October 2nd, 2009
For organization??™s to understand financial reporting under generally accepted accounting principles they will need to understand various affects to the financial statements. This discussion will contemplate deferred taxes, correction of accounting changes and errors, and the rationale behind a corporate subsidiary.
The process used to determine deferred taxes.
Organization??™s compute income tax payable based on the regulations of taxing authorities. For financial reporting under GAAP companies report taxable income based on financial reported income. There are differences that arise between the financial income and taxable income based on such things as when revenue is recognized. GAAP financial reporting is based accruals while tax reporting is based on modified cash reporting. Deferred tax assets and liabilities represent the difference between GAAP financial statements and income and expenses that are recognized on an organization??™s taxes for a period. They represent a future effect to taxes that is not represented on financial reports.
Deferred liabilities can be a difference in depreciation that is accelerated on a fixed asset purchase for taxes which establish an expense that will be smaller or nonexistent in the future tax periods. Adjustments are made to the balance sheets accounts when the deferred tax is temporary, meaning the event that caused the difference between financial reporting and tax reporting will equal. When an event is permanent it will always be different and no changes to a financial statement accounts is necessary. Differences that are permanent have specific taxation reasons like the deductibility of life insurance premiums since life insurance proceeds are not taxable.
Deferred tax assets and liabilities are reported on the balance sheet and current assets or liabilities are netted together, this applies to noncurrent as well. Loss carry forwards are considered a deferred tax asset other deferred assets include net loss carryovers because of their benefit from reduced taxes in subsequent tax years. Deferred tax assets may be reduced based on evidence if the realization is not expected to develop. The taxable expense reported is based on the enacted tax rates.
The procedures for reporting accounting changes and error corrections.
Accounting changes include changes in accounting principle (changing from one GAAP principle to another), change in estimate (new or additional information found), change in reporting an entity from one different type to another. Inappropriately applied principles that did not follow GAAP are considered an error correction. A retrospective accounting change of inappropriate principle requires the new principles application to all applicable prior periods by adjusting the earliest retained earnings affected. An inventory principle that changes to LIFO requires a base year and previous year adjustments is impractical so, the current year of adoption becomes the base-year for the LIFO method.
Changes in estimates are reported and adjusted prospectively so no adjustments are made to prior periods. Estimates are uncertain future predictions and easily change with new information as long as GAAP requirements are followed. Changes in reporting entities is more significant and requires the restatement of all the prior periods that are affected by the change to show all the entity??™s years of financial representation.
Corrections of an error are adjustments to the retained earning balance, given certain situations discussed. A correction of an error is an adjustment to the current period??™s beginning retained earnings for prior period adjustments. The correction is reported in the financial statements of the year of discovery. Comparative financial statements that contain an error in the prior period require restatement in that period and the disclosure of the error is in the discovery year.
The rationale behind establishing the subsidiary as a corporation.
To form a corporation articles of incorporation are filed with the applicable state to form a charter. Corporations are a separate legal entity that file its own taxes, can sue and be sued, and can enter into contracts by way of management. Corporations are owned by investors. Investors do not manage the corporate activities so; investors are liable only up to what they invested. Ownership of corporations is easily transferable because no approval is needed from other owners because liability is limited. Corporations live beyond the investor??™s life. In partnership ownership when an owner/investor transfers their portion the consent of other partners is required and the partnership dissolves to form a new partnership.
The makeup of a Corporations stockholder??™s equity account includes: retained earnings which includes net income/loss and distributions (i.e. dividends), capital stock accounts, additional paid in capital, and stock repurchased by the corporation which is treasury stock. The financial impacts from ownership changes to corporate stock only come from the issuance of new or previously repurchased stock and treasury stock.
Management is hired by those assigned to govern the corporation called, the board of directors who are voted into office by shareholders. GAAP is required. There are two types of corporations called a C Corporation and an S Corporation. S corporations have a different taxation where the corporation is not separately taxes but, taxation flows through to the individual so are limited by the number and type of investors. C Corporations pay their own taxes and shareholders pay taxes on their dividends and sales of their investment.
A strong understanding of financial reporting concepts comes from understanding basic principles such as deferred taxes, changes due to an error or principle, and understanding types of organizations.
To: Accounting Manager, Smith Inc.
From: Anderson Wood
Date: October 2nd, 2009
Subject: Professional responsibilities and differences between reviews and audits
It is important to understand our responsibilities as CPAs when assuring reviews and audits.
A CPA??™s professional responsibilities
A CPA plays an important role in the financial reporting process. An external auditor maintains independence through financial interest separation. Auditors must be the impartial observer. Responsible CPA??™s review confidential information and must maintain confidentiality otherwise independence and objectivity can be damaged unless called upon by government agency. To protect public interest the AICPA must regularly review the CPA??™s role in the changing business activities society and strive for greater credibility with professionalism and knowledge. Responsible CPA??™s ensure a higher quality of service in their principal role of financial reporting, ensure objectivity to financial reporting, and integrity.
The difference between a review and an audit.
Audits and reviews are both attestations which are a form of assurance service that provides an explanatory report of the reliability of the financial statements. Audits on financial statements are characterized by an opinion issued by the independent auditors on the fair representation of the financial statements to GAAP. Publicly traded entities are required to report audited financial statements to the SEC. A review in comparison to audited financial statements requires less time and less analysis of supporting evidence. Reviews are less costly because the assurance from the review on the financial statements is only moderate. Both audits and reviews promote quality of viewer information from an independent professional. It is up to the responsible CPA to promote quality of financial information for the general public.
Arens, A. A., Elder, R. J., & Beasley, M. S. (2006). Auditing and assurance services: An integrated approach (11th ed.). Upper Saddle River, NJ: Pearson.
Bline, D. M., Fischer, M. L., & Skekel, T. D. (2004). Advanced accounting. Hoboken, NJ: Wiley.
Comiskey, E. E., & Mulford, C. W. (2000). Guide to financial reporting and analysis. New York, NY: Wiley.
Kieso, D. E., Weygandt, J. J., & Warfield, T.D. (2007). Intermediate accounting (12th ed.). Hoboken, NJ: Wiley.