The Profit Statement

The Profit Statement Asset impairment: What it is and why you should care Various Financial Accounting Standards Board pronouncements require that certain assets be reported at fair value or tested periodically to determine if their book value is greater than their fair market value. If book value exceeds fair value, an asset is deemed to be “impaired.” Why is impairment something to be concerned about? Because an impaired asset must be reduced to fair value on the company’s books, and a corresponding impairment loss must be taken on the company’s income statement or directly to stockholders’ equity. This means that an impaired asset will adversely impact the company’s balance sheet and, possibly, reported earnings. Under certain debt or other contract covenants, impairment could even result in default. Many assets may be impaired The economic crisis has reduced market value for many classes of assets, including stocks, bonds, closely held businesses and real estate. Therefore, it is now more likely that the fair value of such assets is less than what appears on the books of companies holding them. In fact, as of December 23, 2008, more than 25% of the companies in the S&P 500 were valued by the market at a discount to their accounting book value. This may be continued on page 2 Summer 2009 In This Issue n Asset impairment: What it is and why you should care 6 ways to keep your business afloat in a stormy economy Making the best of an economic downturn Tax planning for tough times 1 1 n n 3 n Trying to cope with business losses? Use an NOL deduction to gain something back 5 6 ways to keep your business afloat in a stormy economy Captaining a successful company is never easy. But when sales slump, receivables lag and lenders get Scroogeminded, staying profitable is particularly challenging. Here are some ways to keep your business from going under in rough economic seas. 1. Ask your crew to help Because they are personally involved in the details of your company’s operations, employees often know best how to cut costs and do things more efficiently. And because they have a vested interest in your company’s survival, they’ll be quick to suggest ways to operate more profitably — if you ask them. So let them know about the need to curb spending, and get their ideas for ways to reduce expenses and increase productivity. Honor frugal crew members by noting in a companywide e-mail or newsletter what they’ve done to control costs, and provide rewards for ideas that increase efficiency or boost profitability. 2. Run a tight ship According to the Association of Certified Fraud Examiners, the average business loses 7% of its revenue to occupational fraud. So make sure you take steps to prevent fraud, especially the two most prevalent types: corruption and fraudulent billing schemes. Reduce these threats by implementing sound hiring practices (including background checks on new employees) and solid internal accounting controls. continued on page 4 Kerry Balagtas n (301) 280-2730 n kerry.balagtas@reznickgroup.com n www.reznickgroup.com The Profit Statement Asset impairment... continued from page 1 n 2 an indication that the reported asset balances are impaired and that adjustments in reported value will be required. Impairment testing and reporting rules In light of Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, and greater attention to impairment by both regulators and the financial press, auditors now consider fair value a high-risk area and will be placing greater importance on impairment measurements. To help you avoid financial reporting surprises, here’s a summary of the different approaches used to test for and record impairment for various types of assets: Fair value reporting. On specified dates, companies must report both increases and decreases in the fair value of their assets. Changes in fair value are reported either in earnings or, for certain assets, directly to stockholders’ equity. Assets that must be reported under a fair value model include: n Financial instruments (assets and liabilities) elected to be carried at fair value under SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. Fair value impairment testing. On an annual basis or upon a triggering event, such as loss of a key customer or a significant change in the business climate, companies must test for impairment and report decreases (only) in fair value if the book value of an asset exceeds its fair value. Assets that must be tested under a fair value impairment testing model include goodwill and intangible assets, such as trademarks, with indefinite lives. Multistep process. Upon triggering events, such as significant deterioration in operations or the market outlook, companies first test whether the book value of an asset can be recovered based on the asset’s expected undiscounted cash flow. If that test fails, they must evaluate impairment of the asset under a fair value model. Assets tested under a multistep process include: n Recoverability model. Upon certain triggering events, companies report the net realizable value — the amount recoupable from the sale of an asset in a current transaction, less the selling costs to dispose of the asset. Assets that must be tested under a recoverability model include: n Component and finished product inventory, Land and home inventory that is held for sale, such as completed but unsold homes, and Assets the company acquired with the intent to sell. n n Special rules. Certain assets are given very specific rules for evaluating impairment. For example, loans receivable (that do not have observable market prices) can be tested by: 1. Comparing the sum of the loan’s expected cash flows, discounted to present value, to the effective rate of the loan note rate; 2. Comparing the fair value of the collateral, if the loan is collateral dependent, to the book value of the loan; or 3. Aggregating loans and comparing historical results on similar loans to their carrying values. It’s not clear whether cost and equity investments (generally, less than 20 percent ownership interests) in closely held businesses must be tested under a recoverability model or a fair value model. However, more and more auditors are requiring a fair value model that requires a complex valuation of the noncontrolling ownership interest under SFAS 157. Don’t be caught unaware Understanding and implementing the rules for reporting fair value and impairment are important to avoid adverse audit findings and other unwelcome consequences. To determine whether your assets are impaired, or for more information about SFAS 157 requirements, please contact Brent Solomon at 301.280.3660 (Brent. Solomon@reznickgroup.com) or Jordan Klinger at 301.907.2324 (Jordan.Klinger@ reznickgroup.com). n Investments in marketable (traded) equity securities, Marketable debt securities held for trading and available for sale, Derivatives (options, warrants, forwards, swaps and caps) and embedded derivatives, All assets of companies that are treated as investment companies, and Land inventory held and used, or under development, Operating properties, such as company headquarters, Income-producing properties, such as rental properties, and Finite-lived intangible assets, such as customer relationships and noncompete agreements. n n n n n n Editorial Board n Atlanta Kenneth E. Baggett, CPA 404.847.9447 Baltimore William T. Riley, Jr., CPA 410.783.4900 Bethesda Managing Editor Kerry Balagtas 301.280.2730 Charlotte Anthony V. Portal, CPA 704.332.9100 n Chicago Jarvis H. Friduss, CPA 847.324.7500 Sacramento Beth Mullen, CPA 916.442.9100 Tysons Corner Ernie Sanders, CPA 703.744.6700 n n n n n 3 Making the best of an economic downturn Tax planning for tough times While there isn’t much you can do to reverse the economic slump, you can take steps to minimize your income, gift and estate taxes. That can lead to a better financial situation for you personally even if the economy is slow to improve. Let’s look at some strategies that can make these times a little less tough. Turn losses into tax savings If you’re holding poor-performing investments, consider selling them to “harvest” the losses. You can use these losses to offset up to $3,000 in ordinary income plus any capital gains you recognize this year. Also, unloading losers gives you an opportunity to replace them with investments expected to yield better returns. Alternatively, you can carry losses forward to future tax years. If you’re expecting to move into a higher tax bracket in the next few years, you may want to wait to “use” your losses until they’ll save you more. Take advantage of retirement tax breaks Contributions to IRAs, 401(k) plans and other tax-deferred savings vehicles reduce your adjusted gross income (AGI). As a result, they not only lower your taxable income but may also increase deductions (although the deductions phase out above certain AGI levels). If you can afford to, put the maximum amount allowed into these accounts so you can max out on tax savings, too. For 2009, you can contribute up to $16,500 to your 401(k) plan ($22,000 if you’re age 50 or older). Depending on such factors as your AGI and whether you participate in an employer-sponsored retirement plan, you may also be able to contribute $5,000 to your traditional or Roth IRA ($6,000 if you’re age 50 or older). Hold off on RMDs When you reach age 701/2, you must take annual required minimum distributions (RMDs) from IRAs, 401(k)s and other to help you with this.) If a Roth IRA seems best, converting a traditional IRA may be a good strategy, especially now while many asset values are depressed. When you do a Roth conversion, you have to pay taxes on the amount you convert. But if your IRA assets have depreciated in value in recent months, you’ll minimize the tax cost while maximizing potential tax-free growth when the economy rebounds. Give assets to loved ones The struggling economy creates some estate planning opportunities. By leveraging depressed asset values and rock-bottom interest rates, you can transfer substantial amounts of wealth to your children or other heirs at minimal tax cost. For example, you can minimize gift taxes by transferring real estate, stocks or other assets whose values have declined. Other transfer tools that allow you to take advantage of low asset values and interest rates include grantor retained annuity trusts, charitable lead annuity trusts, intentionally defective grantor trusts and intrafamily loans. (See “Why you should a lender be” below.) Act now Although many of these strategies will remain effective even when the economy recovers, you may need to act soon to derive the greatest benefit from them. Please check with us to learn how you can make the best of these recessionary times to both save tax and more fully achieve your wealth transfer and estate planning objectives. n retirement accounts. If you don’t, you’ll suffer a tax penalty equal to 50% of the amount you should have withdrawn. Congress suspended the RMD requirement for 2009 to soften the blow of the economic downturn. Unless you need the money for living expenses, consider skipping RMDs this year, leaving more money in your retirement accounts to grow tax free. Convert to a Roth IRA Traditional IRAs offer current tax deductions and tax-deferred growth. But when you or your heirs take distributions, the funds are subject to ordinary income taxes. Contributions to a Roth IRA, on the other hand, are nondeductible, but qualified distributions of contributions and earnings are tax free. To determine which IRA is best for you, you’ll have to consider your expected investment returns and the benefits of paying the tax now or later. (We’d be glad Why you should a lender be One of the most effective estate planning strategies in a low-interest-rate environment is the intrafamily loan. To avoid gift taxes on a loan to a family member, you must charge interest at or above the applicable federal rate (AFR). AFRs have dropped to their lowest levels in decades. So if your borrower (a son or daughter) places the funds in investments that outperform the AFR, the money left over after repaying the loan will essentially be a tax-free gift. 4 … keep your business afloat … continued from page 1 Also, let your crew know that you won’t tolerate fraud. If you suspect fraudulent activity, bring in a forensic accountant to investigate it and, if necessary, prosecute the perpetrator to demonstrate you mean business. 3. Keep your sails up While you need to keep an eye on the economic winds, you don’t have to stay the sails, batten the hatches and ride things out until the weather improves. Instead, it’s time to be proactive in maintaining good communication with suppliers and customers. A good supplier may help you through some tough times by extending credit or setting up a workable payment plan, if you’re up front with them about your situation. Also, strengthen bonds with good customers and referral sources. By working to serve customers in additional ways and rewarding referrals, you’ll likely increase revenue. In addition, try to create new business alliances wherever you can. The more people who know what you offer and can tell others about you, the more business you’ll have. When credit is tight, you may do best with local lenders, such as smaller regional banks, credit unions and private investors. to come by, consider an asset- or equitybased loan. An asset-based loan is secured by the value of your company’s inventory, accounts receivable, equipment or real estate. An equity-based loan is secured by an ownership interest in your company. Although you’d probably prefer an unsecured loan, don’t let a lack of money leave you dead in the water. When credit is tight, you may do best with local lenders, such as smaller regional banks, credit unions and private investors. To increase your chances of getting a loan, develop a strong loan package that includes: a business plan, a competitive analysis and a complete set of financial statements, as well as an analysis of your business’s strengths, weaknesses, opportunities and threats. 5. Don’t run aground on receivables Keeping watch for problem accounts can enable you to avoid getting stuck on them. For example, call a customer before an invoice becomes due to make sure that: n n The client is satisfied and there are no unknown issues, and Payment will be issued by the due date. n It may not be practical to do this with all customers. But if you focus on those that account for the majority of the total dollars coming due soon, you’ll be more likely to avoid unpleasant surprises. 6. Avoid price wars To keep existing customers and boost sales, you may be tempted to lower your prices. But cutting margins so low that even the slightest mistake can result in financial disaster isn’t a good idea. Price cutting often leads to reduced profitability, so a “steady as she goes” approach may be best, even if you lose a few customers. In fact, if you can find ways to pass along costs to your customers without pricing yourself out of the market, you may want to take that tack. For example, shipping costs have increased considerably over the past year, so customers won’t be surprised to pay more for shipping. If you’ve not raised your standard shipping charge for a while, now may be the time. n Above all, don’t stop marketing or investing in new technologies, especially if those activities are the lifeblood of your business. When your markets are shrinking, you need to do more, not less, to stay competitive. Take advantage of all available governmental tax incentives, deductions and credits to quickly and positively impact your company’s bottom line. (Check with us to make sure you don’t miss any.) 4. Keep your treasure chest full If a cash influx is needed to run or grow your business and money seems hard The invoice has been received and processed for payment, 5 Trying to cope with business losses? Use an NOL deduction to gain something back In a recession like the one we’ve gone through this year, many businesses have found that their deductible expenses are exceeding their income. If yours is one of them, you’ll likely end up with a net operating loss (NOL) for your 2009 tax year. While that isn’t good news, it may not be quite as bad as it seems. That’s because you can carry back the loss to offset income in a previous year or carry it forward to a future year. If you choose to carry back the loss, you may be able to obtain an immediate tax refund — and that can provide a very welcome infusion of cash when revenue is down. Which way should you go? You generally can carry back an NOL no more than two tax years. For certain losses attributable to casualty and theft, the carryback period is three years. In presidentially declared disaster areas, as well as for certain other disasters, the carryback period for businesses is five years. Typically, it’s better to carry back an NOL so you can claim a current refund. But you can carry forward unused losses for up to 20 years. In some cases, such as when you expect your business to move into a higher tax bracket, you may want to save your NOLs to reduce your future tax liability. You may even elect to both carry back and carry forward NOLs. But you must first carry back losses to the earliest tax year for which you qualify before you can carry forward any remaining losses. Business structure matters If your business is a C corporation, the net operating loss occurs at that level. If your company is a pass-through entity, such as a partnership, S corporation or multiple-owner limited liability company (LLC), losses are passed through to the partners, shareholders or members and deducted on their individual tax returns — but only to the extent of their adjusted tax basis. Generally, the initial basis for pass-through entity owners is the amount they pay to acquire their interests, plus the adjusted basis of any property they contribute to the company. During the life of the business, basis may be increased by the owners’ shares of company income, subsequent capital contributions and other factors. Conversely, basis may be reduced (though not below zero) by the owner’s shares of distributions, taxable losses and other items. The rules for adjusting basis vary by entity type. In a partnership, the partners may in some circumstances deduct losses in excess of their investment in the company, because their tax basis is increased by certain partnership debt. But an S corporation shareholder’s basis isn’t increased by corporate debt unless the shareholder makes a loan to the S corporation. Therefore, S corporation shareholders generally can’t deduct losses beyond their company investment. Also, at-risk rules make it difficult for LLC members to deduct losses beyond their company investment. (But their basis is increased by company debt.) And passiveloss rules prohibit owners from deducting passive business losses against nonpassive income, such as wages, interest, dividends and capital gains. However, disallowed passive losses may be carried forward to offset future passive income. Consider AMT impact Like individuals, businesses are subject to the alternative minimum tax (AMT), an alternative tax system that calculates tax liability differently. You must pay the AMT if your AMT liability is greater than your regular tax liability. You can deduct NOLs from your AMT income under similar rules as for regular income tax purposes. But, if you opt to forgo a carryback period for regular tax purposes, you’ve automatically done so for AMT purposes, too. Even though the NOL deduction cannot fully make up for losses due to the recession, or bad luck, it can lessen the pain and provide much-needed money for your business. Conversely, if you intend to use a carryback period for regular tax purposes, you must also use it for the AMT. Note that your AMT loss, and therefore the AMT NOL, may be different from the regular tax NOL. So you’ll need to carefully consider the impact of your NOL decision on your total tax liability. With loss, less is definitely more Even though the NOL deduction cannot fully make up for losses due to the recession, bad luck, or poor business decisions, it can lessen the pain and provide much-needed money for your business. To maximize your benefit, though, you’ll need to know the complex rules that govern this tax break. So be sure to check with us to make sure that you turn as much of your loss into gain as you can. n The Profit Statement About Reznick Group Reznick Group is a national leader in accounting, tax and business advisory services. We work in a broad spectrum of industries, including affordable housing, commercial real estate, emerging business and entrepreneurial enterprises, government agencies, nonprofit organizations, professional services, Real Estate Investment Trusts (REITs), renewable energy, and residential home builders. Ranked among the top 20 public accounting firms in the United States, Reznick Group employs approximately 1,450 people and maintains 10 offices nationwide. Founded in 1977, our headquarters are located in Bethesda, Md. Reznick Group is a Certified Public Accounting firm and a Professional Corporation. To learn more about Reznick Group’s services, seminars and conferences, or to view our insights on issues that may impact your industry, visit reznickgroup.com. 6 PLAN TO ATTEND Business professionals look to Reznick Group, a respected leader in the real estate and affordable housing industry, to provide timely information and updates on the latest trends and opportunities. Reznick Group conferences offer networking opportunities with industry veterans, presentations from thought leaders, and training sessions on industry fundamentals. The following Reznick Group conferences will be held in the coming months: Developer’s Conference August 18 – 19, 2009 Atlanta, GA Real Estate and Market Update II November 18 – 20, 2009 San Juan, PR Co-sponsored by Reznick Group, P.C., Nixon Peabody LLP and IPED For more information, visit reznickgroup.com. Atlanta n Austin n Baltimore n Bethesda n Birmingham n Charlotte Chicago n Los Angeles n Sacramento n Tysons Corner 7700 Old Georgetown Rd. 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