Manufacturing and Distribution Group Newsletter – Spring 2018
Joel A. Herman, Seamus M. Donoghue
Compilation, review or audit: Select the right level of assurance
JOEL HERMAN, CPA
The term “financial statement assurance” refers to how much confidence lenders and other stakeholders have that a company’s financial statements will be reliable, informative and in conformity with U.S. Generally Accepted Accounting Principles (GAAP) or another appropriate financial reporting framework. Higher levels of assurance require more in-depth procedures performed by the CPA when evaluating a company’s financial statements. Here’s how the three levels of assurance — compilations, reviews and audits — compare.
Compiled financial statements essentially provide no assurance from the CPA to the reader that the statements are free from material misstatement or that they do not require material changes to conform to GAAP. Here, an accountant simply categorizes management’s data into a financial statement format and that conforms to GAAP (or another appropriate framework). Footnote disclosures and cash flow information are optional in compiled financial statements.
AICPA Statement on Standards for Accounting and Review Services (SSARS) No. 21 recently reduced the length of the CPA’s compilation report addressing the financial statements. Instead of the previous standard three-paragraph statement, compilation reports are now only one paragraph long, unless the company follows a special-purpose framework, such as income tax basis or cash basis. In those cases, an extra paragraph of explanation is included.
Another type of service that provide no assurance are prepared financial statements. These follow many of the same guidelines as compiled financials. The basic difference is that preparation statements do not require the CPA to include a report. Instead, they simply contain a disclaimer on every page that no level of assurance has been provided.
Accountants have been preparing financial statements for years, but SSARS 21 now provides official guidance for accountants to follow. Prepared financial statements are often used by owners who formerly relied on management-use-only financial statements, which have been eliminated under SSARS 21.
Reviewed financial statements provide limited assurance that the statements are free from material misstatement and conform to GAAP. They start with internal financial data. Then, the accountant applies analytical procedures to identify unusual items or trends in the financial statements. He or she will also inquire to evaluate the company’s accounting policies and procedures and probe for any anomalies.
Reviewed statements require footnote disclosures and a statement of cash flows. But, the accountant isn’t required to evaluate internal controls, conduct substantive testing and confirmation procedures, or physically inspect assets.
SSARS 21 calls for review reports to contain emphasis-of-matter (and other-matter) paragraphs when CPAs encounter significant matters that are relevant to stakeholders.
Audited financial statements are viewed by many as the “gold standard” in financial reporting. They provide reasonable assurance that the statements are free from material misstatement and conform to GAAP.
Though there is no level of assurance that provides an absolute guarantee against material misstatement or fraud, significant work goes into preparing audited financial statements. In addition to performing analytical procedures and conducting inquiries as in a Review, auditors also:
- Understand and evaluate the company’s internal control systems;
- Verify and confirm information with third parties, such as customers and lenders;
- Physically observe inventory counts and inspect certain assets;
- Examine limited underlying evidence, such as sales invoices, paid bills, cancelled checks; and
- Assess other forms of substantive audit evidence.
Public companies are required by the Securities and Exchange Commission to have their financial statements audited. Private companies are not all necessarily required to have their financial statements audited, but some are required to in conjunction with bank financing requirements, outside investor agreements or exit strategies. Some private companies choose to have their financial statements audited annually simply as a means of best practices.
Moving up (and down) the assurance chain
Choosing the right level of assurance comes down to:
- The complexity of your operations;
- The abilities of your in-house personnel to accurately report financial results that conform to GAAP;
- Your stakeholders’ expectations; and
Though larger companies have more sophisticated finance and accounting departments, the nature of their transactions and their reliance on outside financing often necessitate an audit.
Over time, manufacturers and large companies may decide to change their level of assurance. For example, a growing company might upgrade from a review to an audit in order to attract an investor. Or, a financially stable company might decide to downgrade from an audit to a review and engage a CPA to perform certain agreed-upon procedures to evaluate accounts receivable and inventory. If assurance is necessary in conjunction with bank lending requirements, banks often perform their own limited scope collateral audits, which saves the company the cost of a full financial statement audit. Discuss these options with your CPA to find the level of assurance that suits your business’s current needs and longer term objectives.
For more information, contact Joel Herman at [email protected], or 312.670.7444. Visit ORBA.com to learn more about our Manufacturing & Distribution Group.
Expanded depreciation deductions: How can you benefit from tax reform?
SEAMUS DONOGHUE, CPA, MST
In December 2017, President Trump signed the Tax Cuts and Jobs Act (TCJA) into law. This is the most comprehensive tax reform package in over three decades, and it will have a major impact on how much income tax manufacturers and distributors will pay in 2018. In addition to lowering business tax rates, the new law significantly expands the tax breaks for capital expenditures.
As a result, you may be able to save big tax dollars on purchases of fixed assets and property improvements that you make before the end of this year.
If you need new plant equipment, want to upgrade your accounting software or decide to remodel your office, it can provide a sizable tax break. Generally, you must capitalize these purchases. In other words, spread the deductions for capital expenditures over several years.
However, there are two tax breaks that allow you to accelerate these deductions for tax purposes: Section 179 and bonus depreciation. Although these deductions have been available in various amounts over the years, they have been expanded by tax reform.
First, the TCJA permanently increased the Sec. 179 expensing limit for qualifying fixed asset purchases from $510,000 in 2017 to $1 million in 2018 and beyond. However, this break is phased out for qualifying purchases over $2.5 million in 2018 (up from $2.03 million in 2017). Going forward, these amounts will be indexed for inflation.
Sec. 179 expensing for fixed asset purchases is phased out on a dollar-for-dollar basis for purchases that exceed the threshold amount. So, a Sec. 179 deduction is not available if your total investment in qualifying property is above $3.5 million for 2018.
Examples of assets that qualify for Sec. 179 include machinery, equipment, vehicles and furniture. The TCJA also expands the leasehold improvement property that is eligible for Sec. 179 to include roofs, HVAC equipment, fire protection and security systems.
With the permanent extension of the increased Sec. 179 expensing limit, you can now plan your annual capital expenditure budget with more certainty. Say you are thinking of spending up to $1 million this year on qualifying fixed assets such as those listed above. If so, you might want to make purchases and place the assets in service before the end of the year.
The second expanded tax break for capital expenditures is bonus depreciation. Under the old rules, businesses were allowed to deduct 50% of qualified property additions in the first year of service for 2017.
Under the TCJA, companies are now allowed to fully deduct capital expenditures made after September 27, 2017, and no later than December 31, 2022.
Unlike Sec. 179, bonus depreciation is not subject to any spending limits or phaseout thresholds. In addition, the new law expands the break to include new and used property, removing one of bonus depreciation’s former disadvantages compared to Sec. 179 expensing.
Unfortunately, the bonus depreciation breaks will sunset, starting in 2023, as follows:
- 80% for qualifying property placed in service after December 31, 2022, and before January 1, 2024;
- 60% for qualifying property placed in service after December 31, 2023, and before January 1, 2025;
- 40% for qualifying property placed in service after December 31, 2024, and before January 1, 2026; and
- 20% for qualifying property placed in service after December 31, 2025, and before January 1, 2027.
For certain property with a longer production period and certain aircraft, the beginning and end dates in the list above are increased by a year.
Qualifying property generally includes Modified Accelerated Cost Recovery System (MACRS) property with a recovery period of 20 years or less, computer software and qualified improvement property. In addition, special rules apply to vehicle purchases and certain real property.
In the past, some corporations chose to accelerate their alternative minimum tax (AMT) credits instead of taking bonus depreciation for assets they acquired. However, that option is no longer available under the new law because the TCJA repeals the corporate AMT.
The potential tax savings with Sec. 179 expensing and bonus depreciation are significant, but the rules can be complicated. Consult with your tax advisor for more details on how you can take full advantage of these taxpayer-friendly opportunities to grow your business.
Sidebar: Got company cars?
Many small and midsize manufacturers provide company cars for their owners and salespeople. However, the deduction for luxury passenger automobiles is limited for federal income tax purposes. Under the new tax law, the limits for vehicles placed in service after December 31, 2017, are:
- $10,000 for the first year the asset is placed in service;
- $16,000 for the second year;
- $9,600 for the third year; and
- $5,760 for the fourth and later years.
These amounts are indexed for inflation annually after 2018. For vehicles for which bonus first-year depreciation is claimed, the maximum additional first-year depreciation allowance remains at $8,000.
For more information, contact Seamus Donoghue at [email protected], or 312.670.7444. Visit ORBA.com to learn more about our Manufacturing & Distribution Group.
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