Today's CPA Jan/Feb 2012 by The Warren Group

Today’sCPA JAN./FEB. 2012

T E X AS S O C IET Y OF

C E RT I F I E D P U BL IC AC C OU N TANT S

HEALTH CARE REFORM WHAT CPAS NEED TO KNOW TO STAY AHEAD

Using a Montana LLC to Avoid Texas’ Taxes Won’t Work Consolidating Variable Interest Entities Audit Engagement Partner Rotation

Also: Becoming a Trusted Advisor to Your Clients

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CHAIRMAN Donna Holliday Wesling, CPA

EXECUTIVE DIRECTOR/CEO John Sharbaugh, CAE

Contents 24

JANUARY/ FEBRUARY 2012

VOLUME 39, NUMBER 4

EDITORIAL BOARD CHAIRMAN Arthur Agulnek, CPA

Staff MANAGING EDITOR DeLynn Deakins ddeakins@tscpa.net 972-687-8550 800-428-0272, ext. 250

TECHNICAL EDITOR C. William Thomas, CPA, Ph.D. Bill_Thomas@baylor.edu

COLUMN EDITORS

Greta P. Hicks, CPA Mano Mahadeva, CPA, MBA James F. Reeves, CPA C. William (Bill) Thomas, CPA, Ph.D.

WEB EDITOR Wayne Hardin whardin@tscpa.net

cover story

CONTRIBUTORS

24 Health Care Reform

Melinda Bentley; Jerry Cross, CPA; Anne Davis, ABC; Donna Fritz; Kelly Harwick; Rhonda Ledbetter; Craig Nauta; Kim Newlin; Jim O’Guinn; Bob Owen, CPA; Catherine Raffetto; Avery Roth; Katey Selph; Rori Shaw

DIRECTOR, MARKETING & COMMUNICATIONS Janet Overton Design/Production/Advertising The Warren Group thewarrengroup.com custompubs@thewarrengroup.com

CLASSIFIED Donna Fritz Texas Society of CPAs 14651 Dallas Parkway, Suite 700 Dallas, Texas 75254-7408 972-687-8501 dfritz@tscpa.net

Editorial Board Arthur Agulnek, CPA-Dallas; Lisa Bauman, CPA-Dallas; James Danford, CPA-Fort Worth; Greta Hicks, CPA-Houston; Jeffrey Liggitt, CPA-Dallas; Mano Mahadeva, CPA-Dallas; Alyssa Martin; CPA-Dallas; Dawne Meijer, CPAHouston; Ty Moore, CPA-Houston; Jan Taylor Morris, CPA-Houston; Windford Paschall, CPA-Fort Worth; Marshall Pitman, CPA-San Antonio; Mattie Porter, CPA-Houston; Kamala Raghavan, CPA-Houston; James Reeves, CPA-Fort Worth; Brinn Serbanic, CPA-East Texas; Paul Willey, CPA-Dallas. © 2012, Texas Society of CPAs. The opinions expressed herein are those of the authors and are not necessarily those of the Texas Society of CPAs. Today’s CPA (ISSN 00889-4337) is published bimonthly by the Texas Society of Certified Public Accountants; 14651 Dallas Parkway, Suite 700; Dallas, TX 75254-7408. Member subscription rate is $3 per year (included in membership dues); nonmember subscription rate is $28 per year. Single issue rate is $5. Periodical POSTAGE PAID at Dallas, TX and additional mailing offices. POSTMASTER: Send address changes to: Today’s CPA; 14651 Dallas Parkway, Suite 700; Dallas, TX 75254-7408.

Today’sCPA

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CPAs need to stay informed about the latest developments.

42 Do Audit Committee Members Care about Audit Engagement Partner Rotation?

society features 14 Keeping Up With the Joneses

Many Changes Add Up to Success for Transplanted East Coast CPA and Family

19 Becoming a Trusted Advisor to Your Clients

A look at ways to acquire clients and improve client retention.

20 Capitol Interest

The Interim – Preparing for the 2013 Legislative Session

technical articles 30 Using a Montana LLC to Avoid the Texas Sales/Use Tax Will Not Work

A Montana LLC will not relieve consumers of tax burdens in Texas.

34 CPE: Consolidating Variable Interest Entities

Identifying variable interest entities pursuant to ASC Topic 810.

Audit committee members’ perceived benefit from acceleration of audit engagement partner rotation.

columns 5 Chairman’s & Executive Director’s Message

Report on CPA Horizons 2025 Project

6 Tax Topics

Changing the IRS Audit Location

8 Business Perspectives

A Stitch in Time Saves Nine

9 Accounting and Auditing

Clarity Standards Bring Changes to the Audit Report

10 Emerging Issues Let’s Make a Deal

12 Chapters

West Texans Sow Next Season’s Crop

departments 16 Take Note 44 Classifieds 46 CPE Calendar 3

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Chairman’s & Executive Director’s Message By Donna Holliday Wesling, CPA | TSCPA Chairman & John Sharbaugh, CAE | TSCPA Executive Director/CEO

Report on CPA Horizons 2025 Project Second in a Series In the last issue of Today’s CPA, we discussed the American Institute of CPAs (AICPA) initiative CPA Horizons 2025. This initiative began in 2010 and focused on gaining the insights of CPAs, business leaders, regulators, thought leaders and futurists into the continuing evolution of the accounting profession. It was an extension of AICPA’s CPA Vision Project that took place in the late 1990s and engaged CPAs and other important stakeholders to create a blueprint for the profession through 2011. CPA Horizons 2025 now extends the original vision into the future. In the project, AICPA examined the trends affecting CPAs, how these trends would impact the profession, and the current and future challenges and opportunities that CPAs face. Over a six-month timeframe, members of the profession were asked to share their insights through an interactive survey, 16 in-person forums, virtual focus groups, and online discussion forums. In total, more than 5,600 CPAs participated, contributing a cumulative 6,000 hours, and generating in excess of 75,000 individual comments. This major effort was completed in partnership with the state CPA societies, including TSCPA. To analyze the significant amount of feedback, an advisory panel consisting of 22 members was created to assess the input that was received. The advisory panel was selected to represent all member segments by practice area, age, gender and diversity. Through their

review and refinement of the participants’ input, the group defined the profession’s core purpose, values and competencies. The core purpose is: CPAs … Making sense of a changing and complex world. The core values include: • integrity, • competence, • lifelong learning, • objectivity, • commitment to excellence, and • relevance in the global marketplace. The core competencies include: • communications skills, • leadership skills, • critical-thinking and problem-solving skills, • anticipating and serving evolving needs, • synthesizing intelligence to insight, and • integration and collaboration. In addition, 10 key themes emerged that give insight into how CPAs will conduct business, remain competitive, serve clients and employers, and attract and retain employees. The themes include: • understand and leverage relevant technology in conjunction with core CPA competencies to deliver superior services, • evolve the educational framework to keep pace with the changing dynamics

• • • •

• • •

•

of business, government and our profession, position the CPA as a premier designation of the accounting and finance profession throughout the world, encourage pride among CPAs in the accounting profession and in the value CPAs create throughout society, preserve the role of the CPA as the trusted attester of financial and other information, promote the CPA as the trusted advisor who, in addition to providing core CPA services, develops solutions to complex problems by integrating knowledge, expertise and resources from multiple disciplines, leverage the strengths of the profession to expand market permissions, address continual changes in the marketplace, economy, businesses and regulations, increase the visibility of the profession’s value proposition by demonstrating the core values in multiple areas of business and society, and continue to offer opportunities that enhance the profession’s appeal and be proactive in addressing both U.S. and global demographic shifts.

The research of the CPA Horizons 2025 project shows that the accounting profession has a bright future, and it will need to respond quickly and competitively to any shifts in economic, technological, social, political, and regulatory fronts. TSCPA will be examining the research results and using them to help determine appropriate TSCPA services and initiatives for members. If you would like to read AICPA’s final report, please visit their website at www.aicpa.org and search on the term CPA Horizons 2025. n

Donna Holliday Wesling can be contacted at donna@weslingcpa.com. John Sharbaugh can be contacted at jsharbaugh@tscpa.net.

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Tax Topics By Greta P. Hicks, CPA | Column Editor

Changing the IRS Audit Location One of the first issues to negotiate with an Internal Revenue Service (IRS) auditor is the time and place of the audit. If it is a field audit, the auditor will press to go to the taxpayer’s place of business. In a correspondence audit, the auditor will most likely want to complete the audit by mail even if you request that it be transferred to a local office. Below are code, regulations and Internal Revenue Manual (IRM) references that will be helpful when negotiating the location of the audit or attempting the transfer of an audit.

Who determines the location of the audit? The time and place of audit pursuant to the provisions of Code Sections 6420(e)(2), 6421(g)(2), and 6427(j)(2) are to be fixed by an officer or employee of the IRS, but Code Sec. 7605 and related regulations admonishes employees to schedule a time and place that is reasonable under the circumstances. What about scheduling audits during the filing season? The IRS website states: “… it is reasonable for the IRS to schedule audits throughout the year, without regard to seasonal fluctuations

in the businesses of particular taxpayers or their representatives. However, the IRS will work with taxpayers or their representatives to try to minimize any adverse effects in scheduling the date and time of an audit.”1 Once the audit location is set, can the location of audit be changed? Yes. Is it easy for the location to be changed? Sometimes. Treasury Regulations 301.7605 – 1 and 301.7605-1(e) are the legal references for setting the time and place of the audit, and for requesting a change of place of audit.

Can a correspondence audit be changed to an office or field audit? Yes, but it may take some strong negotiations on the part of the representative. The IRS website states: “If the audit is by correspondence, you can request a face-to-face audit because the books and records may be too voluminous to mail” but it gives no legal reference for this statement.2 On April 1, 2011, an article in The Tax Adviser stated: “If an assessment in a CP 2000 notice is incorrect or if a response is to be made to the initial contact letter, the practitioner should consider whether to ask that the matter be transferred from the IRS campus to a local office. The IRS tends to not want to transfer cases because of the possibility of delay and possible increased costs. Regs. 301.7605-1(e) (1) provides that the IRS will consider, on a case-bycase basis, written requests to change the audit venue. Many IRS campuses take the view that correspondence audits will be transferred only in instances of hardship. If there are problems in transferring an audit, the representative may want to contact the local taxpayer advocate’s office and request assistance in having the matter transferred to the local IRS office.” Both the Treasury Inspector General for Tax Administration (TIGTA) and the National Taxpayer Advocate have issued reports identifying problems with the conduct of correspondence audits.3 Can an office audit be held at a location other than the IRS office? Yes. An office audit generally will take place at the closest IRS office within the district encompassing the taxpayer’s residence or within the district where the entity’s books, records and source documents are maintained. Are there exceptions to the general rules regarding office audit locations? In scheduling office audits, the IRS will grant a request to hold an office audit at a location other than an IRS office in a

Greta P. Hicks, CPA, is a consultant on IRS problems, seminar discussion leader, author of continuing education courses and web content provider. She can be reached at gretahickscpa@yahoo.com or www.gretahicks.com.

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case of clear need, such as when it would be unreasonably difficult for the taxpayer to travel to an IRS office because of the taxpayer’s advanced age or infirmed physical condition, or when the taxpayer’s books, records and source documents are too cumbersome for the taxpayer to bring to an IRS office.4 What are the circumstances for approval of transferring an office audit? Again, from the IRS website: “…a request by a taxpayer to transfer the place of audit for an office audit will generally be granted if the current residence of the taxpayer or the location where the taxpayer’s books, records and source documents are maintained is closer to a different IRS office in the same area as the office where the audit has been scheduled. The IRS normally will agree to transfer the audit to the closer IRS office.” What if you want to change the location of a field audit? The site states: “…a request by a taxpayer to transfer the location of audit for field audits will generally be granted under the following circumstances: • if a taxpayer does not reside at the residence where an audit has been scheduled, the IRS will agree to transfer the audit to the taxpayer’s current residence; • if the taxpayer’s books, records and source documents of an individual sole proprietorship or a business return are maintained at a location other than the location where the audit has been scheduled, the IRS will agree to transfer the audit to the location where the taxpayer’s books and records are maintained. See IRM 4.10.2.8.3.” What factors should be included in a request to transfer an audit? The factors include: • the location of the taxpayer’s current residence; • the location of the taxpayer’s current principal place of business;

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• the location at which the taxpayer’s books, records, and source documents are maintained; • the location at which the IRS can perform the audit most efficiently; • the IRS resources available at the location to which the taxpayer has requested a transfer; and • other factors indicating that conducting the audit at a particular location could pose undue inconvenience to the taxpayer. Are there any other arguments regarding the location of field audits? According to the IRS: “…If an audit is scheduled by the IRS at the taxpayer’s place of business and the taxpayer represents to the IRS in writing that conducting the audit at the place of business would essentially require the business to close or would unduly disrupt business operations, the IRS, upon verification, will change the place of audit to an IRS office within the district where the taxpayer’s books, records and source documents are maintained.”5 What are the representative’s best resources for presenting a good case for transferring an IRS audit? Since the decision to transfer or not transfer an audit is made by a local IRS employee, IRM 4.11.29, IRM 4.4.33, IRM 4.1.4.3.18, IRM 4.10.2.8.3, and IRM 4.19.13.14 should be used as resources for requesting the transfer of audits. These IRM sections plus Treasury Regs. 301.7605 – 1 are the representative’s best guidelines when making a written request for the change of an IRS audit location. n FOOTNOTES 1. 2. 3.

4. 5.

Regs. 301.7605 – 1(b) http://www.irs.gov/businesses/small/ article/0,,id=219636,00.html#keypoint5 See www.treasury.gov/tigta/auditreports/2009re ports/200940099fr.pdf and www.irs.gov/pub/irsutl/nta2011objectivesfinal.pdf. Regs. 301.7605 – 1(c)2 Regs. 301.7605 – 1(d)(3)(iii)

TAX ISSUES Community on TSCPA’s Website

Are you ready for tax season? To assist you, TSCPA’s Tax Issues Community on the website provides a number of resources and links to tax-related information. In the Federal Information section of the community, you’ll find links to IRS documents, directories and tax articles, as well as links to other publications, articles and tax-related issues. In the Online Resources section of the community, you can access: • FORMS AND PUBLICATIONS; • INFORMATION ON ELECTRONIC FILING; • BUSINESSES GETTING STARTED; • EMPLOYEES; • IRS CONTACT LISTS; • FACTS ABOUT ABUSIVE TAX SCAMS AND SCHEMES; • A LEARNING CENTER; • OTHER NON-IRS ONLINE RESOURCES. TSCPA provides the Federal Tax Policy blog to keep you up to date throughout tax season. In addition, there are links to information on state taxation, AICPA taxation and related CPE opportunities, as well as the activities of the Relations with IRS Committee and Federal Tax Policy Committee. You can also sign up to receive the free Tax Issues electronic newsletter that includes important updates throughout the year. Other resources include links to TSCPA’s Ask a Member program, information on identity theft prevention/ awareness, past Tax Topics columns written by Greta Hicks, and more. To visit the Tax Issues Community, go to TSCPA’s website at tscpa.org. Under Resource Center, scroll down to Member Communities, select Tax Issues, and log in as a member.

Business Perspectives By Mano Mahadeva, CPA, MBA | Column Editor

A Stitch in Time Saves Nine Unemployment remains at elevated levels across the United States. As a result, larger numbers of candidates are applying for positions in which performance makes a substantial difference within your organization. Successful hires make a positive difference through exceptional performance, while unsuccessful hires lead to higher costs, loss of time, lower morale and lower productivity. Therefore, it is important that you hire someone who has a “can do” attitude, with a “will do” motivation and who is a great fit for your organization the very first time an opportunity presents itself. The selection process of most organizations relies primarily on the employment interview. The employment interview not only helps to assess the candidate’s technical skills, training and experience, but also offers ways to obtain a deeper insight into a candidate’s intangibles, such as motivation, enthusiasm, integrity, personality and ethics. However, managers may be ill prepared to screen candidates. Ill-prepared managers tend to ask the “usual” questions, such as “what are your strengths and/or weaknesses,” or “what skill sets do you bring to us,” instead of asking those probing questions that help assess the candidate’s likelihood of success. In addition, due to the proliferation of self-help websites and recruiter coaching, potential employees prepare for these usual questions with “prepared” answers. We push, prod and probe candidates with meaningful questions to gain valuable insight. Where appropriate, ask a lead question and follow up with probing questions to ascertain if there is substance to a candidate’s answer. An example may be: “Tell me about an initiative you have undertaken to improve procedures at work. How did you approach the initiative? Were you successful, and why or why not? What would you have done differently? What did you learn from this experience?” As a variation, we could describe a situational setting by providing “real live” data from our company and ask the candidate to respond

to questions. For example, the situation and questions might include: “We discussed our payables area in detail. As you are aware, we are merging with Company X next month. A key initiative will be consolidating our payables function within three months. How do we get this done? How do we communicate this action? Who are the customers involved? How do we meet the expectations of our customers? What benchmarks do we use to measure success?” Is the candidate passionate, confident, smart, fearless and concise? Can he/she make people around him/her better? Can he/she lead a team? How does he/she process information? Is he/she of good character? Can he/she move the needle or work through a crisis? Are there too many “I” and “me” versus “us” in responses? Considering the present economy, is the candidate simply trying to get a job until the market turns? The manager’s objective is to ask questions that help elicit insightful information to make a judgment on the candidate. Usual questions, such as “how did your boss rate you,” or “what staff turnover did you have,” do not provide the insight that you seek due to lack of confirmation. Instead, you may ask the candidate to tell you what your company does. You may be amazed at the number of candidates who provide vague answers or simply say they do not know! This might caution you that the candidate just wants a job,

does not care about the company, or may not be very thorough with any approach on the job. I would expect a candidate to have some sense of what the company does, discuss strategy, list some competition and present an issue or two. A follow up might be how he/she plans to fit within your organization based on unique talents or specific qualities that he/he brings. To explore leadership, you may ask what kinds of people the candidate hires and what qualities he/she looks for in those people. You may ask him/her to name leaders he/she looks up to as role models. A probing question may be asking how many of his/her reports have moved up in the organization. To assess learning, you could ask the candidate to discuss any newly learned skills in the recent past, if he/ she is presently learning any new skills and why, and to discuss briefly the last book he/she read. These questions may suggest that the candidate is keeping up with new literature and today’s skills to keep up with present job demands. There are many facets to a hiring process. The manager needs to prepare for the interview, spend the time needed with the candidate, ask questions, follow up with probing questions, do background checks and check references. But it is human judgment in the face-to-face assessment and questioning that appears to be the linchpin in determining the successful candidate. Take the time to prepare; do not cut corners. You will be happy that you did! n

Mano Mahadeva, CPA, is executive director with U.S. Oncology in Plano. He serves on both the Editorial Board and the Business and Industry Issues Committee for TSCPA. Mahadeva can be reached at mano.mahadeva@usoncology.com.

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Accounting and Auditing By C. William (Bill) Thomas, CPA, Ph.D. | Column Editor

Clarity Standards Bring Changes to the Audit Report The clarity auditing standards, drafted over the last five years and set to take effect for audits of periods ending on or after Dec. 15, 2012, have two purposes: (1) to simplify auditing standards, making them easier to read, understand and apply; and (2) to bring U.S. standards into closer alignment with auditing standards set by the International Audit and Attestation Standards Board (IAASB). The majority of “clarity” changes will not be significant from the standpoint of application. Rather, the new standards simply rephrase and re-codify existing rules. However, a few of the changes under this project are more substantial. Perhaps the most noteworthy of these is the auditor’s report. Under the new clarity standards, the auditor’s report has been redesigned to more clearly communicate responsibilities, process and outcome of the audit.

WHAT WILL THE NEW REPORT LOOK LIKE? The new auditor’s report under the clarity standards will require headings to identify significant sections of the report. There are four major sections: Introductory Paragraph, Management’s Responsibility for the Financial Statements, Auditor’s Responsibility and Auditor’s Opinion. The introductory paragraph will still contain an identification of the entity, a statement that the financial statements have been audited, an identification of the title of each statement, and a specification of the dates covered by each of the financial statements. The second paragraph will be titled “Management’s Responsibility for the Financial Statements.” It will include a description of the responsibility of management for both the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework, as well as the design, implementation and

maintenance of internal controls relevant to the preparation and presentation of financial statements that are free of material misstatements, whether due to error or fraud. The third paragraph of the report will be titled “Auditor’s Responsibilities.” This paragraph will be similar to the current scope paragraph. It will state the auditor’s responsibility to express an opinion on the financial statements and will reference generally accepted auditing standards (GAAS). Additionally, this paragraph will retain the current statement that GAAS require the auditor to plan and perform the audit to obtain reasonable assurance that the financial statements are free from material misstatement. It will also describe the scope of the audit process: (1) performing procedures to obtain evidence about amounts and disclosures in the financial statements; (2) that the procedures selected depend on the auditor’s judgment regarding the assessed risk of material misstatement, and that this assessment considers the entity’s internal controls in order to design the procedures but not to express an opinion on these controls, and disclaiming such an opinion; and (3) that an audit includes evaluating the appropriateness of the accounting policies used, the reasonableness of significant estimates made by management, and the overall presentation of the financial statements. The final sentence of the paragraph will conclude with a statement that the auditor believes the audit evidence obtained is sufficient and appropriate to provide a basis for the auditor’s opinion.

The final paragraph will be titled “Opinion.” This section is relatively unchanged from the opinion paragraph in the current audit report. Consistent with the other clarity standards, the reporting standards have been expanded to accommodate a reference to the “applicable reporting framework,” which includes not only U.S. generally accepted accounting principles (GAAP), but international financial reporting standards (IFRS) and a variety of other comprehensive bases of accounting. The standards requiring signature and date of the report are unchanged from existing standards.

DIFFERENCES WITH PCAOB AUDIT REPORT The Public Company Accounting Oversight Board (PCAOB) is expected to make changes to its standard report as well over the next few months. While the details of those changes have not been revealed, we can expect the reports under GAAS and PCAOB standards to retain somewhat the same differences as currently exist. Specifically, PCAOB will require reference to PCAOB auditing standards, where the clarity report requires reference to GAAS. The PCAOB report must still include a separate paragraph describing the auditor’s opinion on the internal controls over financial reporting, whereas the standard clarity report does not include this paragraph.

IT’S ALL ABOUT CLEAR COMMUNICATION Overall, the new audit report under the clarity standards primarily rearranges the audit report and adds more detail to the description of management’s responsibility and the auditor’s responsibility. This new standard will become effective on audits of financial statements for periods ending on or after Dec. 15, 2012. n

C. William Thomas, CPA, Ph.D., is the KPMG/Thomas L. Holton Chair and the J.E. Bush Professor of Accounting in the Hankamer School of Business at Baylor University in Waco. Thomas can be reached at Bill_Thomas@baylor.edu.

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Emerging Issues By James F. Reeves, CPA | Column Editor

Let’s Make a Deal only in the country where it is earned – and provide a tax holiday for the repatriation of corporate profits currently held overseas. And noteworthy for CPAs, this plan would repeal Section 404 of Sarbanes Oxley.

DOOR #2

Maybe Rick Perry was right. The debates are more like a sideshow, more about personalities and taking the spotlight off the substantive issues facing the country. What if, instead of getting to know our candidates through a series of debates (that aren’t really debates), we followed the format of the game show Let’s Make a Deal, whereby each of the candidates’ policies, platforms and proposals are presented from behind a closed door without any visual clues as to which candidates are proposing which plans, so the voters get to decide on the policies rather than personalities. Sound like a deal? Monty Hall, come on down! With regard to proposed tax policy, President Barack Obama’s position is known – allow the expiration of the Bush tax cuts on ordinary income, dividends and capital gains for higher income individuals to occur, beginning in 2013, along with imposition of the yet-to-be-defined Buffett Rule for the “fortunate few;” capping the benefit of itemized deductions at 28 percent; returning the estate tax to the 2009 structure of a 45 percent tax rate and a $3.5 million exemption; eliminating LIFO (Last In, First Out) and tax preferences for the energy industry; and a host of international tax provisions to minimize the incentives to shift income and assets overseas.

Against that backdrop, let’s take a look at the most prominent Republican tax proposals, each from behind a different door.

DOOR #1 This candidate has proposed a tax plan that while sweeping in scope, retains the basic framework of the existing Code. This “Time to Compete” plan would eliminate all itemized deductions and credits for individuals while reducing the rate structure to 8 percent, 14 percent and 23 percent and eliminating the Alternative Minimum Tax (AMT), and taxes on dividends and capital gains. The plan would reduce the top corporate rate to 25 percent, shift to a territorial tax system – taxing income

The “Believe in America” plan would cut the corporate tax rate from 35 percent to 25 percent while implementing a territorial tax system that would equalize tax rates on corporate profits earned overseas. The plan would also eliminate the estate tax, as well as tax on interest, dividends and capital gains for those earning less than $200,000 a year. This candidate would otherwise retain the current tax rate structure, making the Bush tax cuts permanent and retaining current deductions. The candidate has also alluded to a long-term plan to lower rates and reduce tax preferences, without providing specifics.

DOOR #3 This is the plan Jimmy Buffet has been waiting for. The “Cut, Balance and Grow” plan would offer individuals a choice between filing under the current system with a top rate of 35 percent or a flat rate of 20 percent and no AMT. The latter structure would eliminate tax on Social Security benefits, dividends and capital gains, as well as the estate tax. Each individual in the flat tax scheme would be entitled to a standard deduction of $12,500, thus eliminating income tax altogether for a family of four making less than $50,000, countering the argument that a flat tax is inherently regressive. The standard deduction would begin to phase out when AGI reaches $500,000, countering the assertion that the plan favors the rich. The flat tax plan would retain itemized deductions for mortgage interest, charitable contributions, and state and local taxes, avoiding pressure from the real estate, nonprofit and local government lobbies. The plan would lower the corporate tax rate to 20 percent, transition to a territorial

James F. Reeves, CPA, is Senior Vice President, New Product Development at the Tax and Accounting business of Thomson Reuters. Contact him at jim.reeves@thomson.com, or visit his blog at http://jamesfreeves.blogspot.com.

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system, and allow multinationals to repatriate foreign earnings at a 5.25 percent tax rate for a temporary period. This candidate’s plan would also repeal Section 404 of Sarbanes Oxley.

DOOR #4 This plan would impose a low, single-digit tax rate on individual income, corporate profits, and on consumption. The charitable contributions deduction for individuals would be retained, while payroll taxes and taxes on capital gains would be eliminated. Households below the poverty level would be exempt from the income tax, and deductions would be available for folks living or working in Federal Empowerment Zones, thus countering attacks the plan is regressive. The tax on corporate profits would be applied to gross income less purchases, investments and dividends, and the plan would eliminate tax on repatriated earnings. Critics call the plan a flat tax on middle-class labor. The candidate has made some noise about eventually replacing the

income tax with a national sales tax, but few specifics have been revealed at this time.

accounts, and tax foreign profits at the same rate as domestic income.

DOOR #5

WHICH DOOR?

This candidate’s Jobs and Prosperity Plan includes an optional 15 percent flat tax for individual taxpayers, retaining the charitable contributions deduction. Taxpayers could file under the existing system if they so choose, ensuring no one is forced into a tax increase. The flat tax scheme would eliminate tax on interest, dividend and capital gains, but retain the earned income and child tax credits, to deflect criticism that it is regressive. Charitable contributions and home mortgage interest could be deducted, but not state and local taxes, and a $12,000 personal exemption would be allowed for each individual. The estate tax would be eliminated. This plan would impose a 12.5 percent tax on corporate income, eliminate capital gains tax for corporations, allow immediate expensing of new equipment, eventually replace the payroll tax with personal

So, a question for our Republican members … without reflecting on the personalities, which plan do you choose? If it’s not apparent, behind Door #1 is Jon Huntsman; behind Door #2 is Mitt Romney; Rick Perry lies waiting behind Door #3; behind Door #4 is Herman Cain’s 9-9-9 plan (though he’s no longer in the race); and Newt Gingrich is behind Door #5. There is no doubt that taxes will take center stage during the 2012 election cycle. The differences between the two parties are extreme: President Obama believes the wealthy and higher income folks should shoulder more of the tax load, while Republicans generally believe lower rates will spur the economy and job creation. While the best plan may be somewhere in between, voters will ultimately choose the path forward. n

Sensible Investing Successful Results

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9/12/11 10:03 AM

Chapters By Rhonda Ledbetter | TSCPA Chapter Relations Representative

West Texans Sow Next Season’s Crop Texans are an independent bunch. They thrive on a do-it-yourself mentality and pride in self-reliance. But as evidenced by their love of team sports, they’re also pragmatic enough to embrace the value of working together to achieve more. Over the years, TSCPA’s Permian Basin Chapter has formed a valuable partnership with the University of Texas-Permian Basin (UTPB) and area junior colleges. Its purposes are to increase the number of local CPA candidates and make the business community aware of the need for more CPAs in the area. Together, they are enhancing the accounting education available there and helping students with the financial aspect of pursuing a degree. Not long before the beginning of his recent chapter presidency, Phil Davis, CPA, was struck by one aspect of the membership statistics provided by TSCPA. They indicated that 70 percent of CPAs in the chapter were more than 50 years old, compared to 56 percent statewide at that time. The numbers dovetailed with what CPAs in the area were telling him: they were increasingly concerned about being able to find well-qualified young CPA successors and move into retirement. Davis prepared for his presidency by holding a planning meeting that involved the chapter’s leaders in brainstorming about the organization’s role serving members, the profession and the community. That dynamic exchange of ideas created an environment ripe for innovation, leading to development of some exciting new projects and enhancement of ongoing ones. UTPB is the only campus in the chapter area conferring bachelor’s and master’s degrees. Many of its students are already in the workforce and are preparing for a second career. UTPB and area junior colleges coordinate to provide special opportunities for admission, transfer of credit and degree completion.

SEED MONEY The university’s Masters in Professional Accountancy program, offering the opportunity to complete the requirements to sit for the Uniform CPA Exam in Texas, is well-established and has celebrated its 10th anniversary. The Permian Basin Chapter wants to let area students know about it and do things to help them graduate and go on to achieve CPA certification. For several years, the chapter had been giving approximately $3,000-$5,000 in UTPB scholarships annually. That has been increased to $10,000. The purpose of the scholarships was redefined, placing the emphasis on fifth-year and graduate students who are future CPA candidates. In addition, the chapter’s three junior college scholarships were increased from $200 to $1,000 each, and a requirement set that they be given to pre-accounting majors registered at UTPB. After holding scholarship fundraising events for several years, the chapter found that it was a better use of their resources to focus on sponsorships. Letters were mailed to those who had participated as sponsors in previous years’ events, with three dollar levels to choose from. One surprising response was a check with a request that an

even higher level be added; needless to say, chapter leaders were very happy to do so. The chapter has also recently added a $15 contribution option to its dues statement, which has raised several hundred dollars and gotten even more members involved in a convenient, affordable way. Another way the chapter has helped pave the way for students to prepare for CPA certification is being a partner in bringing a Becker CPA Exam Review course to the Permian Basin. The first course there began in July 2010. By the next spring, the chapter had added to its bundle of scholarships, providing up to five for $1,000 each, to apply to the Becker course for an applicant without another source of funding (such as an employer). The number of UTPB graduates sitting for – and passing – the CPA exam has increased dramatically.

GROWING ROOM The ideas generated at the chapter planning meeting eventually led to a conversation about re-establishing an accounting lab at UTPB to replace the one discontinued several years ago because of space limitations. Chapter leaders felt that could be a factor impacting the pass/ fail rate of the university’s accounting students in recent years, so they began planning the steps toward their objective. They envisioned a facility with up-to-date computers and current research software used by CPAs in business and public accounting. The first step was to find a room on campus, which would be endowed by – and, hopefully, named for – the chapter. Expenses would include any necessary remodeling, as well as ongoing maintenance. Utilizing members’ connections with faculty and administrators at the university, chapter leaders spent months investigating possible options and obtaining agreement with the concept. They have carved out $15,000 of the chapter

Rhonda Ledbetter is the TSCPA chapter relations representative. Contact her at 972-687-8508 or at rledbetter@tscpa.net.

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budget, in excess of the minimum set by the university. UTPB President Dr. David Watts has endorsed the project. The final part of the process for officially naming the room is approval from the University of Texas System Board of Regents. The proposed space is in the main building on campus. It would be one of several near the School of Business dean and faculty, encouraging student interaction with them. It is also intended to provide a place for students to study and develop projects in groups, preparing them for a work team environment like that used in the business world. The next steps are for the chapter to determine specifically what equipment and furnishings the room should have, and then to define how much money would be needed from the CPA and business communities. They will develop a plan for recognizing significant donors, with signage in the room and other means. Again, members’ networking is proving valuable; through the University’s Business Advisory Council meeting and others, connections are being made to present the donor opportunity to civic and charitable groups. After all is in place, the chapter will establish an ongoing committee to work with the school’s faculty and students on the upgrades that will be necessary to maintain pace with changes in technology.

WORKING THE FIELD Associations are all about personal contact. And the Permian Basin Chapter provides several ways for students to have meaningful interaction with area CPAs and candidates. Students are actively utilizing those opportunities. To maintain ongoing dialog, the chapter has added non-voting positions on its board of directors for the president of the Student Accounting Association and a faculty member. Accounting students and faculty are special guests at the chapter’s annual Shrimp Boil in September, comprising more than half of the attendees. That event is where the chapter presents its check for scholarships to the university, putting together the dues check-off donations, sponsorships and

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Barbara Scofield, Ph.D., CPA; Shirley Davenport, Ph.D.; Susan Nichols; and Crystal Baylor, CPA. money from the chapter’s funds. During the school year, the student Accounting Association arranges for area CPAs to speak to an accounting class and answer questions informally after the presentation. Taking the topics that are being covered in their coursework, the CPAs talk about real-work experiences and difficult lessons learned. Spring brings an event on campus consisting of CPAs, candidates, students and faculty. CPAs from various work niches serve on a panel and share aspects of their career in accounting to give students a perspective on possibilities (and bust a few myths). Additional CPAs and their staff participate, networking with students and giving them further insights into accounting life. Students are invited to provide their resumes for inclusion in a book given to each CPA who attended. The chapter partners with the faculty to fine-tune details of the event and maximize its effectiveness, moving it from lunchtime to evening for the students’ benefit and providing sandwiches rather than a meal to keep it informal. To show students year-round that their involvement is welcome, the chapter has begun underwriting $10 of the $20 TSCPA

dues plus the full $15 chapter portion for all who join. At the Shrimp Boil the last couple of years, a member has stepped forward to pay the remaining $10 for those who join that night.

HARVEST TIME According to Davis, the number of those enrolled in the university’s MPA and MBA programs or taking graduate courses necessary to get the 150 hours to sit for the CPA Exam has increased. His conversations with members of other professions in the area indicate that they are also experiencing a shortage of professionals at the entry level. The chapter’s projects could be a model for those who want to turn that around. It all comes back to planning. Davis says: “Having that initial meeting to set goals, develop strategies and assign tasks made all the difference for us. We created an open dialog about what we wanted to achieve together and made plans that were adaptable to developments as we went along. It’s important to know where you want to go, but to also be flexible to take advantage of opportunities you didn’t expect.” n

Spotlight on CPAs By Anne McDonald Davis, ABC

Keeping Up With the Joneses – Many Changes Add Up to Success for Transplanted East Coast CPA and Family Back when Janelle Jones, CPA-Houston, was a kid in Brooklyn, New York, she wasn’t sure what she wanted to grow up to be one day … but she had a back-up plan in case she couldn’t decide. Jones laughs: “In elementary school, I had a close friend whose father was a sanitation worker in Brooklyn and he was paid pretty well. So I figured if nothing else, I could lift a whole lot of weights and get to be a really strong woman and do that.”

wouldn’t work any longer. When Andrew, an engineer, was offered a transfer position with his employer, General Electric, in Houston, the Joneses continued their trek southward (and a little to the west). Not long after their move, Jones came on board as a senior associate with PricewaterhouseCoopers (PwC), where she remains today as a manager.

On the other hand, her own father was an accountant and by the time she was in high school, Jones herself was interested in the business world, so her sanitation engineering career and possible Janelle Jones, women’s bodybuilding CPA-Houston championships were not to be. Instead, Jones embarked on a road that would lead to juggling her present-day family of four, a career as a CPA, and volunteering as a TSCPA leader. But back to the beginning. What was it like growing up in a place many consider to be the center of the civilized world? “I didn’t really know the jewel that was before me until I started attending high school in Manhattan and going around the city. Until then, it was like growing up anywhere else,” recalls Jones. The East Coast remained Jones’ universe for many years as she earned her B.S. in accounting at the University of Albany and her Master’s in Taxation at The George Washington University. “I knew after my first undergraduate tax class that I wanted to be a tax accountant,” enthuses Jones, who interned in tax at

Unlike some of the harried business women of bygone decades, Jones offers no clever tips or super-woman-type solutions to juggling a power career and family. She says: “Work/life balance? … I’m still working on that. A large part of how I manage is my husband – he really does his part. His support and help with the family is why it works. It’s both of us.” This past summer, Jones gave birth to her second child, Chase. She reminisces, “One thing that I learned when my daughter, Sydney, stayed home from daycare with Chase and I for a month was that it is challenging to handle two young children by yourself – I have a newfound respect for single parents. Their ability to do it all … is a lot and impressive.” Somehow, somewhere, Jones found the time to get involved with TSCPA’s Diversity and Inclusiveness Committee and is now chairing it. She is invested in the committee’s current focus of diversity/ inclusiveness in the areas of recruiting for the profession in Texas, increasing Society membership through diversity initiatives, and serving as a resource to those members. “The doors are opening to a broader subset of people,” notes Jones. “Just look at Texas and California, with their large Latino populations. Look at colleges

KPMG and then accepted a position as a tax associate at Arthur Andersen’s New York office after completing her master’s degree. “But what I really liked during my time at Andersen was the writing and the research … and I realized that the tax attorneys were getting to do most of that.” Easy solution? Go to law school! Well, maybe not easy, exactly. But law school it was for Jones who received her Juris Doctor from Howard University School of Law. But Jones’s life on the East Coast took a detour not long after that.

SOUTHWARD BOUND Apparently her career was not, and is not, Jones’s sole focus in life, however hard she has worked toward her achievements. “I had started dating my husband, Andrew, while I was at Arthur Andersen. We married at the end of my second year in law school and then there was a whirlwind of changes.” After law school, Jones switched gears and experienced life in the Old South, signing on as an associate with the law firm McKenna, Long and Aldridge in Atlanta, Georgia. She had a long commute each day, and her husband’s commute was literally hours to his company in South Carolina. Once the couple decided to start a family, they agreed that their commutes

HAVING IT ALL?

Today’sCPA

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today – more than half of the incoming classes consist of women. This has and will continue to work its way up through all the professional levels. On a larger scale, the world market is close to being a majority minority, so it makes sense that the collegiate level will continue to have an increase in minority enrollment.” Jones is pleased to see increasing numbers of young women in schools of business and majoring in accounting. She lauds the Big Four for having the foresight to establish policies that enable women, if they wish, to be wives, mothers and CPAs. “Even many second-tier firms are making it possible for women to have that balance,” she smiles. “And those firms are seeing less turnover because they create an environment where women can make it work.” Jones says that she entered a workforce that had already come a long way. “When I started in the profession after graduate school, I saw some of the traditional work force of the past … but at the same time, I

saw enough women and people of diverse backgrounds that I knew it wasn’t just me. There were other female managers in my group and the New York office had female partners.”

GROWING HER OWN GARDEN While the Texas drought made gardening a challenge for the Jones family this year, they persevered. Lettuce, peppers and tomatoes, although she says mostly they grew fried tomato buds. When asked of their other activities, the busy mother of two young ones said: “We are ‘out’ doing things a lot. My daughter takes swimming and we look forward to that on Friday nights.” Last fall, Jones volunteered for Junior Achievement, the sort of civic involvement she would like to do more of down the line. Andrew participates in a program called ‘Boys Rites of Passage’ at the family’s church. “That’s big in our household,” explains Jones. “He helps teach high school students about balancing finances, career

We Go To Work For You.

focus and college prep. It brings him a lot of joy.” With a little football in the fall, life evens out. Although they are deep in Texans’ and Cowboys’ country, Jones says that doesn’t affect their allegiances. “My husband is from Pittsburgh, where you come out of the womb a Steelers’ fan,” she says firmly. All in all, the transplanted New York professional seems to make rather light of all she’s accomplished. Still, she says that if she has a philosophy of life, it’s “if at first you don’t succeed, try again.” She muses: “In grad school, there were two kinds of students. Those who hardly cracked a book before an exam and those who had to study pretty hard – that second kind was me. Back when I sat for the CPA exam, you had to take two parts at once and pass. It was challenging for me to pass and I had to keep at it. So my take away from that experience was ‘if at first you don’t succeed, try, try again.’ The main thing is not to let it get you down. Just keep going until you succeed.” n

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Take Note

Outstanding Educator Awards Presented

What’s New on the TSCPA Website New Industry Issues Blog TSCPA recently launched a new blog in the Business & Industry Center on the website. The Industry Issues blog is written by TSCPA member Bill Schneider, CPA-Dallas. Each week, Schneider, a member of TSCPA’s Business & Industry Committee, shares his thoughts on issues facing the profession. Visit the blog at http://www.industryissues.com.

SMS/Text Messaging Marketing Tips for CPAs This brief article covers SMS/text messaging campaigns and their benefits for TSCPA members. Learn more about text messaging campaigns, see how to create them, and view some examples at http://www.tscpa.org/Content/52204.aspx. Updates to the BV/FLS Community The Business Valuation, Forensics and Litigation Services (BV/FLS) Committee recently updated the BV/FLS Community. Members involved in BV/FLS can find links to recent news articles on the web, additional TSCPA and AICPA resources, member profiles, a list of relevant blogs and upcoming CPE courses. On tscpa.org, go to Resource Center, select Member Communities, and then scroll over and select Business Valuation, Forensic and Litigation Services Community.

Four top Texas accounting professors were recognized by TSCPA with the organization’s 2011 Outstanding Educator Award. These awards are presented to accounting educators in Texas who have demonstrated teaching excellence and actively serve the profession. Congratulations goes to recipients: • Glenn McQueary, Houston Community College, • Lauran Schmid, University of Texas at Brownsville, • Barbara Scofield, University of Texas of the Permian Basin, and • Wayne Shaw, Southern Methodist University. The award ceremony was held during the TSCPA Accounting Education Conference. Each outstanding educator received a plaque and a check for $500. If you would like to nominate a professor for the 2012 Outstanding Educator Award, the deadline is March 1, 2012. For more information, please go to TSCPA’s website at tscpa.org/ Content/50282.aspx.

TSCPA: Protecting Your CPA Certificate

Addition to the Information Technology Community – Cloud Computing The IT Community on the website was created to assist members with their technology needs. The community has several neighborhoods that provide information on a particular issue. A new neighborhood was recently added for cloud computing. You’ll find links to a video and articles on cloud computing, as well as a link to ask questions and receive responses from other CPAs who have experience and expertise in that area. On tscpa.org, go to Resource Center, select Member Communities, and then scroll down and select Information Technology Community.

As a member, you likely are aware of the many good things that happen in your professional world because of the Texas Society of CPAs. Just as important are the bad things that don’t. For nearly 10 decades, the Society has provided a protective presence for the profession – in the state legislature, in information and education, and in forming coalitions. It’s sobering to think of the consequences if there had been no TSCPA all those years. We thank you for being a member and encourage you to share this important member benefit with your non-member CPA colleagues to invite them to membership. You can find details to keep yourself informed and inform others in the Join TSCPA section of the website at tscpa.org.

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Accountants Confidential Assistance Network Do you know the warning signs of alcohol, chemical dependency and/or mental health issues? For some people, they can be difficult to detect. You can learn more about the warning signs by visiting the Accountants Confidential Assistance Network (ACAN) area of TSCPA’s website. ACAN is a peer assistance program dedicated to helping Texas CPAs, CPA candidates and accounting students who are dealing with alcohol, chemical dependency and mental health issues. If you recognize any of the symptoms in your life or the life of someone you know, it may be cause for concern and time to make a confidential call to ACAN. A 24-hour hotline is available at 1-866-766-ACAN to help people who need assistance. You can also contact Craig Nauta at cnauta@tscpa.net. All information is kept strictly confidential. For more information, visit the ACAN area of TSCPA’s website at www.tscpa.org/Content/resource/peerasst.aspx.

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Practice Management Institute Do you need assistance with your succession planning needs? The Texas Society Practice Management Institute was developed in partnership with the Succession Institute, LLC, and it focuses on firm management and practice management issues. Through this members’ only resource, you have access to free material and content on succession planning. There are also CPE selfstudy course offerings available to you at a discounted rate if you would like to receive CPE credit. To take advantage of this resource, please go to the CPE section of the TSCPA website at tscpa. org, scroll down and select Practice Management Institute CE.

Take Note

Strategic Planning for Young CPAs and Emerging Professionals Initiatives TSCPA’s Young CPAs and Emerging Professionals Committee examines issues and concerns of members who are 40 years and under, as well as emerging professionals (students/candidates). The committee works to make resources available for this member segment and provide volunteer leadership experience to meet the needs of this next generation of TSCPA leaders. The committee recently held a day-long strategic planning meeting in Dallas. The session was designed to assist the committee in developing a key role in involving and engaging the Society’s young CPAs and emerging professionals. The group spent the day completing a Strengths, Problems, Opportunities and Threats (SPOT) analysis, which involved group brainstorming, sharing and discussing potential new initiatives for the committee, and ways to help the young CPA and emerging professional member segment get more out of their membership. The session resulted in the group identifying ideas for possible TSCPA programs and initiatives. The ideas included: • develop Society communications channels that can be used to share information on the various professional, career and TSCPA chapter community involvement activities of young and emerging professionals across the state; • continue to expand the offerings of CPE programs in flexible formats such as webcasts, since travel out of the office can be difficult for this member segment; • look into ways to possibly enhance and change TSCPA’s Young CPAs and Emerging Professionals Conference to accommodate attendance by more members.

Jennifer Thompson, CPAFort Worth, shared ideas for programs and/or initiatives for the Young CPAs and Emerging Professionals Committee to consider on behalf of her brainstorming group.

The Young CPAs and Emerging Professionals Committee will continue working in its role to involve and engage the Society’s young CPAs and emerging professionals. For additional information about the activities of the committee, please visit the Young CPA Community on TSCPA’s website at http://www.tscpa.org/ Content/51487.aspx. On the site, you’ll find links to connect with TSCPA on Facebook, LinkedIn and Twitter, as well as the committee roster, other resources and more. To get involved with young CPAs and emerging professionals activities in your local area, contact your chapter.

Participating in a group discussion and SPOT analysis were TSCPA members Ryan Johnston, CPA-Corpus Christi; Norm Robbins, CPA-Fort Worth; Justin Watson, CPA-Dallas; Katy Avenson, CPA-Austin; Bobby Schroeder, CPA-Houston; and Willie Hornberger, CPA-Dallas.

Young CPAs and Emerging Professionals Committee Chair Michael Brown, CPA-Central Texas, shared ideas on behalf of his brainstorming group on programs and/or initiatives for the committee to consider.

Justin Watson, CPA-Dallas, shared his group’s suggestions of opportunities for the Young CPAs and Emerging Professionals Committee.

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Society Feature By Libby Bierman | Analyst, Sageworks, Inc.

Becoming a Trusted Advisor to Your Clients When your vehicle’s gas tank is nearing empty, you generally have a multitude of gas stations from which to choose. They all have similar offerings, so your choice is largely dictated by your location at the time and maybe the reward card you have for a certain chain. And while the price may be slightly different from station to station, the discrepancy often isn’t enough to justify searching out the low-cost provider. Gasoline is a true commodity. When a business owner is searching for a CPA, his/her choice is not nearly as easy. Financial services – despite what some of your tax-only clients may believe – is far from a commodity. And in many cases, location and even price are immaterial. What, then, is the best way to acquire clients and improve client retention? Providing quality work is part of the battle, but when everyone in the profession touts their “excellent customer service,” you need a clear differentiator. One proven way to add value to professional relationships is to become a trusted business advisor, which involves helping the management team make better-informed business decisions. Typically, CPAs are providers of data, and they perform that role very well. Financial statements are prepared accurately and in a timely manner, for example, year after year. But presenting clients with this “good” financial data is not usually enough to become an indispensable advisor. Why is it insufficient? 1. Business owners may be intimidated by financial data, and financial statements can seem indecipherable. Usually, business owners can successfully speak

the language of their business and of their customers, but financial jargon can seem like another language entirely. 2. Financial statements are historically oriented, but business owners are largely focused on the future of their company. “Old” data may not seem incredibly useful to them at first glance. 3. Business owners may also see financial analysis as a distraction from the day-to-day operations of their firm or company. They have to make ends meet and don’t have time to devote solely to financials unless there is an obvious return (and they may not recognize the return due to point #1). To become a trusted business advisor, financial professionals must couple the delivery of data with interpretation and sound business advice. Your end goal should be helping clients understand financial statements rather than review them. Some points to consider when planning a client visit include the following. 1. Do not just provide data and hope your client will be able to interpret it, especially if you are not meeting with the client to present the financial

statements. Include a written report that explains in plain language the metrics most important to the success of that firm or company. And with this narrative summary, length is not the goal; keep it succinct so the client is more likely to read it thoroughly. 2. Connect historical financial data with its impact on future company plans. Brian Hamilton, CEO of Sageworks wrote, “Numbers are not just numbers – they tell a story of how the company is moving towards or away from its strategic objectives.” Historical numbers can provide the context needed to look intelligently forward and avoid repeating past mistakes. 3. Focus your conversation on the few, key performance indicators of that business and its wider industry. Determine the most relevant metrics and then explain to the client how those metrics impact revenue and cash flow because those are two indicators the business owner definitely understands. Interactions with business clients can and should be informal, so they feel welcome to ask questions. Then based on their questions (or lack thereof), you can gauge whether they are just seeking data or substantive advice to help grow their business. This more engaged communication will help you, too. In relationships where you do become a trusted business advisor, you’ll see higher client retention, uncover additional consulting opportunities, and your clients will be much less likely to view your firm as a commodity or as just another gas station on the main road. n FOOTNOTES 1.

Brian Hamilton, “How to Fulfill Your Role as a Strategic Advisor,” MSCPA Newsletter, Nov 2007, 4.Profession. 2008. Summary available at: http:// www.treasury.gov/press-center/press-releases/ Pages/hp1158.aspx.

Libby Bierman is an analyst at Sageworks, a financial information company and developer of the financial analysis software suite ProfitCents. Bierman is responsible for the development of new products to improve client retention and practice management within the accounting industry. She received her degree from the Mendoza College of Business at the University of Notre Dame where she graduated summa cum laude.

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Capitol Interest By Bob Owen, CPA | TSCPA Managing Director, Regulation and Legislation

The Interim – Preparing for the 2013 Legislative Session While legislators do the heavy lifting during the biannual legislative session, they are also active in the interim between sessions. The Speaker of the House and the Lt. Gov. issue specific charges to each standing committee of the legislature to be accomplished during the interim. Also, legislative proposals for the next session are developed during the interim.

HOUSE INTERIM COMMITTEE CHARGES As of our publishing deadline, Speaker Joe Straus had issued the House committee charges, while Lt. Gov. David Dewhurst had only issued charges for a couple of committees. Straus issued two blanket charges to all committees: • Study and make recommendations for significantly improving the state’s manufacturing capability. • Find ways to increase transparency, accountability and efficiency in state government.

Of the 38 pages of committee charges, there are at least two charges of significant interest to CPAs. The first charge is to the Ways and Means Committee, emphasis added: Evaluate the state’s tax structure and determine its impact on the competitiveness of the Texas business climate. Specifically, determine the impact of the state’s major taxes, including the sales tax and franchise tax, as well as tax exemptions, exclusions, and credits on economic growth, capital investment, and job creation in Texas. As part of this review, evaluate the franchise

(margins) tax and determine whether the tax structure should continue to exist in its current form or in a revised form, or whether the existing tax structure should be repealed and replaced with a different business tax. The charge states the committee should “determine the impact of the state’s major taxes … on economic growth, capital investment, and job creation in Texas” but makes no specific mention of the property tax, which is one of the most significant business taxes in Texas. Ways and Means Committee Chairman, Harvey Hilderbran, announced that committee hearings on these issues would commence after Jan. 1, 2012. Speaker Straus expressed a personal interest in the franchise tax study. During the last legislative session, there was much discussion about the franchise tax, and a number of legislators expressed publicly their view that the tax needed revision or replacing. The budget crises in the state essentially prevented the legislature from devoting time to the issue. There was discussion during and after the session of a joint select committee to be appointed by the Speaker and the Lt. Gov.; that idea was dismissed and the task has fallen to the Ways and Means Committee. With two lawsuits challenging the constitutionality of the tax and the school district lawsuit challenging the constitutionality of school funding, substantive changes to the franchise tax could be in our future. More on the franchise tax later. One of the charges to the Licensing and Administrative Procedures Committee might also be of concern to CPAs: Study the feasibility of streamlining the process to obtain an occupational license. Consider consolidating all occupational licenses under one state agency and whether such a move would increase efficiency and effectiveness. Analyze the process being used in other states.

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Every few years, the suggestion to consolidate occupational licensing is studied. In fact, the Texas Department of Licensing and Regulation is already a consolidated licensing agency that administers 28 occupational and business licenses ranging from auctioneers to polygraph examiners to water well drillers. Each time this issue has been studied in the past, it has been determined that professional licenses (CPAs, attorneys, architects, engineers, physicians, etc.) should not be consolidated into one agency. Such consolidation would definitely not “increase efficiency and effectiveness.” From discussions with the Speaker’s staff, it appears that the focus of this charge will not be on professional licensing. Hopefully, once again, legislators will differentiate between “occupational” and “professional” licensing. Some states do have consolidated professional licensing agencies and CPA regulation is somewhat ineffective in those states. There are other interim charges that could result in proposed legislative changes that affect CPAs and taxpayers. The Appropriations and Ways and Means committees share one charge: Analyze increases in Texas’s overall state debt burden and the role debt plays in the state’s fiscal management. Recommend strategies to reduce the state’s debt, as well as the calculation of the constitutional debt limit. Despite the fact that the Texas Constitution requires a balanced budget each biennium, there are numerous exceptions and Texas goes deeper into debt each year. Evidently, the debt level has risen to the point of concern by Speaker Straus. Another Appropriations Committee charge might mean scrutiny of the Texas State Board of Public Accountancy (TSBPA): Examine the investment and management of funds held outside the treasury, including

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whether the funds are being utilized for their statutory or constitutional purposes, and whether opportunities exist to utilize these funds in the state budget to reduce the demand on General Revenue. TSBPA is one of several licensing agencies that operate outside of the appropriations process and their funds are held outside the treasury. Unlike most other such agencies, TSBPA pays $700,000 per year into the treasury for this privilege. Operating outside the treasury allows TSBPA to fund its operations solely from examination and license fees. Coincidentally, TSBPA’s authority to operate outside the treasury is subject to Sunset Commission review during the 2013 legislative session. That means the legislature must reauthorize the arrangement in 2013 for it to continue. Other interim committee charges cover the following subjects: • aging Texans; • border issues; • charter school systems; • DNA testing; • economic development; • environmental regulation; • food insecurity; • impact of federal legislation, including the Patient Protection and Affordable Care Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act; • juvenile justice system; • privatization of state services; • property tax valuations; • research at Texas universities; • transportation infrastructure; and • water.

THE STRUCTURAL DEFICIT LOOMS

You can read all the House interim committee charges at www.house.state. tx.us/_media/pdf/interim-charges-82nd. pdf.

On Nov. 28, 2011, the Texas Supreme Court ruled that the Texas Franchise tax, frequently referred to as the margin tax, was

All of the interim committee charges fall under the budget shadow that is expected to darken the 2013 legislative session. Even if the Texas economy bounces back better than expected, legislators anticipate another difficult budget session. “I think at some point, you can’t cut your way to prosperity,” said Speaker Joe Straus in El Paso last October. Straus suggested that the legislature would have to address the Texas structural deficit “now.” Straus said, “We have no choice, unless we want to continue to try to grow our population and continue to shrink spending significantly.” Legislators speaking at the Texas Taxpayers and Research Association’s (TTARA) annual meeting echoed concerns about revenues versus expenditures in Texas. CPA Senator Tommy Williams (R-The Woodlands) said, “We have to have some honest conversations about what it costs to run government.” Williams was clear that he was not suggesting a general tax increase, but a dialogue with voters on how to resolve such problems as “the fastest-growing state in the United States has no money to expand its highway system.” Senate Finance Committee Chairman Steve Ogden (R-Bryan), who is not running for re-election, sounded a similar note when he suggested the voters should be asked: “Do they want to spend more money on public schools? Would voters accept a higher gasoline tax to build roads?” All good questions, but ones this past legislature answered with “shrink spending significantly.”

MARGIN TAX IS CONSTITUTIONAL – SO FAR

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constitutional. From the very beginning of the tax, there was concern about whether the tax violated the so-called Bullock Amendment of the Texas Constitution. In a case brought by Allcat Claims Service, LP, claiming the tax does violate the Bullock Amendment, the court ruled it does not. The Bullock Amendment requires a statewide referendum before the legislature can implement a personal income tax “including a person’s share of partnership and unincorporated association income.” In the ruling, the court did not opine on whether the margin tax is in fact an income tax, but rather ruled that taxing the income of a partnership or unincorporated association does not violate the Bullock Amendment. The court found that a tax directly imposed on a partnership is not the same as a tax on a person’s share of partnership income because a partnership is an entity separate from its partners. In addition to the claim that the margin tax violates the Bullock Amendment, Allcat contended that the Comptroller’s interpretation of certain franchise tax provisions violates Allcat’s right to equal and uniform taxation under the Texas Constitution. The Supreme Court denied jurisdiction over this matter and referred that claim to the District Court in Austin. The court ruling clearly paves the way for the legislature to implement a business income tax in Texas to replace the margin tax. In light of the structural deficit mentioned above and the general unpopularity of the margin tax, legislators may welcome one more tool in their tax tool box; more about that later.

FRANCHISE TAX LAWSUIT NUMBER TWO A second challenge to the constitutionality of the franchise tax was filed by Nestle USA, Inc., Switchplace, LLC and NSBMA, LP, claiming that the margin tax violates the Equal and Uniform Clause of the Texas Constitution, as well as the Equal Protection Clause, the Due Process Clause and the Commerce Clause of the United States Constitution. Nestle claims that although the company is engaged only

in wholesale activity in Texas, it must pay the 1 percent tax rate of a manufacturer because it has manufacturing facilities outside the state of Texas. Switchplace provides temporary accommodations services and complains that it is inappropriately denied the cost of goods sold deduction. NSBMA rents construction equipment and objects that it cannot claim a deduction for cost of goods sold while other types of suppliers of construction equipment do qualify for the deduction. The suit was also filed with the Texas Supreme Court as directed by the margin tax legislation and states that the Supreme Court jurisdiction is supported by Article V of the Texas Constitution and Texas Government Code, Section 22.002. The brief states that the franchise tax is a tax for the privilege of doing business in Texas and is unconstitutional because the tax “results in a non-uniform tax that causes similarly situated taxpayers to have a much higher taxable margin relative to their peers” and “provides certain ad hoc exclusions available to only some taxpayers.” Nestle argues that both total revenue and allowed deductions employ a combination of exclusions and deductions applied to some taxpayers but not others. They also object to the tax rate differentiation between taxpayers. The brief states: The Margin Tax values each taxpayer’s privilege of doing business in Texas differently. The calculation of taxable margin begins with the gross income of the taxpayer, but then employs a combination of exclusions and deductions applicable to some taxpayers and not others. This results in a non-uniform tax that causes similarly situated taxpayers to have a much higher taxable margin relative to their peers. When compared against meaningful economic data, the Margin, and consequently, the effective Margin Tax rate, varies by as much as 3,000 percent from industry to industry in Texas without any recognizable rational relationship to the value of doing business in Texas for that industry. The state’s response does not take issue with the disparities in the application of the tax, but says those disparities are within the authority of the legislature to levy the tax and

therefore are constitutional despite the end result of similar taxpayers paying varying tax amounts. Oral arguments are set for Jan. 12, 2012. Immediately after the Allcat ruling, some suggested that the Nestle claims were similar to the Allcat claims that were referred to the Austin District Court and speculated a similar fate for the Nestle case.

DID THE FRANCHISE TAX MEET ITS GOALS? While the Supreme Court deals with the constitutional issues, TTARA has issued an analysis of the Texas margin tax: Understanding the Texas Franchise – or “Margin” – Tax. The analysis reviews the results of the margin tax against the original policy goals for the tax. The results are mixed. The scorecard: • align the tax with a modern economy – somewhat successful, especially in raising tax revenue from the service sector that is more in line with that sector’s share of the economy; • create a simpler business tax – the tax is more complicated than anticipated and more complicated than the former franchise tax; • eliminate tax planning opportunities – the tax did eliminate the massive tax avoidance schemes successful under the former franchise tax; and • raise roughly $3 billion in new state revenue annually – the tax has collected between $1.4 billion and $2.5 billion less revenue per year than projected. Even though the tax only met two out of four goals, TTARA says not meeting the revenue goal is a good thing because it keeps the primary Texas business tax more in line with other states. If the original revenue goals had been met, Texas would have one of the higher state business taxes. TTARA points out that while the tax does match the economy closer than the previous tax, the overall tax burden is still heavier on manufacturing and production companies than other sectors, primarily due to high property taxes in Texas. The analysis also shows that this closer matching of the economy resulted in huge tax increases

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for some sectors. The tax liability on the information technology sector increased 162 percent, transportation sector 101 percent and for professional services, including CPAs, the increase was 88 percent. The result is likely a combination of making unincorporated entities subject to the tax plus more limited deductions for the service sector businesses. In terms of size, very small businesses saw their tax burden drop 46 percent while the next size category, businesses with revenues of $1 to $10 million, saw the largest percentage increase at 72 percent as compared to the average overall increase of 46 percent. The analysis ends with speculation about reforming the franchise tax – again. Two possibilities are mentioned: • simplify the tax by reducing deductions and making it more like a gross receipts tax; or • shifting the tax base to net income. Both concepts have pros and cons. Going to gross receipts trades off simplicity for potentially making the tax less reflective of the economy. Going the income tax way likely requires a higher tax rate than palatable to business entities. You can read the complete six-page report at www.ttara. org under the documents tab.

FIX THE FRANCHISE TAX The need to fix the franchise tax seems overwhelming, whether to make it fair or to raise more state revenue, depending on your point of view. Remember, there is a structural deficit that won’t go away until there are more state revenues. Straus asked the Ways and Means Committee to work on it. Harvey Kronberg, writing in the Quorum Report, went so far as to suggest “fixing the margins tax system trumps almost everything else” in the next legislative session. Harvey may be right, but I’m reminded of how difficult it was to pass the margin tax the first time. The bill passed the House by a three-vote margin. Then Speaker Tom Craddick told the senators to pass it just like it was because he couldn’t get the votes to pass it again if they made changes. Craddick was a very strong Speaker who busted a few heads to get the bill out of the House during the special session. Speaker Straus doesn’t do head busting. The margin tax was also passed with the support of the big business lobby in Austin. Some say no business tax can pass the Texas legislature without that support. Will that group support a business income tax, even if it is constitutional? If the income tax rate must be as high as 5.5 percent to 6.5 percent as some have suggested, it’s doubtful. Maybe the legislature will offer an offsetting property tax cut.

Would CPAs be in favor of a business income tax instead of the oft-complained about margin tax? It might make franchise tax preparation much easier; but would franchise tax preparation revenue drop? Would CPAs themselves pay higher taxes? Is a 5.5 percent income tax higher than a 1 percent margin tax? CPAs might develop a new fondness for the margin tax. Most of the big businesses seem to be OK with the margin tax as do the very small businesses that now pay no franchise tax. Small- to medium-sized businesses that pay the tax don’t like it at all (remember their taxes went up 72 percent) and some specific industries hate it. Will that split the business lobby enough to make a change possible? As bad as the margin tax may be, it might be more difficult to fix than to live with, absent a court mandate to do so. And there just might be such a mandate. As mentioned above, a school finance lawsuit has been filed against the state of Texas. It’s just the latest in a long series of such suits which have all resulted in the Supreme Court finding the school finance system unconstitutional and giving the legislature a deadline for fixing it. That’s how we got the margin tax in the first place. Whatever happens, legislators do have a new way to tax businesses – and it is constitutional! n

Bob Owen, CPA, is TSCPA’s managing director of regulation and legislation. Contact him at bowen@tscpa.net.

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COVER STORY

HEALTH CARE REFORM

AMIDST CONSIDERABLE UNCERTAINTY, PREPARATION MATTERS BY JEANNE A. SMITH, CPA

The Patient Protection and Affordable Care Act, passed on March 23, 2010, enacted sweeping legislation regarding the health care in the United States. Some of the legislation is already in effect, but many crucial aspects that will impact employers are not slated to become law until 2014. continued on next page

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Considerable uncertainty remains regarding the future of that legislation. Implementing such massive legislation by itself requires considerable time. Announced provisions face revision. Passage of the act generated considerable political controversy too, with Republicans generally opposing the legislation. The outcomes of presidential and Congressional elections in 2012 could lead to repeal of the legislation. Court rulings may affect enactment of provisions. With all of the uncertainty surrounding health care reform, should CPAs stay informed of latest developments and make efforts to share what they know with their clients and employers? Yes, for several reasons. Many of the health care reform provisions utilize the tax reporting system as a means of monitoring whether individuals or employers are in compliance. Depending on their specific actions, individuals and organizations may be subject to related tax credits or excise taxes. That link to the tax reporting system connects the legislation to professional services performed by CPAs. Clients and employers must evaluate the potential costs associated with health care reform compliance. That entails evaluating current costs, the additional costs of compliance, and what options clients and employers have for adjusting their cost structures. Undertaking such evaluation requires financial acumen. Complying with the legislation will touch many organizational functions and require considerable adjustment of existing internal processes, as well as implementation of additional processes to ensure compliance. While all the uncertainty surrounding health care reform’s future may nullify current preparations, the possibility remains that all or some of this legislation will be enacted as proposed. In that instance,

individuals and organizations will need as much time as possible to prepare for compliance. That preparation will require the expertise of CPAs. For those reasons, CPAs need to be informed of recent court decisions affecting health care reform, the general timeline for implementing reform, and the various provisions and how they will affect employers.

RECENT COURT RULING AFFECTS MANDATED PURCHASES OF HEALTH INSURANCE On Aug. 12, 2011, a federal appeals court in Atlanta declared that the portion of the Patient Protection and Affordable Care Act requiring individuals to purchase health insurance coverage was unconstitutional. The opinion, handed down by the Eleventh Circuit Court of Appeals, stated that, “What Congress cannot do … is mandate that individuals enter into contracts with private insurance companies for the purchase of an expensive product from the time they are born until the time they die.” The legislation required that, starting in 2014, any individual not eligible for Medicare or Medicaid would need to obtain “minimum essential coverage” through either an employer-sponsored plan or other options, including a government-sponsored plan or a private coverage plan. The legislation did allow for some exemptions based on economic or religious reasons. If an individual did not comply, he/she would face substantial penalties. A nondeductible tax penalty could be assessed based on the greater of a flat dollar amount (reduced for children under 18 or full-time students) or a percentage of household income. Proponents of that provision argued that requiring everyone to

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purchase insurance was necessary to provide private insurers with pools of premium holders whose health care risk profiles reflected the characteristics of the general population. Opponents argued that a federal mandate requiring individuals to engage in such a form of commerce was unconstitutional. The court case challenging that mandate was filed by the Florida state attorney general and was joined by the governors or attorney generals of 25 other states. The National Federation of Independent Business (NFIB) and two private individuals also joined the case. While the opinion also raised concerns regarding divisions between states’ rights and Congress’ authority to regulate interstate commerce, the appellate judges let stand other crucial provisions of the legislation. The opinion was issued by a three-member panel of the court’s judges, with two of those three judges ruling that a mandate requiring citizens to purchase coverage was unconstitutional. On Sept. 8, 2011, a federal appeals court in Virginia also ruled that a decision on the mandate requiring citizens to purchase health care coverage needed to be put off until the related tax penalties for non-compliance are actually levied. Those penalties do not become law until 2014. The Obama administration won a victory in that Virginia appeals court case. The administration could have also asked the full Eleventh Circuit Court in Atlanta to reconsider its decision. The administration, though, chose not to ask for such a review. All of that means the question of whether that mandate is constitutional will likely be decided by the U.S. Supreme Court.

It appears that the case may be heard before the 2012 presidential elections. That decision and the impact it would have on the legislation as a whole remains to be seen.

IMPLEMENTATION TIMELINE The health care reform legislation passed in March 2010 encompasses more than 2,300 pages. Enactment dates for various provisions span from 2010 to 2018, with many of the crucial provisions affecting employers taking effect in 2014. In 2010, the small business tax credit took effect for employers with less than 50 employees. Dependent coverage was extended to include adult children up to age 26. Preventive health services coverage was mandated, too. Key elements that took effect in 2011 included: • increase in taxation of Health Savings Account (HSA) withdrawals (prior to age 65) that are not used for medical expenses; and • cafeteria plan changes. Key elements slated to take effect in 2012 include: • reporting of health care costs on Form W-2 for employers filing 250 or more forms; (reporting is optional for smaller employers filing fewer than 250 Forms W-2 until further guidance is issued); • encouraging the development of integrated health systems; • providing incentives to acute care hospitals to improve quality care outcomes; and continued on next page

Jeanne A. Smith, CPA, is a partner in Tax and Strategic Business Services for Weaver, the largest independent certified public accounting firm in the Southwest with offices throughout Texas. Jeanne can be reached at 817-882-7708 or Jeanne.Smith@WeaverLLP.com.

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in which particular provisions take effect. With the small business tax credit that took effect for the 2010 tax year, companies with 25 employees or less are eligible for tax credits up to 35 percent of what they pay for employee health insurance. To qualify for the credits, the average annual salary of the employees cannot exceed $50,000. The employer must offer health insurance to all employees and must pay at least 50 percent of the costs. The full 35 percent credit applies to companies with 10 or fewer employees and who pay wages averaging less than $25,000. As a general rule, companies with fewer than 50 employees will not be required to purchase health coverage for employees once additional provisions of health care reform take effect for 2014. In 2014, employers with 50 or more full-time equivalent employees must either provide full-time employees and their dependents with affordable essential minimum coverage or face excise taxes. For purposes of the insurance coverage mandate, a full-time employee is defined as someone working more than 30 hours per week. To arrive at the full-time equivalent total, an employer must divide the total hours worked by part-time employees in a month by 120. The hours worked by seasonal employees who work less than 120 days per year do not need to be included in that calculation. • providing incentives to reduce avoidable hospital readmissions. Key elements slated to take effect in 2013 include: • limiting health Flexible Savings Account (FSA) contributions to $2,500 a year; • eliminating the employer deduction for Medicare Part D subsidy; • increased hospital insurance tax for individual taxpayers who earn more than $200,000, and for married taxpayers filing jointly who earn more than $250,000; and • increased income threshold for claiming itemized medical expenses deduction. Key elements slated to take effect in 2014 include: • restricting health plans from excluding coverage for treatment to adults based on pre-existing health conditions; • eliminating annual coverage limits in plans offered by employers and new plans in the individual market; • establishing health insurance exchanges in each state for individuals and small employers; • requiring individuals to obtain health insurance or face possible penalty; and • imposing penalties on employers with more than 50 employees for not offering coverage.

POTENTIAL IMPACT ON EMPLOYERS, BASED ON WORKFORCE SIZE Numerous factors influence the impact that reform will have on a specific employer, and each organization must evaluate its particular circumstances. Three major considerations for assessing that impact are the number of employees, the wages they are paid and the years

THE IMPACT OF WAGES OR HOUSEHOLD INCOME ON COMPLIANCE COSTS Workforce wages and household incomes of an organization’s employees determine the potential impact the legislation will have on organizations employing more than 50 full-time equivalent employees. An employer is subject to excise tax if it does not offer that minimum essential coverage and has at least one full-time employee who receives a premium exchange tax credit. An employee is eligible for that credit if more than 9.5 percent of household income is needed to pay for minimum essential coverage, or if the employer’s coverage does not reach 60 percent of the expected benefits costs. The excise tax is equal to $2,000 per year, multiplied by the total number of employees (less a 30-employee threshold) for employers that have at least one full-time employee receiving the exchange tax credit. For an employer that does offer essential minimum coverage, but has at least one employee who receives a premium exchange tax credit, the excise tax is the lesser of (1) $3,000 annually for each fulltime employee receiving the credit; or (2) $2,000 annually for each full-time employee over the 30-employee threshold. Premium tax credits are available to U.S. citizens and legal immigrants whose incomes range from 138 to 400 percent of the federal poverty level. The tax credit applies to someone in that income level who purchases coverage through an insurance exchange established as part of the health care legislation. The tax credit is generally not available to individuals who receive coverage through an employer, unless the employer plan does not reach that 60 percent of the anticipated health care costs standard, or if the employee’s contributions exceed 9.5 percent of household income. Pending the outcome of a “safe harbor” provision the Internal Revenue Service (IRS) proposed in August 2011, that 9.5 percent

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income determination may be applied toward an employee’s W-2 wages, rather than that person’s household income. That proposal is intended to make it easier for employers to determine whether that affordability standard is met. Employers need to be aware of the general wage and household income levels of their work forces. Those employers whose work forces contain numerous individuals whose income levels qualify them for the premium tax credit would face the greatest potential impact of compliance. Employers whose work forces are already receiving health care coverage will also face adjustments. Those adjustments, though, will likely focus more on evaluating overall benefit packages, examining items available through cafeteria plans, and considering increases in the percentage of health care costs that employees must pay.

CRUCIAL CONCERNS FACING EMPLOYERS NOW Whether all or portions of the legislation reach the scheduled enactment dates, employers need to address crucial issues related to reform, including overall costs, what adjustments may need to be made to existing coverage, and what steps would be needed to ensure compliance. Health care reform allows plans that existed on March 23, 2010, to have “grandfather” status, enabling employers and employees to stay with those plans. Grandfathered plans must encompass various reform requirements, including no coverage exclusions for children with pre-existing conditions and no annual dollar amount limits on specified types of coverage. Among other items, grandfather plans cannot significantly cut or reduce benefits, raise co-insurance charges or significantly raise deductibles. All employers face the uncertainties of how various provisions of reform that offer greater health care access will affect the overall current and future costs of providing coverage to employees. For those offering plans, adjusting for anticipated additional costs associated with compliance may entail seeking greater employee contributions, benefits changes, and efficiencies throughout the organization to offset increased expenses.

THE NEED TO INCORPORATE COMPLIANCE PROCESSES Within an organization, how many functions will be affected by the reform? Human resources will have a large role in classifying employees, administering and evaluating benefit programs, and addressing other requirements contained in the legislation. Payroll activities will be affected, as will legal, tax, internal audit, compliance and other functions. Organizations will need to identify all of the functional areas affected, and then determine what processes need to be implemented and what controls must be established. Internal audit functions will need to include oversight of compliance concerns.

THE NEED TO REMAIN INFORMED Health care reform legislation continually evolves. The constitutionality of the provisions requiring all individuals to have health care coverage may be decided by the U.S. Supreme Court within the next year. Whether that provision is deemed constitutional will affect only that requirement, but could influence other reform provisions, too. In response to having to provide expanded coverage, private health care insurers may increase costs or adjust coverage provisions. Health care reform has become one of the crucial issues discussed thus far in campaigning and political activities leading up to the 2012 presidential and Congressional elections. Depending on the outcome of those elections, all or portions of the legislation face repeal. While the legislation was already massive in scale when introduced, numerous details still needed to be addressed. Unintended consequences emerged, requiring attention. Previously-published compliance dates were moved back. The legislation continues to be subject to revision and refinement. Regardless of how the legislation may be affected by court decisions or national elections, employers must consider potential changes in how their health care coverage and other benefits are designed and administered. The legislation also calls for the development of statesponsored insurance exchanges to be in place to provide coverage options. Over the next three years, employers need to monitor that development, too. The magnitude of the legislation and the potential impact it may have require that organizations plan and prepare now. Without that planning and preparation, attaining compliance and taking necessary actions could be overwhelming tasks. CPAs and their clients and employers need to stay abreast of this issue and make necessary adjustments as new information becomes available, and as new developments affect the current or pending requirements. n

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Feature

BY DALE W. SPRADLING, PH.D., CPA, GEORGE L. HUNT, PH.D., CPA AND WILLIAM O. GRIMSINGER, JD

Using a Montana LLC to Avoid the Texas Sales/Use Tax Will Not Work Some Texas residents have been using a Montana Limited Liability Company to avoid paying Texas sales and use tax on purchases of expensive personal property such as aircrafts, recreational vehicles and automobiles. This article examines the validity of this idea and determines that, despite the claims of some Montana-based promoters, using a Montana LLC to avoid paying the Texas sales tax will not work for current Texas residents.

THE PITCH The sales pitch goes something like this: “Not only is this RV (plane, boat, car) perfect for you, but I can show you how to beat the Texas sales tax, which at six and a quarter percent will save you a lot of money. Even better, it is all perfectly legal. I know an attorney in Montana who for a small fee can take care of the paperwork and give you a legal opinion.” Many Texas CPAs first hear about this idea when a client hands them a “legal opinion” from a Montana lawyer explaining why the client does not owe Texas sales tax on his/her newly purchased RV. (We’ll use an RV throughout this article, but the idea applies to any expensive purchase, including jewelry.) Basically, the plan works like this: 1. Instead of buying an out-of-state RV in his/her name, a Texas resident forms a Montana LLC, which is typically a singlemember LLC. Prices vary, but the usual fee for handling the paperwork and acting as the registered agent of the LLC is less than $1,500. 2. Because Montana considers the address of the Montana LLC’s registered agent as sufficient to establish domicile, the newly formed LLC is a Montana resident. 3. The Montana LLC then purchases the RV in its name. If the RV is bought in Montana, the Montana LLC will not owe any sales tax because the state has no sales tax. Moreover, if the RV is purchased in another state, the Montana LLC will not owe any sales tax because it is a nonresident. 4. Texas, like most states, requires a resident/owner who buys an RV in another state and brings it back home to pay a

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use tax that is equivalent to the state sales tax. But, according to some Montana promoters, this rule does not apply to an RV owned by a Montana LLC because (1) the Montana LLC is the owner of the RV, not the Texas resident, and (2) because the Montana LLC does not reside in Texas, it is not required to pay the Texas use tax. Therefore – wink-wink – so long as the RV owned by a Montana LLC is driven in Texas for only short periods of time, i.e., “No thanks, I’m just passing through,” it does not have to be registered in Texas, which means the Montana LLC will not owe any Texas sales or use tax.

SCOPE OF THE PROBLEM An Internet search for “montana llc rv” yields over 100,000 hits. What once was a low-key, friend-of-a-friend idea is now a cottage industry that has caught the attention of multiple state taxing authorities. A recent study by Massachusetts found that Montana, with less than one million residents, has almost 50,000 registered LLCs.1 Even worse, from the Bay State’s perspective, Montana’s public records only disclose the name of the resident agent, not the identity of the LLC owners. However, by snooping around, Massachusetts uncovered 80 possible suspects and used its subpoena power to narrow that list down to 23 vehicles for which it eventually collected over $200,000 in additional taxes. California, naturally, has taken an even more aggressive stance. The California Highway Patrol created a program called, “Californians Help Eliminate All The Evasive Registration Scofflaws,” or CHEATERS for short.2 This program asks neighbors to report California residents who they suspect of having a vehicle registered in another state. The CHEATERS system then sends the suspected tax scofflaw a letter demanding they pay up. Overall, California estimates it is missing out on $10 million a year in sales tax. In 2008, the Colorado Attorney General’s Office went after residents who owned RVs registered in Montana and billed them over

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$2.7 million in unpaid sales taxes, penalties and interest.3 The state also convicted 12 people of misdemeanor tax evasion. As punishment, those convicted had to pay restitution and perform community service. One of the 12 was Hilary Pruitt, who formed a Montana LLC to buy a $275,000 RV from a Colorado broker.4 Pruitt used a Montana attorney who told him: “… the practice had been working for many years for thousands of people in multiple states. I even checked with my local attorney and he said there had never been any cases tried. Of course, they both threw in their disclaimers,” said a frustrated Pruitt. Everything was fine until “one of the local TV channels did an expose on how much money the state of Colorado was losing due to people illegally registering their RVs out of state. One of my neighbors saw fit to turn me in.” Because Pruitt used his RV for out-of-state travel for extended periods, he assumed he was within the law. Unfortunately for him, “The way the state works, you just can’t take the risk of going to trial. I spent thousands on an attorney and still had to plead guilty to failure to pay tax.”

ANALYSIS Does the so-called “legal opinion” for using a Montana LLC to avoid the Texas sales/use tax hold water? Let’s take a look. The typical memo comes with an impressive letterhead from a Montana attorney along with various legal citations of the Montana statutes. The letter confirms that the address of the Montana LLC’s registered agent is sufficient to establish domicile and thus residency in Montana. This means the RV never needs to set foot in the state for it to be registered in Montana. The memo wraps the Montana portion by spelling out the required registration fees and other fees, which are typically under $500 a year. The discussion then turns to how the Texas statutes might apply to your client. If the Montana LLC buys the RV in Texas, Sec. 152.021 of the Texas Tax Code imposes a 6.25 percent sales tax on the retail sale of any vehicle to a Texas resident. Rule 3.71(a) of the Texas Administrative Code defines a resident to include any person who lives in the state, and any firm, corporation or association physically located in the state. Further, a person temporarily living in Texas, but who has a continued on next page

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permanent home in another state, can still be a Texas resident because a person can be a resident of more than one state at a time for tax purposes. If, however, the RV is transported out of state, before any use other than driving it out of state and the buyer uses it exclusively outside Texas, the purchase is tax exempt under Sec. 152.092 of the Texas Tax Code. To qualify, the Montana LLC must give the Texas seller a Sales Tax Exemption Certificate that specifies, among other things, the state where the RV will be used and registered and authorizes the state comptroller to provide this information to that state. What happens when a Montana LLC buys the RV out of state, but later decides to bring it to Texas? Clearly, the Texas Tax Code does not apply to an out-of-state purchase of an RV that is used exclusively outside of Texas. But Sec. 502.002 of the Texas Transportation Code requires every “owner of a motor vehicle” used on Texas highways to register with their local county tax assessor. Sec. 502.001(16) of the Texas Transportation Code defines “owner” as anyone who: (1) has the legal title of a vehicle; (2) has the legal right of possession of a vehicle; or (3) has the legal right of control of a vehicle. What does “used on Texas highways” mean? For Texas residents, the Texas Transportation Code is silent on this

point. In theory, once you cross the state line, you have to register. As a practical matter, immediate registration appears unreasonable. While Sec. 521.029 of the Texas Transportation Code gives new residents a 30-day window before they have to register, this rule does not apply to existing residents. Nonresidents, ironically, receive more definitive guidance. Sec. 502.0079 of the Texas Transportation Code says a nonresident owner of a commercial vehicle will not have to register if he/she does not exceed two trips a month of less than four days apiece. Moreover, the nonresident owner of a private vehicle can make up to five occasional trips a month, if each trip is less than five days. Finally, the nonresident owner of a car that is not for hire, which is registered in the state where the person resides, can drive on Texas highways for as long as the car’s license plates are valid. Nonresident for this purpose means: “… a resident of a state or country other than this state whose presence in this state is as a visitor and who does not engage in gainful employment or enter into business or an occupation, except as may otherwise be provided by any reciprocal agreement with another state or country.” Being required to register is the trip wire because, as part of the registration process, Sec. 152.022 of the Texas Tax Code imposes a use tax, equal to the sales

tax, on any RV purchased in a retail sale outside Texas. Sec 3.346(a) of the Texas Administrative Code says an RV stored in Texas is subject to the use tax. Moreover, Sec. 3.346(e) of the Texas Administrative Code provides that an RV shipped or brought into the state by, or at the direction of, a purchaser will be presumed to have been purchased for storage or use in Texas. However, Sec. 3.346(e)(2) creates a counter-presumption that an RV will not be treated as having been purchased for use in Texas if the RV was purchased and used as an RV outside of Texas for more than one year. Connecting the dots, the typical letter concludes by saying that so long as the: (1) RV is used outside of Texas; (2) Montana LLC is not a Texas resident; and (3) Montana LLC is not domiciled in Texas, its purchase will not be subject to the Texas sales tax. The hedging begins when the analysis turns to what might happen if the RV enters Texas. If you assume the Montana LLC, not the Texas resident/LLC member, is the “owner” of the RV, you can drive or store it in Texas for as long as the RV has a valid Montana license plate. However, all bets are off if you believe Texas can use the “legal right of possession or control” doctrine to look through the legal title held by the Montana LLC and assess the use tax on the Texas resident/ LLC member as the equitable owner of the RV.

THE TEXAS COMPTROLLER SPEAKS In 2009, the Texas Comptroller’s office issued Document 200908387L in response to a question about an aircraft owned by a corporation.5 Here, a Texas resident bought an airplane outside of Texas and contributed it to his wholly-owned corporation. The corporation then brought the airplane into Texas and “leased” it to the shareholder for no consideration. (The facts do not mention the domicile of the corporation.) The document, not surprisingly, goes on to say, “The Comptroller of Public Accounts will disregard the corporate fiction under such circumstances and hold the person who purchased the aircraft for

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use in Texas responsible for the use tax, especially when that person makes use of the aircraft in Texas.” The real surprise is the logic used to justify this position: “[T]he comptroller reserves the right to look through the legal form of a transaction to the realities; to look at the end result and disregard the steps and intermediate entities a taxpayer may have chosen to effect that result. The legal fictions may be disregarded, even though legal formalities have been observed and entity and individual property have been kept separately, when the fictions have been used as a device to circumvent the Texas Tax Code. As stated in Gregory v. Helvering, ‘[T]o hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.’ 293 U.S.465, 470 (U.S. 1935); See also Horn v. Commissioner, 968 F.2d 1229, 1236 (D.C. Cir. 1992). In the field of taxation, the comptroller, as well as the courts, are concerned with substance and realities, and although taxpayers have a legal right to decrease their tax burden, they may not do so by creating a series of related transactions as a part of a preconceived plan with no other business or economic purpose other than to qualify for a tax exemption; thus, transactions between related parties that do not affect the economic interest of an independent third party deserve particularly close scrutiny. Coltec Industries, Inc. v. United States, 454 F.3d 1340 (Fed. Cir. 2006).” While a lawyer might quibble over using federal income tax citations to support a finding under Texas law, it should be clear that the comptroller’s office is not going to let legal niceties get in the way of applying the “duck test” to entities formed solely to avoid the Texas sales tax. It is worth noting that the comptroller’s office already monitors the FAA’s website on sales of aircrafts. If the comptroller’s office decided the results might exceed the costs, it would not be hard to imagine them increasing their scrutiny to include motor vehicle sales.

OTHER POSSIBLE LOOPHOLES Under the prior version of Sec. 152.025 of the Texas Tax Code, a Montana LLC could gift the RV to its Texas member/ resident, who would then only pay a $10 fee to register the vehicle. However, in 2009, the Texas legislature amended Secs. 152.025 and 152.001 to provide that only individuals, an estate or a taxexempt organization can make a gift. Consequently, a current gift by a Montana LLC to a Texas resident/member will be subject to sales tax. There is supposedly a “new resident” loophole in Sec. 152.023 of the Texas Tax Code, which says a new Texas resident only has to pay a $90 registration fee in lieu of the use tax. This rule applies when a new resident brings into Texas an RV that was registered previously in the new resident’s name in another state or foreign country. The statute does not require the old state to have an equivalent sales tax. It only requires the RV to have been registered in its former home state. Thus, if the Montana LLC, not the Texas resident/ member, changes the registration of the RV to Texas, it will only have to pay a $90 fee. But this angle will not work if the Texas resident/member is considered to be the true owner of the RV, as mentioned above, because a current resident/member owner, by definition, will not qualify for the new resident exception. There is one more idea called a “Texas Three-Step Merger” where you form a Montana LLC, which buys the RV. Next, you form a separate Texas LLC and merge the Montana LLC into the Texas LLC. You then dissolve the Texas LLC and distribute the RV to the Texas resident/member. According to Sec. 3.64 of the Texas Administrative Code, no sales or use tax is due when assets are distributed as part of the formal dissolution of a Texas LLC. However, if the sole business of either the Montana or Texas LLC is owning the RV, it would not appear to be much of a stretch for the Comptroller’s office to make the “substance over form” argument mentioned

earlier and claim that the lack of a business purpose makes the liquidation of the Texas LLC null and void. The result would be to treat the distribution as a sale subject to the sales tax.

POINT OUT THE PITFALLS So, what should you do when a Texas resident asks your opinion about using a Montana LLC to potentially save thousands of dollars in sales tax? You might begin by pointing out that the downfall of Dennis Kozlowski, who was later convicted of looting Tyco International Ltd., began with a New York state investigation into his attempt to avoid over $1 million in sales tax on artwork. You may also want to ask your client where he/she first heard about using a Montana LLC to avoid the Texas sales tax. Chances are good that the idea came from an out-of-state salesperson whose primary motivation is to close the deal, not to look out for the best interests of your client. Granted, using “tax loopholes” to minimize taxes is as old as dirt. However, when a Texas resident buys an RV (or a boat, plane, or other valuable item) and parks it in his/her Texas driveway, he/she needs to pay the Texas sales tax, regardless of whose name is on the title. It is as simple as that. The risk of facing criminal charges is not worth saving a few dollars. n FOOTNOTES 1.

2. 3.

http://archives.lib.state.ma.us/bitstream/ handle/2452/50060/ocn649846936. pdf?sequence=1 http://www.chp.ca.gov/prog/cheaters.cgi http://www.denverpost.com/ ci_9333908?IADID=Search-www.denverpost. com-www.denverpost.com http://www.fmcastore.com/motorhome/ motorhome-news/312-motorhome-ownerpleads-guilty-to-tax-evasion http://www.bloomberg.com/apps/news?pid=ne wsarchive&sid=a3u08vgG.McM&refer=news_ index

Dale W. Spradling, Ph.D., CPA, and George L. Hunt, Ph.D., CPA, are both assistant professors at the Gerald W. Schlief School of Accountancy, Stephen F. Austin State University. They can be reached at spradlindw@sfasu.edu and/or huntgl@sfasu.edu. William O. Grimsinger, JD, is a shareholder with Chamberlain Hrdlicka in Houston, Texas, and can be reached at william.grimsinger@chamberlainlaw.com.

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CPE Article BY STEVE GRICE, PH.D., CPA, AND RICK TURPEN, PH.D., CPA

Consolidating Variable Interest Entities: An Illustration and New Guidance

CPE Self Study Curriculum: Accounting and Auditing Level: Basic Designed For: This article is relevant to those professionals in public practice and business and industry as it deals with the application of GAAP related to variable interest entities. Objectives: The objective of the article is to discuss the fundamental approach a reporting entity may follow when assessing relationships with other entities to identify variable interest entities pursuant to ASC Topic 810. Key Topics: The topics addressed include the identification of both a variable interest and a variable interest entity, as well as the primary beneficiary determination. Also, this article illustrates the basic consolidation process using a practical scenario and presents consolidated financial statements. Prerequisites: None Advanced Preparation: None

EXHIBIT 1 Evaluation of Variable Interests ASC Topic 810 as amended by SFAS 167 (Alpha = reporting entity; Omega = potential VIE)

QUESTION #1: DOES ALPHA HOLD A VARIABLE INTEREST IN OMEGA?

YES

ASC TOPIC 810 DOES NOT APPLY.

QUESTION #2: IS OMEGA A VIE?

OTHER GAAP APPLIES.

The Financial Accounting Standards Board (FASB) amended the technical guidance provided in Accounting Standards Codification (ASC) Topic 810, Consolidation, as it relates to FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities (FIN 46R). Specifically, FASB issued Statement of Financial Accounting Standards (SFAS) 167, Amendments to FASB Interpretation No. 46(R), to address perceived problems in the way companies have been applying existing guidance for off-balance sheet financings. FASB’s Accounting Standards Update No. 2009-17 codified the provisions of SFAS 167 in ASC Topic 810. Because SFAS 167 was issued in pre-codification form, this article references the new guidance using the original SFAS document number, as well as specific ASC citations. The issuance of SFAS 167 (along with SFAS 166, Accounting for Transfers of Financial Assets – an Amendment to FASB Statement No. 140) represents FASB’s response to the financial industry’s role in the economic collapse. Facing pressure from

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YES

QUESTION #3: IS ALPHA THE PRIMARY BENEFICIARY OF OMEGA?

YES

DISCLOSURES ARE REQUIRED.

THE VIE MUST BE CONSOLIDATED.

financial statement users, and especially Congress and the Securities and Exchange Commission, FASB targeted these rules for companies that, according to FASB Chair Robert Herz, “were stretching the use of off-balance sheet entities to the detriment of investors.” Though aimed primarily at the banking and finance sector, the new guidance applies broadly to most for-profit entities. This article discusses the fundamental approach a reporting entity may follow when assessing relationships with other entities to identify variable interest entities (VIEs) pursuant to ASC Topic 810. It illustrates the basic consolidation process using a practical scenario, and presents a consolidating worksheet and the resulting consolidated financial statements. In addition, this article highlights the major changes to ASC Topic 810 ushered in by SFAS 167. Importantly, the new guidance was effective as of the beginning of the fiscal year beginning after Nov. 15, 2009 (Jan. 1, 2010, for calendar year-end). continued on next page

Consolidating Variable Interest continued from previous page

CONSOLIDATION – THE FUNDAMENTAL APPROACH In general, SFAS 167 does not change the fundamental approach to assessing relationships with other entities that may ultimately require consolidation pursuant to ASC Topic 810. As illustrated in Exhibit 1, the process of applying the provisions of ASC Topic 810 broadly consists of the following basic questions, where Alpha represents the reporting entity and Omega represents a potential VIE: 1. Does Alpha hold a variable interest in Omega? 2. Is Omega a VIE? 3. Is Alpha the primary beneficiary of Omega? The consolidation provisions of ASC Topic 810 do not apply when the answer to question #1 or question #2 is “no.” That is, consolidation is not required if Alpha does not hold a variable interest in Omega or if Omega does not qualify as a VIE. In some instances, it may be determined that Alpha holds a variable interest in Omega and that Omega is a VIE, but that Alpha is not the primary beneficiary (i.e., only the answer to question #3 is “no”). Though Alpha is not required to consolidate Omega in these instances, Alpha must still comply with the extensive disclosure provisions prescribed by ASC Topic 810. Alpha is required to consolidate Omega pursuant to the provisions of ASC Topic 810 if the answer to all three questions is “yes.” To illustrate the consolidation process, assume the following facts related to a common related-party arrangement involving a real estate lease between Alpha and Omega Companies.

FACTS Alpha is a professional service company that is owned by four shareholders having the following equity interests: John (30 percent), Adam (30 percent), Jordan (20 percent) and Eli (20 percent). On Jan. 1, 2010, Omega was formed as a limited liability company (LLC) by the shareholders of Alpha to hold the operating real estate of Alpha. The shareholders contributed a total of $20,000 to the LLC and their equity interest in Omega is the same as that in Alpha. On Jan. 1, 2010, Omega borrowed $990,000 from a financial institution to finance the purchase of commercial real estate costing $900,000 and to provide $90,000 in initial operating capital. This real estate will be used in the operations of Alpha. As part of the funding arrangement, the financial institution required Alpha to guarantee the loan to Omega. Alpha entered into an operating lease agreement with Omega to lease the commercial real estate for an annual rental of $100,000. The terms of the rental agreement are in line with similar commercial real estate leases with no guaranteed residual value. During 2010, Omega recorded the following in its financial reporting system: • receipt of $100,000 lease payment from Alpha; • loan payments totaling $60,000 ($12,000 to principal and $48,000 to interest); • payment of other operating expenses totaling $10,000; • depreciation on the commercial real estate of $30,000. Exhibit 2 presents the relevant financial information for Omega. Panel A presents Omega’s beginning and ending balance sheet items for 2010. Panel B presents Omega’s income statement items for the period ending Dec. 31, 2010.

STEP 1: IDENTIFY VARIABLE INTERESTS

The initial step is to identify any variable interests in Omega that are held by Alpha. SFAS 167 keeps the following basic definition for variable interest described in ASC Topic 810-10-20: A contractual, ownership or other financial interest in an entity that changes whenever the fair value of the entity’s net assets changes.

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EXHIBIT 2 OMEGA FINANCIAL INFORMATION PANEL A At January 1, 2010

At December 31, 2010

Cash

$110,000

$140,000

Commercial real estate

900,000

Accumulated depreciation Total Assets

(30,000) $1,010,000

$1,010,000

Loan payable

$990,000

$978,000

Equity

20,000

32,000

$1,010,000

Total Liabilities and Equity PANEL B

For period ended December 31, 2010 Lease Revenue

$100,000

Operating expenses

(10,000)

Interest expense

(48,000)

Depreciation

(30,000)

Net Income

$12,000

In essence, the value of a variable interest depends on the success of the underlying entity, and that value will vary according to how successful it is in achieving its intended purpose. Various types of variable interests are described in paragraphs 810-10-55-16 through 55-41 of the ASC. Specific examples of arrangements that may create a variable interest include guarantees, equity investments, creditor relationships (not necessarily trade payables), and certain types of fees paid to decision makers or service providers. In this illustration, it is assumed that the fair value of Alpha’s guarantee of Omega’s debt would change with changes in the fair value of Omega’s net assets, thus, an explicit variable interest exists. The guarantee represents an explicit variable interest because the reporting entity (i.e., Alpha) directly guarantees the debt. However, in some instances the debt is guaranteed by one (or more) of the common owners (e.g., John, Adam, Jordan and/or Eli). In these instances, ASC 810-10-25-54 requires an evaluation of the guarantee to determine whether it represents an implicit variable interest. For example, the guarantee represents an implicit variable interest if Alpha is expected to fund Omega to prevent any losses to the common owners as a result of their guarantee (i.e., Alpha is effectively guaranteeing Omega’s debt). ASC 810-10-55-87 provides an illustration of this situation in Example 4 titled, “Implicit Variable Interests.” In the end, the key issue is whether a variable interest exists, regardless of whether it is explicit or implicit. Another consideration not included in this illustration that is relevant to the identification of variable interests relates to fees paid to decision makers or service providers. The following describes how SFAS 167 impacts this consideration:

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• Fees paid and kick-out rights. SFAS 167 amended the list of conditions that must be met to conclude that fees paid are not variable interests. For example, the term “trivial” was replaced with “insignificant” when describing the conditions, and the provision related to kick-out rights was eliminated. Practitioners should carefully review the amended conditions in ASC 810-1055-37 (or Appendix B of FIN 46R) when evaluating whether fees paid constitute a variable interest.

STEP 2: VIE DETERMINATION The next step is for Alpha to determine whether Omega is a VIE. ASC 810-10-25-37 indicates that the initial determination of whether Omega is a VIE should be made on the date at which Alpha became involved with Omega (i.e., Jan. 1, 2010). Though SFAS 167 does not change the definition of a VIE, it does modify one of the characteristics used to identify a VIE. In general, ASC 810-10-1514 indicates that a VIE is an entity that exhibits any of these three conditions: 1. The total equity investment at risk is not sufficient to permit the entity to support itself financially. 2. As a group, the holders of the equity investment at risk lack (a) the power to direct the entity’s activities that most significantly affect its economic performance; (b) the obligation to absorb its expected losses; or (c) the right to receive its expected residual returns. 3. With regard to the preceding characteristics, these economic relationships do not align with the investors’ voting rights. Prior to the issuance of SFAS 167, condition 2(a) read as follows: “the direct or indirect ability to make decisions.” The new guidance modified the wording to read as shown above. Further, the SFAS 167 amendment to ASC 810-10-25-38C could also affect the VIE determination. Specifically, this amendment relates to the characteristic described above in condition 2(a) and the effect of kick-out and participating rights held by the holders of equity investments at risk. These rights give the ability to remove (or block the actions of) a party that has the power to direct the entity’s most significant activities. SFAS 167 indicates that the presence of these kick-out and participating rights does not prevent interests other than the holders of the equity investment at risk from having this characteristic unless a single equity holder (or entity) has the unilateral ability to exercise such rights. That is, unless that unilateral ability exists, such rights are ignored for purposes of determining whether the entity is a VIE. ASC 810-10-25-45 indicates that equity of less than 10 percent of an entity’s total assets should not be considered sufficient to support itself financially. Based on the information in Exhibit 2, Omega’s equity was 1.8 percent ($20,000/$1,110,000) of its total assets on Jan. 1, 2010. Thus, Omega exhibits condition 1 described above since it did not have sufficient equity on Jan. 1, 2010. Importantly, qualitative considerations could overcome this presumption of insufficient equity. For example, if Omega had demonstrated in the past that it can support itself financially, then the presumption of insufficient equity may be mitigated. For purposes of this illustration, it is assumed that there are no meaningful qualitative considerations. Thus, based on the quantitative analysis, it is concluded that Omega is a VIE.

Consolidating Variable Interest continued from previous page

As previously discussed, Alpha’s guarantee of Omega’s debt gives Alpha a variable interest in Omega. Arguably, the guarantee also suggests that Omega is automatically a VIE since Omega needed the loan due to insufficient capital to finance its activities and Omega would not have been able to obtain the loan without Alpha’s guarantee. Additional consideration could be given to the impact of Alpha’s guarantee on the power to direct Omega’s activities and the obligation to absorb expected losses (i.e., conditions 2(a) and 2(b)). For example, the guarantee arguably is an obligation to absorb Omega’s losses, which is a position Alpha would not likely accept unless it also has the power to direct Omega’s activities. This point is also discussed below in Step 3, which relates to the primary beneficiary determination. SFAS 167 also amends the ASC 810-10-35-4 guidance related to the reconsideration of whether an entity is a VIE. The reassessment remains event-driven, but the list of the events requiring that reconsideration has been expanded. Specifically, the list of events was expanded to indicate that the VIE status must also be reconsidered when the holders of the equity investment at risk (as a group) lose the power to direct the activities of an entity that most significantly impact its economic performance. Additionally, the amendments indicate that a troubled debt restructuring is now considered a reconsideration event.

EXHIBIT 3 CONSOLIDATING WORKSHEET DECEMBER 31, 2010 CASH

ALPHA

OMEGA

$250,000

$140,000

$390,000

900,000

COMMERCIAL REAL ESTATE EQUIPMENT ACCUMULATED DEPRECIATION OTHER ASSETS TOTAL ASSETS ACCOUNTS PAYABLE

80,000 (20,000)

TOTAL LIABILITIES AND EQUITY PROFESSIONAL SERVICE FEES

(50,000)

$1,010,000

1,340,000

20,000

$70,000 $978,000

978,000

260,000 $330,000

260,000 32,000

32,000

$1,010,000

1,340,000

$600,000

LEASE REVENUE OPERATING EXPENSES

(30,000)

$70,000

EQUITY—OMEGA

(375,000)

INTEREST EXPENSE

CONSOLIDATED

80,000

20,000 $330,000

LOAN PAYABLE EQUITY—ALPHA

ELIMINATION

$600,000 $100,000

DR. 100,000

(10,000)

CR. 100,000

(285,000)

(48,000)

DEPRECIATION

(10,000)

(30,000)

(40,000)

NET INCOME

$215,000

$12,000

$227,000

STEP 3: PRIMARY BENEFICIARY DETERMINATION The primary beneficiary continues to be defined as the entity that consolidates a VIE. Prior to the issuance of SFAS 167, the primary beneficiary was deemed to be the entity that held a variable interest in a VIE and would absorb a majority of the VIE’s expected losses and/or receive a majority of the entity’s expected residual returns. For example, using the scenario previously described, if Alpha does not absorb more than 50 percent of Omega’s expected losses and/or receive more than 50 percent of Omega’s expected residual returns, then pursuant to pre-SFAS 167 guidance, Alpha would not be the primary beneficiary (i.e., consolidation would not have been required). The amendments to ASC 810-10-25-38 instituted by SFAS 167 significantly change the method for determining the primary beneficiary by eliminating this quantitative approach and replacing it with a qualitative assessment. Essentially, a reporting entity is the primary beneficiary if its variable interest in a VIE gives it controlling interest. Pursuant to the new guidance, the primary beneficiary assessment begins with identification of the VIE’s purpose and design, as well as the risks it was intended to create (and pass through) to the variable interest holders. According to the amendments shown in ASC 810-10-25-38A, an entity is deemed to have controlling financial interest in a VIE if it exhibits both of the following characteristics: 1. The entity has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance (power). 2. The entity has the obligation to absorb losses of the VIE or the right to receive benefits from it that could potentially be significant to the VIE (economics). It should be noted that the guidance anticipates that a VIE will have only one, if any, primary beneficiary. The existence of the guarantee does not automatically indicate that Alpha is the primary beneficiary; it must be determined whether the guarantee gives Alpha controlling interest in Omega. A key consideration in the primary beneficiary determination is the relationship between the controlling interest characteristics described above. For example, the second characteristic focuses on the economic substance of the reporting entity’s interest in the VIE and the significance of that interest to the VIE. The significance of the interest to the VIE is informative because it indicates the degree of power the reporting entity likely holds over the VIE (i.e., the focus of the first characteristic). That is, logic would suggest that the more significant the reporting entity’s potential VIE-derived losses and benefits (economics), the more motivated it would be to have a strong voice in the VIE’s affairs (power). Therefore, SFAS 167 requires increased skepticism whenever a reporting entity’s economic interest in a VIE is disproportionately greater than its stated power to direct the VIE’s most significant activities. Following the illustration previously described, Alpha holds a variable interest in a VIE (Omega) and that variable interest provides Alpha controlling interest in Omega. That is, Alpha’s guarantee of Omega’s debt means it is obligated to absorb Omega’s losses, an obligation it logically would not assume without the power to direct Omega’s activities in such a way as to

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avoid those losses. Accordingly, Alpha is deemed to be the primary beneficiary and so consolidation is required. There are other considerations not included in this illustration that are relevant to the primary beneficiary determination. The following describes how the provisions of SFAS 167 impact several of those considerations: Removal rights. As previously noted, equity investors (or sometimes other parties with an economic interest in the VIE) may be able to remove (or block the actions of) an entity that has the power to direct the entity’s most significant activities. Consistent with the change it makes to determining whether an entity is a VIE, ASC 810-10-25-38C indicates that the determination of who holds that power should not be affected by the presence of kick-out or participating rights unless those rights reside in a single investor with the unilateral ability to exercise those rights. Related parties. Related parties must be considered in the primary beneficiary determination. ASC 810-10-25-44 indicates that when a group of related parties concludes that no single entity exhibits both of the controlling interest characteristics (i.e., “power” and “economics”), then the entity within the group most closely associated with the VIE is the primary beneficiary. Shared power. ASC 810-10-25-38D and 38E describes the amended guidance related to shared power among multiple related parties. Shared power exists when multiple unrelated parties together can direct the activities that most significantly impact the VIE’s economic performance and those decisions require consent of all the sharing parties. There is no primary beneficiary when power is shared. However, when power is not so shared, the party that directs the majority of those activities is considered to have met the “power” characteristic related to controlling interest. Also, the nature of the activities controlled by each party should be considered. SFAS 167 also amended the guidance in paragraphs ASC 810-1025-39 through 41 for reconsideration of the primary beneficiary determination. Essentially, the new guidance replaced the list of reconsideration events with a general requirement for an ongoing assessment of the primary beneficiary determination as facts and circumstances change. Also, the amended guidance includes a troubled debt restructuring as a reconsideration event.

THE CONSOLIDATION PROCESS In this illustration, it was concluded that (1) Alpha holds a variable interest in Omega, (2) Omega is a VIE, and (3) Alpha is the primary beneficiary. Consequently, Alpha must consolidate Omega in accordance with ASC Topic 810. Once a decision has been made to consolidate a VIE, the initial measurement basis depends on whether the primary beneficiary and VIE are under common control, as is the case in this illustration. Since Alpha and Omega are under common control, there is no step-up in basis of the Omega carrying amounts. According to ASC 810-10-30-1, when the primary beneficiary and the VIE are under common control, the assets, liabilities and noncontrolling interests of the VIE are measured at the amounts at which they are (or would be) carried in the GAAP-based (generally accepted accounting principles) financial statements of the primary beneficiary. If the

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entities are not under common control, the consolidation follows the guidance of ASC Topic 805 titled Business Combinations. Exhibit 3 presents the consolidating worksheet for this illustration. In general, the consolidation process is similar to that for a voting interest entity. For example, ASC 810-10-45-1 indicates that inter-company transactions that occurred between Alpha and Omega Companies should be eliminated in determining the consolidated amounts for assets, liabilities and net income. In this illustration, the only inter-company transaction relates to the $100,000 lease payment from Alpha to Omega, which is eliminated. After adjusting for the inter-company transactions, the carrying amounts of the Alpha and Omega financial statement line items are simply combined to determine the consolidated amounts. Exhibit 4A shows the Consolidated Balance Sheet for Alpha and Omega (a VIE subsidiary) as of Dec. ASSETS 31, 2010. The presentation CASH $390,000 of the equity amounts in COMMERCIAL REAL 900,000 this statement is somewhat ESTATE atypical because Alpha EQUIPMENT 80,000 does not have an equity ACCUMULATED (50,000) interest in Omega. ASC DEPRECIATION Topic 810 does not provide OTHER ASSETS 20,000 specific guidance related TOTAL ASSETS 1,340,000 to the presentation of a VIE’s equity in consolidated financial statements when LIABILITIES AND EQUITY the primary beneficiary does ACCOUNTS PAYABLE $70,000 not have an equity interest LOAN PAYABLE 978,000 in the VIE. However, ASC EQUITY – ALPHA 260,000 810-10-45-16 requires that NONCONTROLLING 32,000 the consolidated equity INTEREST – OMEGA be allocated between TOTAL LIABILITIES AND 1,340,000 the controlling and EQUITY noncontrolling interests within the equity section of the Consolidated Balance Sheet. In this illustration, Alpha does not hold an equity interest in Omega; consequently, the allocation of equity to the noncontrolling interest represents the entire equity of Omega. EXHIBIT 4A ALPHA AND AFFILIATE CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 2010

EXHIBIT 4B ALPHA AND AFFILIATE CONSOLIDATED INCOME STATEMENT FOR THE PERIOD ENDING DECEMBER 31, 2010 PROFESSIONAL SERVICE FEES

$600,000

OPERATING EXPENSES

(285,000)

INTEREST EXPENSE

(48,000)

DEPRECIATION

(40,000)

CONSOLIDATED NET INCOME

$227,000

NET INCOME OF OMEGA

12,000

NET INCOME OF ALPHA

215,000

Exhibit 4B shows the Consolidated Income Statement for Alpha and Omega for the period ending Dec. 31, 2010. As required by ASC 810-1050-1A, the Consolidated Income Statement discloses the net income attributable to the parent (Alpha) and the noncontrolling interests (Omega) separately on the continued on next page

Consolidating Variable Interest continued from previous page

Exhibit 4C shows the Consolidated Statement of Changes in Equity for the period ending Dec. 31, 2010. ASC 810-10-50-1A requires that the reconciliation of the beginning and ending equity balances for the parent and noncontrolling interest be reported in either the statement or the notes to the statements. This illustration uses the Consolidated Statement of Changes in Equity to demonstrate this disclosure requirement.

THE ‘NEW’ GAAP – TRANSITION, EXCEPTIONS AND DISCLOSURE

face of the statement. The consolidated net income is $227,000 after eliminating the inter-company transaction related to the lease payments (see consolidating worksheet in Exhibit 3). Pursuant to ASC 810-10-35-3, the effect of the inter-company elimination should be attributed to the primary beneficiary, not to noncontrolling interests, in the consolidated financial statements. Essentially, the consolidated net income amount is the same as if Alpha had performed all of Omega’s activities as opposed to utilizing an LLC. The Consolidated Income Statement in Exhibit 4B is designed to show the consolidated net income, as well as the net income attributable to Alpha and Omega. The result is that the net income amounts attributed to Alpha and Omega are the amounts that would have been reported by each entity in standalone financial statements. EXHIBIT 4C ALPHA AND AFFILIATE CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE PERIOD ENDING DECEMBER 31, 2010 BALANCE – JANUARY 1, 2010

ALPHA

OMEGA

CONSOLIDATED

$45,000

INVESTMENTS BY OWNERS NET INCOME BALANCE – DECEMBER 31, 2010

20,000

215,000

12,000

227,000

$260,000

$32,000

$292,000

The transition guidance related to SFAS 167 is described in ASC 810-10-65. The transition provisions indicate that reporting entities must evaluate all existing VIEs and reevaluate all potential VIEs using the provisions of SFAS 167, regardless of when the relationships began. Importantly, there is no grandfather provision for conclusions previously reached pursuant to the pre-SFAS 167 guidance. In essence, a company must assess all its relationships with other entities as though SFAS 167 had always been in effect. Moreover, if consolidation is required upon adoption of SFAS 167, the amounts that must be used are those that would have been carried in the consolidated financial statements had SFAS 167 been effective when the reporting entity first became the primary beneficiary. There are exceptions to certain provisions when a reporting entity judges their determinations to be “not practicable.” Nevertheless, considerable documentation is likely to be needed to justify such exceptions. Furthermore, auditors will find it necessary to scrutinize these situations carefully given that they may lead to report modifications due to scope limitations or GAAP departures. Those implementing SFAS 167 should be aware that there are expanded disclosures required in situations where there is involvement with entities that may be VIEs, whether or not consolidated. With or without consolidation, SFAS 167 significantly increases the disclosures required whenever a company determines that it has a VIE. Gathering the information needed to develop these disclosures and to perform the assessments that precede the actual financial statement preparation process is likely to demand substantial effort. As with any major changes to the technical guidance, the earlier this work is initiated the better, particularly given the current economic environment. The financial downturn has led to many restructurings, reorganizations and realignments. Interest in these new business arrangements will mean greater scrutiny by investors and lenders, making compliance with SFAS 167 all the more important. Though implementation may seem somewhat daunting, reporting entities may gain a better understanding of the potential benefits and risks of the relationships they have formed when adopting this new guidance. n

Steve Grice, Ph.D., CPA, is a professor of Accounting, University of Alabama at Birmingham, and Scholar In Residence, Carr, Riggs, and Ingram, LLC. Rick Turpen, Ph.D., CPA, is an associate professor of Accounting, University of Alabama at Birmingham.

Today’sCPA

| JANUARY/FEBRUARY 2012

CPE Quiz Today’s CPA offers the self-study exam below for readers to earn one hour of continuing professional education credit. The questions are based on technical information from the preceding article. Mail the completed test by February 29, 2012, to TSCPA for grading. If you score 70 or better, you will receive a certificate verifying you have earned one hour of CPE credit – granted as of the date the test arrived in the TSCPA office – in accordance with the rules of the Texas State Board of Public Accountancy (TSBPA). If you score below 70, you will receive a letter with your grade. The answers for this exam will be posted in the next issue of Today’s CPA. Answers to last issue’s self-study exam: 1. b 2. d 3. a 4. c 5. d 6. b 7. d 8. c 9. a 10. a PARTICIPATION EVALUATION (Please check one.) 5=excellent 4=good 3=average 2=below average 1=poor 1. The authors’ knowledge of the subject is: 5__ 4__ 3__ 2__ 1__. 2. The comprehensiveness of the article is: 5__ 4__ 3__ 2__ 1__. 3. The article and exam were well suited to my background, education and experience: 5__ 4__ 3__ 2__ 1__. 4. My overall rating of this self-study exam is: 5__ 4__ 3__ 2__ 1__. 5. It took me___hours and___minutes to study the article and take the exam. Name _______________________________ Company/Firm________________________ Address (Where certificate should be mailed) ___________________________________ City/State/ZIP_________________________ Enclosed is my check for: ___ $10 (TSCPA member) ___ $20 (non-member) Please make checks payable to The Texas Society of CPAs. Signature____________________________ TSCPA Membership No._______________ After completing the exam, please mail this page (photocopies accepted) along with your check to: Today’s CPA; Self-Study Exam: TSCPA CPE Foundation Inc.; 14651 Dallas Parkway, Suite 700; Dallas, Texas 75254-7408. TSBPA Registered Sponsor #260.

Today’sCPA

| JANUARY/FEBRUARY 2012

Consolidating Variable Interest Entities: An Illustration and New Guidance

5 Assuming that Alpha represents the reporting entity and Omega represents a potential VIE, which of the following is not one of the basic questions that needs to be addressed when applying the guidance in ASC Topic 810?

1 A reporting entity is deemed to be the primary beneficiary if its variable interest in a VIE gives the reporting entity:

6 Which of the following is a true statement related to the new guidance ushered in by SFAS No. 167? A. The new guidance does not apply to most forprofit entities. B. The new guidance is effective as of the beginning of the fiscal year beginning after Nov. 15, 2009 (Jan. 1, 2010 for calendar year-end). C. The new guidance has not been codified into the ASC by FASB. D. None of the above statements is true.

A. The opportunity to perform very limited management functions. B. The right to receive dividends from the VIE. C. The right to provide consulting advice to certain personnel. D. Controlling interest.

A. Does Alpha hold a variable interest in Omega? B. Does Omega control the activities of Alpha? C. Is Omega a VIE? D. Is Alpha the primary beneficiary of Omega?

2 A reporting entity is deemed to have 7 The specific examples of controlling financial interest in a VIE if arrangements that may create variable the reporting entity: interests described in ASC 810 include: A. Only has the power to direct the activities of A. Guarantees. the VIE that most significantly impact the VIE’s B. Equity Investments. economic performance. B. Only has the obligation to absorb losses of the VIE C. Certain types of fees paid to decision makers. or the right to receive benefits from it that could D. All of the above. potentially be significant to the VIE. C. Has both the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses of the VIE or the right to receive benefits from it that could potentially be significant to the VIE. D. None of the above.

8 A guarantee of the VIE’s debt: A. Is never deemed to be an explicit variable interest. B. Is never deemed to be an implicit variable interest. C. Could be deemed an implicit variable interest or an explicit variable interest, depending on the circumstances. D. Is always considered an implicit variable interest, regardless of the circumstances.

3 Which of the following is a condition 9 The amendments to ASC 810 that indicates that an entity is a VIE? instituted by SFAS 167 significantly change the method for determining the A. The total equity investment at risk is not sufficient primary beneficiary by: to permit the entity to support itself financially. B. The total equity investment at risk is sufficient to A. Eliminating the quantitative approach and permit the entity to support itself financially. replacing it with a qualitative assessment. C. The entity routinely exhibits a moderate return on B. Eliminating the qualitative approach and replacing equity. it with a quantitative assessment. D. The entity has an average bond rating. C. Requiring both the quantitative and qualitative assessment. 4 One condition that indicates that an D. Stating that the primary beneficiary will not entity is a VIE is when the holders (as a consolidate the VIE in most instances. group) of the equity investment at risk 10 SFAS 167 keeps the basic definition lack: for a variable interest, which is: A. The power to direct the entity’s activities that most significantly affect its economic performance. A. An equity relationship in a related party entity. B. The right to receive dividends. B. A contractual, ownership or other financial C. The power to direct all of the entity’s activities. interest in an entity that changes whenever the D. The right to benefit economically from the entity’s fair value of the entity’s net assets changes. activities. C. An entity that consolidates a VIE. D. An entity that does not have sufficient equity at risk.

Feature By Denise Dickins, Ph.D., CPA; Brian Daugherty, Ph.D., CPA; and Julia Higgs, Ph.D., CPA

Do Audit Committee Members Care About Audit Engagement Partner Rotation? Audit engagement partners are required to rotate their audit client assignments at least every five years and may not return to their audit client assignments until at least five years have passed – coined the five-year on, five-year off rule. This rule was established by the Securities and Exchange Commission (SEC), as directed by the Sarbanes-Oxley Act of 2002 (SOX), as a way of directly enhancing auditor independence, and indirectly enhancing financial reporting quality. The effect of the rule was to accelerate audit engagement partner rotation from seven years and extend the required cooling-off period from two years. The revised rules now extend to concurring partners, previously not subject to mandatory rotation. Economic bonding – how the auditor and company are linked – influences whether regulation aimed at enhancing auditor independence will achieve its intended goal.1 When audit committees monitor the auditor, as now explicitly required by SOX, auditors are incented to maintain their independence to retain the audit engagement. Accelerating audit engagement partner rotation decreases the economic gains that come from repeat audit engagement experience and reduces auditor incentives to maintain their independence and retain the audit engagement. In other words, unless the auditor’s cost of accelerated rotation can be passed along to his/her clients, shorter partner engagement tenure may indirectly reduce financial reporting quality. There is some post-SOX evidence that supports this notion. For example, audit partners required to rotate client assignments often opt to learn a new industry rather than relocate, even though they perceive having to learn a new industry may be more detrimental to audit quality than is relocating.2

To determine whether, in today’s environment when audit committees have explicit charge over monitoring auditors, audit committee members perceive a benefit from acceleration of audit engagement partner rotation, we sent a survey to audit committee members of middle-market, publicly-traded companies.3 The survey consisted of 18 questions covering changes to the audit engagement partner rotation rules, the impact of the rule changes on audit committees and senior financial management, and audit committee members’ perceptions of timetables for audit partner and audit firm rotation. The introduction to the survey reminded audit committee member participants that SOX changed the mandatory audit engagement partner rotation rule from sevenyears on, two-years off, to five-years on, fiveyears off. A sample of the survey questions and responses are presented in Table 1; 13 individual questionnaires representing 10 different middlemarket, publicly-traded companies were used.4 The survey responses indicated that audit committee members strongly believe the five-

year on, five-year off audit engagement partner rotation rule has fallen short of its goal in terms of increasing auditor independence, enhancing financial reporting quality, or improving the detection of financial statement fraud. In terms of the work of the audit committee and senior financial management, audit committee members perceive only a modest increase associated with the rule change. A perhaps unintended impact of the rule change, audit committee members report a somewhat increased likelihood that they will change auditors in the year the engagement partner rotates. Further, in general, companies are moderately likely to change auditors more frequently as a result of the rule change. This suggests the possibility that audit committee members may value partner expertise more than an association with a particular audit firm. Further, audit committee member participants report a belief that investors and equity analysts are generally unconcerned with audit engagement partner rotation timetables. Lastly, in terms of the optimal time period for audit engagement partner rotation, audit committee member participant responses ranged from a minimum of four years to an unlimited number of years, and had a median time period of five years. This finding suggests Congress may have gotten it right; irrespective of a perceived lack of difference in auditor independence, financial reporting quality, and fraud detection between a seven-year and five-year rotation period, five years may be an appropriate maximum for an audit engagement partner to serve an audit client. In contrast, audit committee member participants generally believe the optimal period before an audit engagement partner should return to an audit engagement is three years compared to the currently-mandated five years.

Denise Dickins, Ph.D., CPA, CIA is an assistant professor at East Carolina University where she teaches courses in auditing and corporate governance. She may be contacted at dickinsd@ecu.edu. Brian Daugherty, Ph.D., CPA, is an assistant professor at the University of Wisconsin – Milwaukee where he teaches courses in auditing. He may be reached at daughert@uwm.edu. Julia Higgs, Ph.D., CPA, is an associate professor at Florida Atlantic University where she teaches courses in accounting and auditing. She may be reached at jhiggs@fau.edu.

Today’sCPA

| JANUARY/FEBRUARY 2012

TABLE 1. SAMPLE OF SURVEY QUESTIONS AND RESPONSES QUESTION

SCALE

RANGE

MEDIAN

MEAN (SIG. DIFFERENT FROM MIDPOINT)

IN YOUR OPINION, HOW HAS THE 5-YEAR ON, 5-YEAR OFF REQUIREMENT ENHANCED EXTERNAL AUDITOR INDEPENDENCE?

1 = NO ENHANCEMENT, 3 = MODERATELY ENHANCED, 5 = STRONGLY ENHANCED

1.00 TO 4.00

2.00

2.00 (P = 0.004)

IN YOUR OPINION, HOW HAS THE NEW 5-YEAR ON, 5-YEAR OFF REQUIREMENT ENHANCED FINANCIAL REPORTING QUALITY?

1 = NO ENHANCEMENT, 3 = MODERATELY ENHANCED, 5 = STRONGLY ENHANCED

1.00 TO 2.00

1.00

1.15 (P < 0.001)

MOST INVESTORS ARE HIGHLY CONCERNED ABOUT AUDIT ENGAGEMENT PARTNER ROTATION TIMETABLES.

1 = STRONGLY DISAGREE, 4 = NEUTRAL, 7 = STRONGLY AGREE

1.00 TO 4.00

2.00

2.10 (P = 0.001)

MOST AUDIT COMMITTEES ARE HIGHLY CONCERNED ABOUT AUDIT ENGAGEMENT PARTNER ROTATION TIMETABLES.

1 = STRONGLY DISAGREE, 4 = NEUTRAL, 7 = STRONGLY AGREE

2.00 TO 7.00

3.50

3.90 (P > 0.10)

WHAT DO YOU VIEW AS THE OPTIMAL PERIOD THAT AN AUDIT PARTNER SHOULD SERVE ON A CLIENT ENGAGEMENT?

CHOOSE ANY NUMBER OF YEARS (1, 2, 3, ETC.) OR UNLIMITED

4 TO UNLIMITED

5.00

WHAT DO YOU VIEW AS THE OPTIMAL PERIOD THAT AN AUDIT PARTNER SHOULD COOL-OFF OF A CLIENT ENGAGEMENT?

CHOOSE ANY NUMBER OF YEARS (1, 2, 3, ETC.) OR UNLIMITED

1 TO 5

3.00

IN YOUR OPINION, HOW WOULD A REQUIREMENT THAT COMPANIES PERIODICALLY ROTATE THEIR AUDIT FIRM ENHANCE AUDITOR INDEPENDENCE?

1 = NO ENHANCEMENT, 3 = MODERATELY ENHANCE, 5 = STRONGLY ENHANCE

1.00 TO 3.00

2.00

1.92 (P = 0.001)

IN YOUR OPINION, HOW WOULD A REQUIREMENT THAT COMPANIES PERIODICALLY ROTATE THEIR AUDIT FIRM ENHANCE FINANCIAL REPORTING QUALITY?

1 = NO ENHANCEMENT, 3 = MODERATELY ENHANCE, 5 = STRONGLY ENHANCE

1.00 TO 3.00

1.00

1.62 (P < 0.001)

CHOOSE ANY NUMBER OF YEARS (1, 2, 3, ETC.) OR UNLIMITED

8 TO UNLIMITED

UNLIMITED

WHAT DO YOU VIEW AS THE OPTIMAL PERIOD THAT AN AUDIT FIRM SHOULD SERVE A CLIENT?

In light of the continued debate concerning whether investors would benefit from audit firm rotation, the survey next asked audit committee participants to respond to a series of questions about their perceptions of mandatory audit firm rotation. The survey responses indicated that audit committee members strongly perceive no increased benefit of audit

firm rotation in terms of auditor independence, financial reporting quality, or detection of financial statement fraud. They also report expectations of at least a moderate increase in workload should audit firms be periodically required to rotate their audit clients. Given these reports, not surprisingly, audit committee participants believe there should be no

FOOTNOTES 1.

Dickins, D., and T. Skantz. 2010. The Impact of Regulation on Economic Bonding and Auditor Independence: An Analysis of SOX and Suggestions for Future Research. Advances in Public Interest Accounting 15: 1-21. Daugherty, B., D. Dickins, and J. Higgs. 2010. Mandatory audit partner rotation: partners’ perceptions of impacts on quality of life and audit quality. Working paper presented at a concurrent session of the Auditing Section of the American Accounting Association’s Annual Meeting (August). A total of 1,267 questionnaires were distributed using the address of each audit committee members’ affiliated company, as provided by Audit Analytics. Of these, 73 were returned as, “no longer affiliated with X company,” or with

Today’sCPA

| JANUARY/FEBRUARY 2012

maximum period for which an audit firm should serve an audit client.

THE RESULTS We questioned whether audit committee members perceive a benefit from having audit engagement partners rotate their client assignments. Results of our survey suggest audit committee members do not believe SOX’s acceleration of audit engagement rotation enhanced auditor independence, financial reporting quality, or improved detection of financial statement fraud. Although they generally support a five-year rotation period, they believe the optimal period before an audit engagement partner can return to a client audit engagement is three years. Further, they perceive investors and analysts are generally unconcerned about audit engagement partner rotation timetables. We also inquired regarding audit committee members perceptions of the benefits of audit firm rotation. Audit committee member participants perceive no value in terms of auditor independence, financial reporting quality or detection of financial statement fraud from audit firm rotation. Left unexplored was audit committee members’ views of the benefits and costs of the SOX mandate that quality control (i.e., concurring or second) partners also follow a five-year on, five-year off rotation. Such policy may be perceived as independence enhancing, but may also be viewed as even more disruptive – questions left for future research. The U.S. Department of Treasury’s Advisory Committee on the audit profession released its final report in late 2008 encouraging further study into the costs and benefits of a number of the SOX-imposed mandates on auditors.5 The committees’ recommendations include studying how mandatory partner rotation impacts audit quality, whether rotation differentially impacts smaller and larger auditors, and continued consideration of the benefits and costs of periodic firm rotation. Our study’s findings further contribute to the debates. n

incorrect addresses. We surmise the one percent is primarily attributable to questionnaires received at the company location not being passed along to audit committee members, and the generally poor rate of response to surveys. Although the sample is small, it is taken from a random group of middlemarket, publicly-traded companies, and we have no reason to believe it suffers from bias, including non-response bias. However, it is possible that results of the sample may not be generalizable to the population of all issuers, or to the population of all middle-market issuers. U.S. Department of the Treasury, Advisory Committee on the Auditing Profession. 2008. Summary available at: http://www.treasury.gov/press-center/ press-releases/Pages/hp1158.aspx.

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CPE Calendar TSCPA Continuing Professional Education Programs FEBRUARY MONDAY

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CPE Personal Assistant

Preparing the Nonprofit Series of Tax Returns for New Staff and Para-Professionals Dallas CPE Credits: 8

Be sure to use your CPE Personal Assistant on the TSCPA website. 6 It’s an online tool TSCPA members 13 can use to track, maintain and

3 Preparing the Nonprofit Series of Tax Returns for New Staff and Para-Professionals Houston CPE Credits: 8

update their CPE records. You can

Personal and Professional Ethics for Texas CPAs San Antonio CPE Credits: 4

access this tool by going to the

Personal and Professional Ethics for Texas CPAs Houston CPE Credits: 4

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Statement of Cash Flows: Preparation, Presentation and Use Houston CPE Credits: 8

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(tscpa.org) and clicking on the Wizard. 20

21 Personal and Professional Ethics for Texas CPAs Dallas CPE Credits: 4

22 Advanced Controller and CFO Skills Dallas CPE Credits: 8

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24 Advanced Controller and CFO Skills Houston CPE Credits: 8

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Personal and Professional Ethics for Texas CPAs Dallas CPE Credits: 4

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Texas Property Taxation Houston CPE Credits: 8 26

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