis businesses.  This increase is due to the 1099-K reporting.  The IRS will be looking for filers who only report exactly what the merchant sales were as income, leaving out any possibilities of cash or check sales.  This is an easy and very profitable target audience.

Be aware of what might cause an audit and properly document your deductions!  It can make all the difference between whether or the IRS letter is a short correspondence, or an every expanding audit!!

And, because I'm also a tax preparer, DON'T EVER TALK TO THE IRS WITHOUT REPRESENTATION!  It's in your taxpayer bill of rights.  Even if you don't have one, get one, before going toe to toe with the IRS.  Politely take their card and let them know your representative will be contacting them shortly.  And then, of course, have your representative contact them .

How to allocate overhead

Overview: Reciprocal Method of Cost Allocation

Article written by EricBank

The topic of intra-company cost allocation can sometimes seem a little hairy. Many businesses are structured with departments that provide service and support to production departments and to other service departments. For example, your company might have a private gym and a food service department. Non-production departments can be costly to run, so using a cost allocation scheme ensures that production departments pick up their fair shares of these costs. One of three widely used techniques for allocating the costs of service departments is the reciprocal, or double-distribution, method. The direct and step-down methods are the two other popular ones, but as we discuss below, the reciprocal method usually gives the most accurate results.

Benefits of Cost Allocation

There is no better way to sensitize a department manager to the budgetary impact of service costs than to assign these costs to the manager's department. You know you are getting the manager's attention if the department suddenly adjusts its budget to reduce its utilization of overhead service from other departments once these services come with a price tag. Another benefit of overhead-cost allocation is to ration it, on the assumption that these costs involve scarce or expensive resources. For example, you might have a company with a central Information Technology Department that services requests from six other departments. No matter how many people you hire, you never have enough to quickly satisfy all requests. In this case, department managers might bid for IT services by rearranging their budgets to support more of this overhead. Presumably, those with the greatest needs would make the highest bids.

Cost Allocation Methods

The easiest technique for assigning service department costs is the direct method. That's because it allocates costs to production departments only and turns a blind eye to the overhead costs between service departments. For example, the food service department wouldn't charge the gym personnel for their snacks, and the gym wouldn't allocate costs to the food service employees who use the gym. The step-down method allocates service department costs in only one direction. For example, the company might allocate gym usage cost to the food service department but charge no food service costs to the gym. The reciprocal method would charge costs in both directions.

Reciprocal Method

The reciprocal method permits service departments to charge each other for the services they deliver. You must solve a set of simultaneous equations to use this method. Luckily, computer programs or spreadsheets provide this functionality. Some rational metric serves to allocate costs to each department. Metrics such as the physical square footage of a department or its number of employees are popular choices.

Example

Let's say your business has three support departments, A, B and C, and two production departments, M and N. To allocate costs using the reciprocal method, you first assign each support department a linear equation. Then you simultaneously solve all three equations. Suppose the annual budget of Dept. A is $70,000 and that it uses 9 percent of Dept. B's services. Thus, Dept. A's linear equation sets its assignable costs equal to $70,000 plus 9 percent of Dept. B's budget. Similarly, you set up linear equations for the other support departments, let the computer solve them, and then modify the budgets of the production departments to absorb these costs.

Cash is King!

Small Business Capital Management

Article written by EricBank

Cash is the lifeblood of small businesses, because often they do not have alternative sources of funding. A company's current assets minus its current liabilities are its working capital. Cash and its equivalents -- short-term Treasury bills and commercial paper -- plus assets that can become cash within a year, such as accounts receivable, inventory and negotiable securities, are current assets. Debt due within a year, accounts payable, taxes payable, wages and salaries payable and other short-term liabilities are current liabilities. It's up to you to choose how aggressively or conservatively to manage your working capital.

Aggressive Management

The use of short-term credit coupled with minimal spending on current assets characterizes aggressive management of working capital. You are basically operating on a shoestring budget, cutting purchases of supplies and inventory to the nub while delaying bill payment until you start receiving threatening letters. You also aggressively try to collect your A/R. You must not delay interest payments or tax payments. Your creditors will sue and might force you into bankruptcy and liquidation. The Internal Revenue Service takes a very dim view of missed tax payments.

Conservative Management

At the opposite end of the spectrum, your working capital policy might be conservative: plenty of cash in the bank, inventory levels fully stocked and all bills paid on time. Your supply cabinets are full and employees need not justify a requisition for a new pencil. Typically, a conservative policy has a working capital ratio -- that's current liabilities divided into current assets -- of 2 or greater. In other words, for every dollar of current liabilities, you have $2 of current assets. Following this less-risky policy, you're not anticipating a cash crunch, but you might be getting a lower return, because cash in the bank doesn't pay much.

Risk

As you make your working capital policies more aggressive, default and bankruptcy risk increases. For example, if you have little cash on hand and are hit with a sudden emergency, you might have to default on an interest payment. Debtors might seize your property or wrestle the company away from you. In a less drastic example, if you skimp on inventory replacement, you're vulnerable to stockouts, lost sales and alienated customers. Your vendors might stop doing business with you if you string them along for several months before coughing up payment. If you want to float new debt, your deteriorating credit rating will raise your interest rates and make it harder to find new lenders. Conversely, if your working capital policy is too conservative, you incur opportunity costs by not working your money as hard as possible. This can lower your sales efficiency ratio -- working capital divided into sales revenue -- which can discourage investors in new debt and equity.

Return

An aggressive policy increases your return on assets, but hurts your bottom line by lowering your inventory levels, crippling sales and receipts. A conservative policy creates some lazy money that doesn't earn much of a return. The optimal working capital policy lies somewhere between the two extremes. Your goal is to minimize risks while maximizing revenue -- experience and experimentation will help you get it right.

Tips for Accelerating Income and Deferring Expenses

Accelerating Revenue and Deferring Spending

Article written by EricBank

As a small business owner or corporate CEO, you can employ strategies that affect your net income and cash flow by accelerating your revenues and postponing your spending. This is the opposite of a tax management strategy, because it tends to increase your current-year taxes. Rather, you increase collections and defer expenditures to conserve cash, and you accelerate revenue recognition and postpone expense recognition to increase earnings.

Accelerating Revenue

Under accrued accounting, you recognize revenue when you earn it. By offering your customers special inducements, you can incentivize them to make quicker and/or larger purchases. You have several options, including:

·       Better credit terms

·       Volume discounts

·       Rebates

·       Markdowns

Another tactic is to speed up the shipping cycle, which allows quicker revenue recognition. Depending on your cash needs, you might auction your inventory to accelerate income, although your total income will probably be lower. If you perform work billable in stages, you might speed up the delivery of goods or services linked to billable milestones.

Accelerating Collections

Your goal might be to simply increase you cash balance. For this purpose, you can consider accounts receivable factoring. Under this procedure, you receive a percentage of your A/R's value from a factor -- a bank or other financial institution -- that purchases your customer invoices. For example, the factor might advance you 80 percent of your A/R balance and then pay you a portion of the money it collects above that threshold. If you'd rather not sell your invoices, you can hire a bill collector to track down delinquent accounts, or you can auction off your inventory, which accelerates both collections and revenues. Another ploy is to offer a better cash discount for prompt payment. For example, if you normally offer 2/10 net 30, you can consider changing it to 4/7 net 20 -- a 4 percent discount if paid in seven days, bill due in 20 days.

Deferring Expenses

Despite the accounting principle that matches expenses to revenues, you often have some discretion in recognizing or paying expenses. A spending freeze applied to items like inventory, equipment and supplies will postpone expenses. You might also cancel or delay attending corporate junkets, conventions and training sessions. In tough times, you can stop hiring and even lay off workers, perhaps filling some gaps with unpaid interns. You might also be able to skip your annual contributions to employee retirement accounts, cut employee benefits, defer advertising and insurance purchases, and even save money on paper by going paperless whenever possible.

Deferring Spending

You must be careful to recognize expenses in the proper period -- your accountant will advise you on this -- but you certainly can delay paying cash. Of course, if you extend you accounts payable cycle too far, you could lose purchase discounts, but this might be a good trade-off for you nonetheless. A corporation can withhold dividends or terminate stock buyback programs to conserve cash. Perhaps some employees would be willing to take a smaller salary in return for stock options. However, never fail to pay your interest and taxes on time -- as your accountant will tell you, now you're playing with fire.

Do you offer Warranties, if so, do you know how they should be accounted for?

How to Account for  Warranty Liability

Article written by EricBank

Many businesses, large and small, issue warranties on the products they sell and the services they deliver. A warranty is actually a contract between a company and its customers guaranteeing that specific facts and conditions are or will be true. Normally, the warranty permits the customer to seek redress for faulty purchases, through either refund, repair or replacement, for a stated period following purchase.

Accounting Steps

The purpose of warranty accounting is to allow your business to record a liability that estimates warranty costs for your offerings -- that is, the goods and services you offer. Under generally accepted accounting principles (GAAP), you front-load the estimated expenses for servicing the warranty by booking the liability in the period of the sale. As you actually process warranty claims, you debit (reduce) the warranty liability account by the amount you spend to fulfill the warranty. The result is that you accurately match warranty expenses with the revenues they support on your financial reports. This makes sense, because a warranty is an added inducement to a potential customer that helps to close a sale.

Step 1

You need to estimate your warranty costs for the upcoming period. To do so, research warranty costs by examining your own historical data to find an appropriate relationship between sales revenues and warranty costs. If you are a new business or otherwise don't have access to such data, use average warranty cost rates for your industry, which you can find by searching websites that publish this kind of information.

Step 2

However you develop the warranty costs as a percentage of sales, apply that number to your sales forecast for the new period. Suppose you manufacture, sell and warranty hard cases for cell phones. You guarantee customers that the cases will not to crack, scratch or chip for one year. You project $500,000 in revenues for the upcoming quarter, and experience tells you that you will need 1 percent of those revenues to cover warranty expenses. Your projected warranty liability is therefore 1 percent of $500,000, or $5,000.

Step 3

Make an accounting entry on the first day of the quarter debiting the warranty expense account and crediting the warranty liability account for the estimated expense, which in this case is $5,000.

Step 4

Relieve the warranty liability as you incur warranty costs. For example, if you replace a $50 hard case you sold, debit the warranty liability account and credit cash or accounts payable for $50.

Keep in Mind

If you provide warranties that cover periods beyond one year, split the warranty liability on the balance sheet between the sections for current and long-term liabilities. Make sure you consider product changes when you estimate your warranty liability. For example, imagine you previously sold only plastic hard cases, but have recently changed over to aluminum ones. Your new warranty liability estimate for the upcoming period should reflect the fact that the metal cases are sturdier and less prone to damage than are the plastic ones. Of course, you'll also need to factor in the different repair/replacement costs for metal vs. plastic hard cases.