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Strong internal controls and audits can help safeguard against data breaches

ediaz — Wed, 04 Sep 2024 14:39:59 +0000

The average cost of a data breach has reached $4.88 million, up 10% from last year, according to a recent report. As businesses increasingly rely on technology, cyberattacks are becoming more sophisticated and aggressive, and risks are increasing. What can your organization do to protect its profits and assets from cyberthreats?

Recent report

In August 2024, IBM published “Cost of a Data Breach Report 2024.” The research, conducted independently by Ponemon Institute, covers 604 organizations that experienced data breaches between March 2023 and February 2024. It found that, of the 16 countries studied, the United States had the highest average data breach cost ($9.36 million).

The report breaks down the global average cost per breach ($4.88 million) into the following four components:

$1.47 million for lost business (for example, revenue loss due to system downtime and costs related to lost customers, reputation damage and diminished goodwill),
$1.63 million for detection and escalation (such as forensic and investigative activities, assessment and audit services, crisis management, and communications to executives and boards),
$1.35 million for post-breach response (including product discounts, regulatory fines, legal fees, and costs related to setting up call centers and credit monitoring / identity protection services for breach victims), and
$430,000 for notifying regulators, as well as individuals and organizations affected by the breach.

A silver lining from the report is that the average time to identify and contain a breach has fallen to 258 days from 277 days in the 2023 report, reaching a seven-year low. One key reason for faster detection and recovery is that organizations are giving more attention to cybersecurity measures.

Implementing cybersecurity protocols

Cybersecurity is a process where internal controls are designed and implemented to:

Identify potential threats,
Protect systems and information from security events, and
Detect and respond to potential breaches.

The increasing number of employees working from home exposes their employers to greater cybersecurity risk. Many companies now have sensitive data stored in more places than ever before — including laptops, firm networks, cloud-based storage, email, portals, mobile devices and flash drives — providing many potential areas for unauthorized access.

Targeted data

When establishing new cybersecurity protocols and reviewing existing ones, it’s important to identify potential vulnerabilities. This starts by inventorying the types of employee and customer data that hackers might want to steal. This sensitive material may include:

Personally identifiable information, such as phone numbers, physical and email addresses and Social Security numbers,
Protected health information, such as test results and medical histories, and
Payment card data.

Companies need to have effective controls over this data to comply with their obligations under federal and state laws and industry standards.

Hackers may also try to access a company’s network to steal valuable intellectual property, such as customer lists, proprietary software, formulas, strategic business plans and financial data. These intangible assets may be sold or used by competitors to gain market share or competitive advantage.

Auditing cyber risks

No organization, large or small, is immune to cyberattacks. As the frequency and severity of data breaches continue to increase, cybersecurity has become a critical part of the audit risk assessment.

Audit firms provide varying levels of guidance, both when assessing risk at the start of the engagement and when uncovering a breach that happened during the period under audit or during audit fieldwork.

We can help

Contact us to discuss your organization’s vulnerabilities and the effectiveness of its existing controls over sensitive data. Additionally, if your company’s data is hacked, we can help you understand what happened, estimate and disclose the costs, and fortify your defenses going forward.

The post Strong internal controls and audits can help safeguard against data breaches first appeared on KSDT CPA.

Mind the GAAP: How to ensure transparency when using non-GAAP metrics

ediaz — Wed, 03 Apr 2024 13:42:09 +0000

At Financial Executives International’s Corporate Financial Reporting Insights Conference last November, staff from the Securities and Exchange Commission (SEC) expressed concerns related to the use of financial metrics that don’t conform to U.S. Generally Accepted Accounting Principles (GAAP). Companies continue to have trouble complying with the SEC’s guidelines on non-GAAP reporting, said Lindsay McCord, chief accountant of the SEC’s Division of Corporation Finance.

Here’s some guidance that may help as you prepare your company’s financial statements for the first quarter of 2024.

Ongoing concerns

GAAP is a set of rules and procedures that accountants typically follow to record and summarize business transactions. These guidelines provide the foundation for consistent, fair, honest and accurate financial reporting. Private companies generally aren’t required to follow GAAP, but many do. Public companies don’t have a choice; they’re required by the SEC to follow GAAP.

Over the years, the use of non-GAAP measures has grown. These unaudited figures can provide added insight when they’re used to supplement GAAP performance measures. But they can also be used to mislead investors and artificially inflate a public company’s stock price.

Specifically, companies may include unaudited performance figures — such as earnings before interest, taxes, depreciation and amortization (EBITDA) — to cast the company in a more favorable light. Non-GAAP metrics may appear in the management, discussion and analysis section of their financial statements, earnings releases and investor presentations.

For example, a company’s EBITDA is typically higher than its GAAP earnings. That’s because EBITDA is commonly adjusted for such items as stock-based compensation, nonrecurring items, intangibles and other company-specific items.

In addition, non-GAAP metrics or adjustments may be cherry-picked to present a stronger financial picture than what appears in audited financial statements. Some companies also may erroneously present non-GAAP metrics more prominently than GAAP numbers — or fail to clearly label and describe non-GAAP measures.

10 key questions

The Center for Audit Quality (CAQ) recommends considering the following 10 questions to help ensure transparent non-GAAP metric disclosures:

1. What’s the purpose of the non-GAAP measure, and would a reasonable investor be misled by the information?

2. Has the non-GAAP measure been given more prominence than the most comparable GAAP measure?

3. How many non-GAAP measures have been presented, and are they all necessary and appropriate for investors to understand performance?

4. Why has management selected a particular non-GAAP measure to supplement GAAP measures that are already established and consistently applied within its industry or across industries?

5. Does the company’s disclosure provide substantive detail on its purpose and usefulness for investors?

6. How is the non-GAAP measure calculated, and does the disclosure clearly and adequately describe the calculation, as well as the reconciling items between the GAAP and non-GAAP measures?

7. How does management use the measure and has that use been disclosed?

8. Is the non-GAAP measure sufficiently defined and clearly labeled as non-GAAP or could it be confused with a GAAP measure?

9. What are the tax implications of the non-GAAP measure, and does the calculation align with the tax consequences and the nature of the measure?

10. Does the company have material agreements, such as a debt covenant, that require compliance with a non-GAAP measure? If so, are they disclosed?

The CAQ provides additional questions that address the consistency and comparability of non-GAAP metrics.

We can help

Non-GAAP metrics can provide greater insight into the information that management considers important in running the business. However, care should be taken not to mislead investors and lenders. Contact us to discuss your company’s non-GAAP metrics and disclosures.

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Understanding Lease Standard ASC 842

ediaz — Mon, 22 May 2023 18:41:05 +0000

Stay compliant with The Standard ASC 842

Increase transparency and comparability in financial reporting
Requires lessees to recognize most leases on their balance sheets
Recognize operating leases and finance leases
Record right-of-use (ROU) assets and lease liabilities
Lease term and present value of lease payments determine recognition and measurement
Different treatment for operating leases and finance leases in income statements
Additional disclosures to provide users with more information

Get the Roadmap and Connect with an Expert.

Click here

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Understanding IRS Audit Guidance

ediaz — Thu, 16 Feb 2023 18:02:03 +0000

IRS examiners usually do their homework before meeting with taxpayers and their professional representatives. This includes reviewing any relevant Audit Techniques Guides (ATGs) that typically focus on a specific industry or audit-prone business transaction.

IRS Jumps into Golden Parachutes

The IRS updated its Audit Techniques Guide (ATG) on golden parachute payments in 2017. After a corporate takeover, officers who leave the company may receive “golden parachutes.” Such payments may be controversial with shareholders if they exceed severance given to other departing employees. Golden parachute payments are nondeductible and could trigger a 20% penalty if deemed excessive.

A parachute payment doesn’t include any reasonable amount paid for services to be rendered before, on or after the date of change in ownership or control. Certain exceptions may be made for qualifying small business corporations. And payments to or from a qualified pension or profit-sharing plan, 403(a) annuity, simplified employee pension or SIMPLE plan aren’t considered parachute payments.

The new ATG explains how examiners can detect golden parachute payments, including a nine-step guide and flowchart to performing a parachute examination. It also provides a laundry list of documents to review in connection with these issues.

The IRS updated several ATGs, including ones for conservation easements and cost segregation studies, at the end of 2016.

Though designed to help IRS examiners prepare for audits, ATGs are available to the public. So, small business taxpayers can review them, too — and gain valuable insights into issues that might surface during audits.

Auditor Specialization

In the past, IRS examiners were randomly assigned to audit taxpayers from all walks of life, with no real continuity or common thread. For example, after an examiner audited a dentist, the next assignment he or she received might have been a fishing boat captain or a convenience store owner. Therefore, there was little chance to develop expertise within a particular niche.

To remedy this, the IRS created its Market Segment Specialization Program (MSSP), which expanded rapidly during the 1990s. The MSSP allowed IRS auditors to focus on specific sectors. Through education and experience, examiners became better equipped to identify and detect noncompliance with the tax code.

The IRS started publishing ATGs as an offshoot of the MSSP. Most ATGs target major industries, such as construction, manufacturing and professional practices (including physicians, attorneys and accountants). Other ATGs address issues that frequently arise in audits, such as executive compensation and fringe benefits.

The IRS periodically revises and updates the ATGs and adds new ones to the list. (See “IRS Jumps into Golden Parachutes” at right.)

A Closer Look at ATGs

What does an ATG cover? The IRS compiles information obtained from past examinations of taxpayers and publishes its findings in ATGs. Typically, these publications explain:

The nature of the industry or issue,
Accounting methods commonly used in an industry,
Relevant audit examination techniques,
Common and industry-specific compliance issues,
Business practices,
Industry terminology, and
Sample interview questions.

The main goal of ATGs is to improve examiner proficiency. By using a specific ATG, an examiner may, for example, be able to reconcile discrepancies when reported income or expenses aren’t consistent with what’s normal for the industry or to identify anomalies within the geographic area in which the taxpayer resides. The guides also help examiners plan their audit strategies and streamline the audit process.

Over time, the information and experience gained about a particular market segment can help examiners conduct future audits with greater efficiency. Some of this information is incorporated into periodic ATG updates. Furthermore, IRS examiners are routinely advised about industry changes through trade publications, trade seminars and information sharing with other personnel.

Site Visits and Interviews

ATGs also identify the types of documentation that taxpayers should provide and information that might be uncovered during a tour of the business premises. These guides may be able to identify potential sources of income that could otherwise slip through the cracks.

For example, the ATG for the legal profession identifies revenue streams derived from outside the general practice, such as serving on a board of directors, speaking engagements, and book writing or editing. The guide encourages IRS examiners to inquire about potential revenue sources during the initial interview with the taxpayer.

Other issues that ATGs might instruct examiners to inquire about include:

Internal controls (or lack of controls),
The sources of funds used to start the business,
A list of suppliers and vendors,
The availability of business records,
Names of individual(s) responsible for maintaining business records,
Nature of business operations (for example, hours and days open),
Names and responsibilities of employees,
Names of individual(s) with control over inventory, and
Personal expenses paid with business funds.

For example, one ATG focuses specifically on cash-intensive businesses, such as liquor stores, salons, check-cashing operations, gas stations, auto repair shops, restaurants and bars. It highlights the importance of reviewing cash receipts and cash register tapes for these types of businesses.

Cash-intensive businesses may be tempted to under report their cash receipts, but franchised operations may have internal controls in place to deter such “skimming.” For instance, a franchisee may be required to purchase products or goods from the franchisor, which provides a paper trail that can be used to verify sales records.

Likewise, when auditing a liquor store owner, examiners are taught to search for off-book wholesalers and check cashers. For gas stations, examiners must check the methods of determining income, rebates and other incentives. Restaurants and bars should be asked about net profits compared to the industry average, spillage, pouring averages and tipping.

Bottom Line

During an audit, IRS examiners focus on those aspects that are unique to the industry, as well as ferreting out common means of hiding income and inflating deductions. ATGs are instrumental to that process.

Although ATGs were created to benefit IRS employees, they also help small businesses ensure they aren’t engaging in practices that could raise red flags. To access the complete list of ATGs, visit the IRS website. And for more information on hot tax issues that may affect your business, contact your tax advisor.

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New accounting rules for supplier finance programs

KSDT Marketing — Tue, 01 Nov 2022 19:22:20 +0000

Does your company use supplier finance programs to buy goods or services? If so, and if you must adhere to U.S. Generally Accepted Accounting Principles (GAAP), there will be changes starting next year. At that time, you must disclose the full terms of supplier finance programs, including assets pledged to secure the transaction. Here are the details of this new requirement under GAAP.

Gap in GAAP

Supplier finance programs — sometimes called “structured payables” and “reverse factoring” — are popular because they offer a flexible structure for paying for goods and services. In a traditional supplier arrangement, the buyer agrees to pay the supplier directly within, say, 30 to 45 days.

Conversely, with a supplier finance program, the buyer arranges for a third-party finance provider or intermediary to pay approved invoices before the due date at a discount from the stated amount. Meanwhile the buyer receives an extended payment date, say, 90 to 120 days, in exchange for a fee. This enables the buyer to keep more cash on hand. However, many organizations haven’t been transparent in disclosing in their financial statements the effects those programs have on working capital, liquidity and cash flows.

That’s the reason the Financial Accounting Standards Board recently issued Accounting Standard Update (ASU) No. 2022-04, Liabilities — Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations. It will require buyers to disclose the key terms of supplier finance programs and where any obligations owed to finance companies have been presented in the financial statements.

More details

Supplier finance programs are a relatively new form of arrangement that continues to evolve and grow in popularity. Even after this ASU becomes effective, GAAP doesn’t provide any specific guidance on where to present the amounts owed by the buyers to finance companies. It’s up to the buyer to decide whether these obligations should be presented as accounts payable or short-term debt.

However, the updated guidance does require that in each annual reporting period, a buyer must disclose:

The key terms of the program, including a description of the payment terms and assets pledged as security or other forms of guarantees provided for the committed payment to the finance provider or intermediary, and
For the obligations that the buyer has confirmed as valid to the finance provider or intermediary 1) the amount outstanding that remains unpaid by the buyer as of the end of the annual period, 2) a description of where those obligations are presented in the balance sheet, and 3) a roll-forward of those obligations during the annual period, including the amounts of obligations confirmed and obligations subsequently paid.

In each interim reporting period, the buyer must disclose the amount of obligations outstanding that the buyer has confirmed as valid to the finance provider or intermediary as of the end of the period.

Ready, set, go

The new rules take effect for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, except for the amendment on roll-forward information. That provision is effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. Contact us for more information or help implementing the changes.

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FASB proposes last-minute changes to lease accounting rules

KSDT Marketing — Mon, 03 Oct 2022 00:35:13 +0000

Accounting Standards Codification Topic 842, Leases, requires organizations to report the full magnitude of their long-term lease obligations on their balance sheets — a historic first. For private companies and nonprofits, the changes take effect this year. Public entities adopted the rules in 2019. While the Financial Accounting Standards Board (FASB) conducts its post-implementation review of the new-and-improved lease standard, the guidance is concurrently being adopted by private organizations.

A major issue that has surfaced relates to leases under common control. In a surprise move, the FASB voted on September 21 to propose changes to address stakeholder concerns.

Practical expedient for related-party leases

Topic 842 requires an organization to account for a lease that’s under common control on the basis of the legally enforceable provisions. Problems arose for private companies because some don’t have written documentation of related-party leases, and they’re confused about what’s “legally enforceable.”

FASB members unanimously agreed to propose a practical expedient for private entities to simplify the guidance for determining whether a lease exists for arrangements between entities under common control. A practical expedient is an accounting workaround with a simpler approach to arriving at the same answer as the initial rule.

The proposal specifies that entities would only consider the written terms and conditions when determining whether a lease exists, and the classification and accounting for that lease. Entities wouldn’t be required to determine whether those written terms and conditions are legally enforceable. Moreover, if no written terms and conditions exist, an entity would apply Topic 842 to any verbal or implicit terms and conditions. If no lease exists, other rules would apply.

Clarity on leasehold improvements

An affiliated issue that came up during the FASB’s review of Topic 842 is how to handle the treatment of leasehold improvements when there’s a verbal related-party transaction. In many cases, the life of the related-party lease could substantially differ from the actual life of the underlying lease asset.

The term “leasehold improvement” generally refers to changes, buildouts or upgrades to real property made by a commercial tenant. For example, you might paint, update lighting, install new carpet or make repairs to a space.

FASB members voted 4-3 to propose an amendment to Topic 842 that would specify that leasehold improvements associated with leases between entities under common control be “amortized by the lessee over the useful life of the improvements (regardless of the lease term) as long as the lessee continues to use the underlying asset.” If the lessee stops using the leased asset, it would then be “accounted for as a transfer between entities under common control.”

To be clear, if approved, this change would apply to both public and private entities. Public companies already implemented the updated standard in 2019.

It’s important to note that three FASB members dissented to proposing changes to leasehold improvement rules. The dissenters said that they didn’t have enough information to vote to propose changes for public companies and were uncertain about any secondary or indirect implications of the proposal. The members who were in favor of the proposal indicated that public companies would largely be unaffected by the changes. Their leases tend to be arm’s length, written agreements, regardless of whether the lessors are third parties or under common control.

Stay tuned

Since the updated lease guidance was issued in 2016, it has been deferred twice and amended five times. Once these two last-minute proposals are issued, there will be a 45-day comment period. In the meantime, private organizations must continue pushing forward with adopting the updated guidance for 2022. Contact us for help onboarding the changes, including any amendments for leases under common control.

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Evaluating “going concern” concerns

KSDT Marketing — Wed, 03 Aug 2022 18:42:23 +0000

Under U.S. Generally Accepted Accounting Principles (GAAP), financial statements are normally prepared based on the assumption that the company will continue normal business operations into the future. When liquidation is imminent, the liquidation basis of accounting may be used instead.

It’s up to the company’s management to decide whether there’s a so-called “going concern” issue and to provide related footnote disclosures. But auditors still must evaluate the appropriateness of management’s assessment. Here are the factors that go into a going concern assessment.

Substantial doubt and potential for mitigation

The responsibility for making a final determination about a company’s continued viability shifted from external auditors to the company’s management under Accounting Standards Update (ASU) No. 2014-15, Presentation of Financial Statements — Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern. The updated guidance requires management to decide whether there are conditions or events that raise substantial doubt about the company’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued, to prevent auditors from holding financial statements for several months after year end to see if the company survives).

Substantial doubt exists when relevant conditions and events, considered in the aggregate, indicate that it’s probable that the company won’t be able to meet its current obligations as they become due. Examples of adverse conditions or events that might cause management to doubt the going concern assumption include:

Recurring operating losses,
Working capital deficiencies,
Loan defaults,
Asset disposals, and
Loss of a key franchise, customer or supplier.

After management identifies that a going concern issue exists, it should consider whether any mitigating plans will alleviate the substantial doubt. Examples of corrective actions include plans to raise equity, borrow money, restructure debt, cut costs, or dispose of an asset or business line.

Aligning the guidance

After the FASB updated its guidance on the going concern assessment, the Auditing Standards Board (ASB) unanimously voted to issue a final going concern standard. The ASB’s Statement on Auditing Standards (SAS) No. 132, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, was designed to promote consistency between the auditing standards and accounting guidance under U.S. GAAP.

The updated guidance requires auditors to obtain sufficient appropriate audit evidence regarding management’s use of the going concern basis of accounting in the preparation of the financial statements. It also addresses uncertainties auditors face when the going concern basis of accounting isn’t applied or may not be relevant.

For example, SAS No. 132 doesn’t apply to audits of single financial statements, such as balance sheets and specific elements, accounts, or items of a financial statement. Some auditors contend that the evaluation of whether there’s substantial doubt about a company’s ability to continue as a going concern can be performed only on a complete set of financial statements at an enterprise level.

Prepare for your next audit

With increased market volatility, rising inflation, supply chain disruptions, labor shortages and skyrocketing interest rates, the going concern assumption can’t be taken for granted. Management must take current and expected market conditions into account when making this call — and be prepared to provide auditors with the appropriate documentation. Contact us before year end if you have concerns about your company’s going concern assessment. We can provide objective market data to help evaluate your situation.

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FAQs about fair value in accounting

KSDT Marketing — Mon, 11 Apr 2022 14:57:47 +0000

In recent years, accounting rule makers have issued guidance that requires certain items on the balance sheet to be reported at “fair value.” Here are some answers to frequently asked questions about this standard of value and how it’s measured.

What is fair value?

Under U.S. Generally Accepted Accounting Principles (GAAP), fair value is “the price that would be received to sell an asset or pay to transfer a liability in an orderly transaction between market participants at the measurement date.” The use of the term “market participants” refers to buyers and sellers in the item’s principal market. This market is entity specific and may vary among companies.

Fair value estimates are used to report such assets as derivatives, nonpublic entity securities, certain long-lived assets, and acquired goodwill and other intangibles. These estimates specifically exclude entity-specific considerations, such as transaction costs and buyer-specific synergies.

Does fair value differ from fair market value?

Although fair value is similar to fair market value, the terms aren’t synonymous. The most common definition of fair market value is found in IRS Revenue Ruling 59-60. The IRS defines fair market value as “[T]he price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”

The Financial Accounting Standards Board (FASB) chose the term “fair value” to prevent companies from applying IRS regulations or guidance and U.S. Tax Court precedent when valuing assets and liabilities for financial reporting purposes. The use of this term also shouldn’t be confused with its use in certain legal situations — for example, when valuing a business for a divorce or a shareholder buyout. Statutory definitions of fair value typically differ from the definition provided under GAAP.

How is fair value measured?

The FASB recognizes three valuation approaches: cost, income and market. It also provides the following hierarchy for valuation inputs, listed in order from most important to least important:

Quoted prices in active markets for identical assets and liabilities,
Observable inputs, including quoted market prices for similar items in active markets, quoted prices for identical or similar items in active markets, and other market data, and
Unobservable inputs, such as cash-flow projections or other internal data.

Valuation specialists are often used to estimate fair value. But ultimately, management can’t outsource responsibility for fair value estimates. Management has an obligation to understand the valuator’s assumptions, methods and models. It also must implement adequate internal controls over fair value measurements, impairment charges and disclosures.

How do auditors assess fair value measurements?

External auditors evaluate accounting estimates as part of their standard audit procedures. They may inquire about the underlying assumptions (or inputs) that were used to make estimates to determine whether the inputs seem complete, accurate and relevant.

Whenever possible, auditors try to recreate management’s estimate using the same assumptions (or their own). If an auditor’s estimate differs substantially from what’s reported on the financial statements, the auditor will ask management to explain the discrepancy. Don’t be surprised if auditors ask questions related to fair value estimates or request additional documentation to support your conclusions in today’s uncertain marketplace.

For more information

Contact us about any additional questions you may have about fair value measurements. We can help ensure that you’re meeting your financial reporting responsibilities.

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Claiming a theft loss deduction if your business is the victim of embezzlement

KSDT Marketing — Thu, 09 Sep 2021 14:28:48 +0000

A business may be able to claim a federal income tax deduction for a theft loss. But does embezzlement count as theft? In most cases it does but you’ll have to substantiate the loss. A recent U.S. Tax Court decision illustrates how that’s sometimes difficult to do.

Basic rules for theft losses

The tax code allows a deduction for losses sustained during the taxable year and not compensated by insurance or other means. The term “theft” is broadly defined to include larceny, embezzlement and robbery. In general, a loss is regarded as arising from theft only if there’s a criminal element to the appropriation of a taxpayer’s property.

In order to claim a theft loss deduction, a taxpayer must prove:

The amount of the loss,
The date the loss was discovered, and
That a theft occurred under the law of the jurisdiction where the alleged loss occurred.

Facts of the recent court case

Years ago, the taxpayer cofounded an S corporation with another shareholder. At the time of the alleged embezzlement, the other original shareholder was no longer a shareholder, and she wasn’t supposed to be compensated by the business. However, according to court records, she continued to manage the S corporation’s books and records.

The taxpayer suffered an illness that prevented him from working for most of the year in question. During this time, the former shareholder paid herself $166,494. Later, the taxpayer filed a civil suit in a California court alleging that the woman had misappropriated funds from the business.

On an amended tax return, the corporation reported a $166,494 theft loss due to the embezzlement. The IRS denied the deduction. After looking at the embezzlement definition under California state law, the Tax Court agreed with the IRS.

The Tax Court stated that the taxpayer didn’t offer evidence that the former shareholder “acted with the intent to defraud,” and the taxpayer didn’t show that the corporation “experienced a theft meeting the elements of embezzlement under California law.”

The IRS and the court also denied the taxpayer’s alternate argument that the corporation should be allowed to claim a compensation deduction for the amount of money the former shareholder paid herself. The court stated that the taxpayer didn’t provide evidence that the woman was entitled to be paid compensation from the corporation and therefore, the corporation wasn’t entitled to a compensation deduction. (TC Memo 2021-66)

How to proceed if you’re victimized

If your business is victimized by theft, embezzlement or internal fraud, you may be able to claim a tax deduction for the loss. Keep in mind that a deductible loss can only be claimed for the year in which the loss is discovered, and that you must meet other tax-law requirements. Keep records to substantiate the claimed theft loss, including when you discovered the loss. If you receive an insurance payment or other reimbursement for the loss, that amount must be subtracted when computing the deductible loss for tax purposes. Contact us with any questions you may have about theft and casualty loss deductions.

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Have you followed up on the management letter from your audit team?

KSDT Marketing — Wed, 11 Aug 2021 14:34:22 +0000

Auditors typically deliver financial statements to calendar-year businesses in the spring. A useful tool that accompanies the annual report is the management letter. It may provide suggestions — based on industry best practices — on how to fortify internal control systems, streamline operations and reduce expenses.

Managers generally appreciate the suggestions found in management letters. But, realistically, they may not have time to implement those suggestions, because they’re focusing on daily business operations. Don’t let this happen at your company!

What’s covered?

A management letter may address a broad range of topics, including segregation of duties, account reconciliations, physical asset security, credit policies, employee performance, safety, Internet use and expense reduction. In general, the write-up for each deficiency includes the following elements:

Observation. The auditor describes the condition, identifies the cause (if possible) and explains why it needs improvement.

Impact. This section quantifies the problem’s potential monetary effects and identifies any qualitative effects, such as decreased employee morale or delayed financial reporting.

Recommendation. Here, the auditor suggests a solution or lists alternative approaches if the appropriate course of action is unclear.

Some letters present deficiencies in order of significance or the potential for cost reduction. Others organize comments based on functional area or location.

What elements are required?

AICPA standards specifically require auditors to communicate two types of internal control deficiencies to management in writing:

1. Material weaknesses. These are defined as “a deficiency, or combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the organization’s financial statements will not be prevented or detected and corrected on a timely basis.”

2. Significant deficiencies. These are “less severe than a material weakness, yet important enough to merit attention by those charged with governance.”

Operating inefficiencies and other deficiencies in internal control systems aren’t necessarily required to be communicated in writing. However, most auditors include these less significant items in their management letters to inform their clients about risks and opportunities to improve operations.

Have you improved over time?

When you review last year’s management letter, consider comparing it to the letters you received for 2019 (and earlier). Often, the same items recur year after year. Comparing consecutive management letters can help track the results over time. But, be aware: Certain issues may autocorrect — or worsen — based on factors outside of management’s control, such as changes in technology or external market conditions. If you’re unsure how to implement a particular suggestion from your management letter, reach out to your audit team for more information.

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