Accounting Study Guide

An item of income or expense is included in the taxable year as determined by a taxpayer’s accounting method. The two primary accounting methods are the cash method and the accrual method. Under the cash method, income is included in the year it is either actually or constructively received and expense is recorded in the year it is paid. Under the accrual method, income and expense are included in the year when the right to the income or the liability for an expense becomes fixed, the amount can be determined with reasonable accuracy, and economic performance has occurred.

IRC Section 172

Accounting Period

Capital gain or loss is gain or loss derived from the sale or exchange of capital assets. It may be short term (held for 1 year or less) or long term (held for more than 1 year).

To determine how long a taxpayer has held the investment property, begin counting on the date after the day the property is acquired (trade date, not settlement date, for securities traded on an established market) and include the day the property is disposed. Put another way, a taxpayer cannot count both the acquisition and disposal dates.

Capitalization is the process of recording a cost as an asset and deferring its recognition as an expense to future periods. The asset can be either tangible (e.g., inventory or fixed assets), intangible (e.g., securities, organization, or rearrangement costs), or represent the right to receive services in the future (e.g., a prepaid expense, such as prepaid rent, insurance, subscriptions, or any service paid for in advance of receipt of the service). Assets are subject to an assessment of recoverability by the enterprise, such as the benefits to be derived and the periods benefited.

Accounting issues involve determination of the following:

• • The valuation of the asset, which usually equals the cash outlay at the market price of the asset acquired, plus costs to put the asset into productive use
  • The periods that will be benefited by the asset
  • The appropriate method of amortization of the deferred cost

Common law is the body of rules developed from custom, usage, and previous court decisions rather than from written legislation. It has been subsequently used as a basis for later court decisions (judge-made law or case law as opposed to legislated law).

Common law liability for accountants relies on the common law theory of negligence—the accountant is obligated to exercise the ordinary reasonable care, skill, and competence of other members of the profession (i.e., the generally accepted standards of the profession).

A contract is an agreement between two or more persons that establishes an enforceable legal relationship between the parties. The essential elements of a contract are:

• • an agreement (offer and acceptance),
  • consideration,
  • valid subject matter, and
  • legal capacity.

A void contract never had any legal status. A voidable contract is valid only until one party exercises a right to void the contract. An unenforceable contract is valid when made but is made unenforceable by some later event, such as the statute of limitations, discharge of the contract in bankruptcy, or involuntary destruction of the subject matter.

A control person is a person or party who possesses the power, actual or implied, to direct or control the direction of an entity’s management and policies of the entity. The identity of a control person is a question of the facts and circumstances. Factors to be considered include:

• • stock ownership (e.g., more than 5%),
  • actual or practical control (e.g., member of the board of directors),
  • officer or director, and
  • possession of the ability to control, whether or not exercised.

Standards and liabilities related to control persons are specified by the federal securities laws. (This term is used and defined in the federal securities laws. Similar terms include “insider,” “affiliate,” and “related party.” A control person is usually both an insider and a related party.)

Senior officers, directors, certain large shareholders, and family members who live in a control person’s house are also considered control persons. In addition, corporations, partnerships, estates, and trusts in which a control person has an interest, and estates and trusts for which a control person is executor, trustee, or a similar role are considered control persons.

A copyright is an exclusive right granted by law for a specific period of time to make and dispose of copies of a literary, artistic, or musical work. It is also an intangible asset that is identifiable and separable, may be purchased or developed internally, and has a legal life equal to the life of the author (or artist or composer) plus 70 years.

The useful life of an intangible asset is defined in FASB ASC 350-30-35-02 as “the period over which the asset is expected to contribute directly or indirectly to the future cash flows of that entity.” All relevant information should be considered when estimating the useful life of an intangible asset. FASB ASC 350-30-35-03 lists the following as specific items that should be considered:

1. 1. “The expected use of the asset by the entity.
   2. “The expected useful life of another asset or group of assets to which the useful life of the intangible asset may relate.
   3. “Any legal, regulatory, or contractual provisions that may limit the useful life. The cash flows and useful lives of intangible assets that are based on legal rights are constrained by the duration of those legal rights. Thus, the useful lives of such intangible assets cannot extend beyond the length of their legal rights and may be shorter.
   4. “The entity’s own historical experience in renewing or extending similar arrangements, consistent with the intended use of the asset by the entity, regardless of whether those arrangements have explicit renewal or extension provisions. In the absence of that experience, the entity shall consider the assumptions that market participants would use about renewal or extension consistent with the highest and best use of the asset by market participants, adjusted for entity-specific factors in this paragraph.
   5. “The effects of obsolescence, demand, competition, and other economic factors (such as the stability of the industry, known technological advances, legislative action that results in an uncertain or changing regulatory environment, and expected changes in distribution channels)
   6. “The level of maintenance expenditures required to obtain the expected future cash flows from the asset (for example, a material level of required maintenance in relation to the carrying amount of the asset may suggest a very limited useful life). As in determining the useful life of depreciable tangible assets, regular maintenance may be assumed but enhancements may not.”

An intangible asset with a finite useful life should be amortized over its useful life to the reporting entity. There is no arbitrary maximum amortization period. (The 40-year maximum amortization period previously prescribed by APB Opinion 17 was deleted by SFAS 142.) Although SFAS 142 (FASB ASC 350-30-35) may allow an amortization period longer than 40 years, many accountants and managers would question the value of a copyright after 40 years plus the impracticality of delaying the recovery of the investment far into the future. Forty years would still be an allowable period for recovery.

After 1997, individuals may establish Coverdell education savings accounts (ESAs, previously called education IRAs) and, subject to an adjusted gross income (AGI)-based phaseout, may make annual nondeductible cash contributions to the ESA for a designated beneficiary who is under the age of 18 or a special-needs beneficiary when the ESA is established. Contributions to these accounts accumulate earnings free of income tax, and distributions are tax-free up to the amount paid for qualified higher education expenses during that year. The proceeds from a Coverdell ESA may fund expenses of elementary, secondary (K–12), undergraduate, and graduate education.

Tax credits are amounts deducted from tentative tax to compute income tax payable. Available tax credits include the credit for the elderly or disabled, the credit for child and dependent care, the foreign tax credit, the general business credits, the earned income credit, the adoption credit, the child credit, and the lifetime learning credit. (One must be careful not to confuse this term with the recording process of a transaction in financial accounting, i.e., debits and credits).

Credits are significant in that they directly reduce the tax liability. Deductions decrease the taxable income.

A debtor is an entity who owes either money, goods, or services to another entity (creditor) that is due in the future. The debt may be payable on demand or at some fixed or determinable future date. The debt is often evidenced by a legal document but may arise from a stated or implied contract. The debt may bear interest if it extends over time.

The term “dependent” means:

• • a qualifying child or
  • a qualifying relative.

Special test for qualifying child of more than one person—A child can only be claimed as a dependent by one taxpayer. If a child is a qualifying child for more than one taxpayer, the taxpayers can apply a series of tie-breaker tests to determine which taxpayer will prevail. Subject to these tiebreaker rules, the taxpayers may be able to choose which of them claims the disputed child as their qualifying child. The tiebreaker rules are explained in IRS Publication 501.

Qualifying Child:

1. 1. Pass the relationship test:
      1. Child or descendant of a child
      2. Brother, sister, stepbrother, or stepsister
      3. Father, mother, or ancestor of either
      4. Stepfather or stepmother
      5. Niece or nephew
      6. Aunt or uncle
      7. Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister in law
      8. An individual who at no time during the year was the taxpayer’s spouse, who has the same principal place of abode as the taxpayer, and is a member of the taxpayer’s household
   2. Has the same principal place of abode as the taxpayer for more than one-half of the year
      1. has not attained the age of 19 as of the close of the year,
      2. is a student who has not attained the age of 24 as of the close of the year, or
      3. is permanently and totally disabled
   3. Meets the age requirement; is younger than the taxpayer and:
   4. Has not provided over one-half of their own support for the year
   5. Has not filed a joint return (other than to claim a refund) with their spouse

Qualifying Relative:

1. 1. Passes the relationship test of qualifying child
   2. Gross income is less than the exemption amount
   3. The taxpayer has provided over one-half of the individual’s support for the year.
   4. Is not a qualifying child of the taxpayer or any other taxpayer

IRC Section 152; IRS Publication 501

Depreciation is the process of systematic, rational allocation of the cost of operational assets to the accounting periods benefited. Depreciation is not a process of valuation (FASB ASC 360-10-35-4), does not represent a reserve to replace the asset, and does not mean that cash will be available to replace the asset. Depreciation allowed for tax purposes often differs from depreciation allowed for accounting.

Accounting depreciation attempts to match the cost of the asset to the revenues generated over the life of the asset. It represents accrual accounting and has no effect on cash flows (a noncash expense). Depreciation expense must be added back to accounting income when reconciling to cash from operations using the indirect method.

Computation of depreciation requires the following:

• • Acquisition cost
  • Estimated useful life
  • Estimated residual (salvage) value
  • Depreciation method (four GAAP alternatives):
    1. Straight-line
    2. Sum-of-the-years’-digits
    3. Double-declining balance
    4. Units of production—units of product and machine hours

Factors which cause the need for depreciation include the following:

• • Physical factors:
    • Wear and tear
    • Effects of time and other elements
    • Deterioration and decay
  • Functional factors:
    • Inadequacy of capacity
    • Obsolescence

In the macroeconomic sense, depreciation is the part of business earnings/gross profit that is considered the replacement of capital stock used or worn out during the period. It is not included in net profit and is not a factor payment. (It is not a claim on the value of output by a factor of production.) Depreciation represents replacement investment, the amount that must be reinvested to maintain the existing level of capital stock, and the amount by which capital contributes to current production. It is a component of GNP (approximately 10%) and is computed by the income approach to national income accounting. Depreciation is the difference between gross and net investment.

In the foreign exchange sense, depreciation is the decline in the value of one currency against or in relation to another, in the sense that it now takes more of a particular currency to buy a unit of a foreign currency. Devaluation is the official change in the value of a country’s currency.

Example: Country A has an inflation rate of 5% and Country B has an inflation rate of 10%. The goods of Country A become relatively cheaper because the relative prices have changed, thus:

• • increasing the demand in Country B for Country A’s goods,
  • increasing the demand for Country A’s currency (to be able to import Country A’s goods), and
  • decreasing the demand for (i.e., depreciating) Country B’s currency by approximately 5% (10%–5%).

Direct financial interest is ownership in the entity/client, i.e., common stock, preferred stock, or convertible debt. Direct financial interest is prohibited by the AICPA Conceptual Framework for Independence (ET 1.210.010): the independence of an accountant who holds a direct financial interest in a client or in a nonclient investee of a client is deemed to be impaired. There is no exception to this rule (e.g., even securities held in a blind trust are considered to be a direct financial interest). (ET 1.245.020)

Materiality is irrelevant; any direct financial interest, even one share, is considered to impair independence.

In general, to discriminate is to make a judgment sometimes on the basis of prejudice, specifically judgment for or against someone on the basis of race, sex, age, or religion, or general beliefs or attitudes.

With respect to discrimination under the Americans with Disabilities Act (ADA), the general rule is as follows: No covered entity shall discriminate against a qualified individual with a disability because of the disability of such individual in regard to job application procedures, the hiring, advancement, or discharge of employees, employee compensation, job training, and other terms, conditions and privileges of employment.

The following are included among the forms of discrimination explicitly proscribed by the ADA:

• • Limiting, segregating, or classifying a job applicant or employee in any way that adversely affects the opportunities or status of such applicant or employee because of the disability of such applicant or employee.
  • Participating in a contractual or other arrangement or relationship that has the effect of subjecting a covered entity’s qualified applicant or employee with a disability to the discrimination prohibited in the ADA. This includes a relationship with an employment or referral agency, labor union, an organization providing fringe benefits to an employee of the covered entity, or an organization providing training and apprenticeship programs.
  • Utilizing standards, criteria, or methods of administration that have the effect of discriminating on the basis of disability or that perpetuate the discrimination of others who are subject to common administration control.
  • Excluding or otherwise denying equal jobs or benefits to a qualified individual because of the known disability of an individual with whom the qualified individual is known to have a relationship or association.

Under the ADA, employers are legally allowed to discriminate on a number of grounds when hiring, promoting, or terminating employment. For example, a law firm hiring an associate lawyer is justified in requiring the individual to have a law degree and have passed the bar as prerequisites. However, under the ADA, there are several forms of discrimination that are expressly prohibited.

Documents of title are instruments (often negotiable) that represent ownership of goods and the contract with a warehouseman or common carrier (who, by giving the document, acknowledges receipt and possession of the goods). The holder of the document (drawn, issued, indorsed to him or to his order, or in blank or to bearer) is entitled to receive, hold, and dispose of the document and the goods it covers. For example:

• • Bill of lading—issued by a common carrier for the shipment of goods. (Note: A waybill or airbill is not necessarily a bill of lading; it may merely document the details of the shipment without representing a contract or document of title. It is usually a part of the bill of lading.)
  • Warehouse receipt—issued by a warehouse for the storage of goods.

Documents of title are made negotiable by meeting the five requisites of negotiability (SWUPS). Provisions for negotiation are the same as for commercial paper, are negotiable to facilitate and expedite commerce (i.e., to transfer ownership without physical transfer of the goods), and flow from ordinary course of business. A document is “payable” in goods rather than in money. It is an intangible personal property representing tangible goods and is governed by Articles 7 and 8 of the Uniform Commercial Code (U.C.C.).

Risk of loss transfers with/follows from the document. The holder in due negotiation (HDN) is similar to HDC.

• • The holder/bailor of the document of title has 100% title to both the document and the goods it represents.
  • The bailee (giver of the document, e.g., the warehouseman or common carrier) has possession of the goods but no title (i.e., ownership interest) in them.

Documents of title are transferred (negotiated) by due negotiation.

Contrast to commercial paper (payable in money) and security interests (intangible representing intangible asset).

For income tax purposes, an employee is to be distinguished from an independent contractor. This is important, for the withholding of income taxes on wages applies only to employees. Also, employee status will affect the manner and extent of some deductions and credits. The regulations state that an employee is one who is subject to the will and control of the employer not only as to what shall be done but also as to how it shall be done.

The Employee Retirement Income Security Act (ERISA) was enacted by Congress in 1974 to protect employees’ retirement benefits by setting forth rules for employer-provided retirement plans to make them equitable and secure.

Participation rules ensure that certain employee groups cannot be unfairly excluded—by age, income, hours worked, etc. Vesting rules set restrictions and minimum standards. Funding requirements provide a measure of financial safety for a plan and its participants. Tax-free rollover protection allows participants to transfer their vested retirement accounts to other qualified retirement plans. Minimum contributions, maximum benefits, termination insurance, fiduciary responsibilities, and other rules are also defined by ERISA for all qualified benefit plans.

After debating the issue of pension reform for more than seven years, Congress enacted ERISA in 1974. While ERISA did not require employers to establish employee pension plans, this law mandated rules for the management and reporting of those plans that are established (administered and enforced by the Department of Labor and the IRS). Provisions of ERISA are as follows:

• • Specify structure of plans
  • Establish minimum standards for participation, vesting, and funding
  • Impose rigorous standards of fiduciary conduct on plan managers
  • Expand reporting and disclosure requirements by requiring all employee benefit plans (EBPs) to issue annual financial statements
  • Create a program of plan termination insurance

ERISA is a very complex and comprehensive law. The complexity is caused by the breadth of its coverage and the confusion created by the overlapping jurisdiction of federal departments or agencies. Because ERISA amended both the Internal Revenue Code (IRC) and federal laws administered by the Department of Labor (DOL), there is a duplication of many provisions. The labor provisions of ERISA generally affect employee benefit plans maintained by employers engaged in interstate commerce. The tax provisions amended the requirements for qualification under the IRC and thereby extended ERISA’s coverage to plans sponsored by employers not engaged in interstate commerce.

An entity is any person or group of people that owns economic resources, incurs economic obligations, and enters into economic transactions. It is a particular unit of accountability. An economic unit is an entity that is considered to be separate and distinct from its owners or the providers of resources. An entity may or may not be a legal entity.

An entity may have profit-making as its primary objective (an enterprise or business enterprise such as a sole proprietorship, partnership, corporation, consolidated entity, or joint venture) or it may not (an individual, family, trust, estate, nonbusiness organization such as a not-for-profit hospital, voluntary health and welfare organization, other not-for-profit entity, or governmental unit).

Errors may involve the following:

• • Mistakes in gathering or processing accounting data
  • Incorrect accounting estimates arising from oversight or misinterpretation of facts
  • Mistakes in the application of accounting principles relating to amount, classification, manner of presentation, or disclosure (compare to fraud)

The primary factor that distinguishes errors from fraud is whether the underlying cause of the misstatement in the financial statements is intentional. Intent is often difficult to determine and must involve the auditor’s professional judgment and professional skepticism.

The independent auditor has the responsibility to design the audit to provide reasonable assurance of detecting errors and fraud that are material to the financial statements.

An assessment of the likelihood of errors and fraud is an element of the auditor’s assessment of audit risk in the planning stage.

In statistics, the error refers to the difference of one observation in a sample from the unobservable, theoretical value that would be derived from the entire population. Statistics assumes that the errors from individual observations are uniformly dispersed from the theoretical value.

Estate taxes are excise taxes levied on the transfer of a person’s property on that person’s death. There are federal estate taxes and state estate taxes. The amount of the federal estate tax is determined by applying the relevant tax rates to the taxable estate.

Most property in the estate is valued at fair market value for computing the estate tax.

The estate tax is computed by finding the gross estate and taking deductions from gross estate to find the taxable estate. The resulting tax liability can be further reduced by credits.

Individuals, corporations, estates, and trusts must make payments of estimated taxes in order to avoid a penalty for underpayment of estimated taxes. Most often, self-employed people need to pay quarterly installments of estimated tax. Similarly, investors, retirees, and others—a substantial portion of whose income is not subject to withholding—often need to make these payments as well. Besides self-employment income, other income generally not subject to withholding includes interest, dividends, capital gains, alimony, and rental income.

Because the U.S. tax system operates on a pay-as-you-go basis, taxpayers are required, by law, to pay most of their tax liability during the year. This means that an estimated tax penalty will normally apply to anyone who pays too little tax, usually less than 90%, during the year through withholding, estimated tax payments, or a combination of the two.

Exceptions to the penalty and special rules apply to some groups of taxpayers, such as farmers, fishermen, casualty and disaster victims, those who recently became disabled, recent retirees, and those who receive income unevenly during the year. In addition, there is an exception to the penalty for those who base their payments of estimated tax on last year’s tax. Generally, taxpayers will not have an estimated tax penalty if they make payments equal to the lesser of 90% of the tax to be shown on their current-year return or 100% of the tax shown on their prior-year return (110% if their income was more than $150,000). See IRS Form 2210 and its instructions for more information.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants at the measurement date.

The Federal Unemployment Tax Act (FUTA) is federal legislation that:

• • provides temporary economic security for workers who lose their jobs by being laid off (quitting is not covered immediately) and who meet minimum requirements,
  • is a form of insurance,
  • is organized and administered by all states at federal instigation, and
  • is financed by employer contributions. This is paid by the employer only. It applies to the first $7,000 of earned income per employee, per year.

FUTA’s purpose is to compensate unemployed workers for the period of time that is needed to find a new job. The fund accumulates in periods of economic prosperity and is depleted in periods of economic recession, and is designed to act as a stabilizer of consumer consumption by supporting consumption during recessions.

Each state administers the program within its borders. The state programs are structured to follow the unemployment program described in FUTA.

FUTA stands for the Federal Unemployment Tax Act, while SUTA stands for state unemployment tax acts (a generic term used to apply to the provisions of the unemployment tax acts of the various states). For more information on this issue, see IRS Publication 15, (Circular E), Employer’s Tax Guide.

The Financial Accounting Standards Board (FASB) is an independent authoritative body, created in 1973 to replace the AICPA Accounting Principles Board, and authorized by the AICPA Code of Professional Conduct as a promulgator of generally accepted accounting principles (GAAP). The FASB’s main purpose is to establish accounting and reporting standards for large, publicly-owned corporations whose shares of stock are traded and registered in the United States.

Financial statements are the principal means of communicating financial information to those users external to the entity. They are a formal tabulation of names and amounts of items derived from the accounting records by simplifying, condensing, and aggregating. The financial statements are a fundamentally related set of tabulations that articulate with each other and derive from the same underlying data. SFAC 5.5

The full set of financial statements for an accounting period should show the following:

• • Financial position at the end of the period (balance sheet)
  • Earnings (loss) for the period (income statement)
  • Comprehensive income or loss for the period (income statement)
  • Cash flows during the period (statement of cash flows)
  • Investments by and distributions to owners during the period (statement of changes in owners’ equity and the statement of retained earnings)

Financial statements are representations of the assertions of management. The fairness of their presentation in accordance with accounting standards generally accepted in the United States of America or an applicable financial reporting framework is management’s responsibility. Their accuracy is essential to reporting accurate accounting information within a specific period and to illustrate the company’s financial health.

Audited financial statements are statements that have been subjected to an examination by a CPA according to the generally accepted auditing standards (GAAS) (i.e., the accountant has applied auditing procedures to the statements sufficient to permit the issuance of a report on them). Unaudited financial statements have not been the subject of such an examination. An accountant can still be “associated” with unaudited financial statements, however, if the accountant has prepared, assisted in preparing (compiling), or reviewed them.

In summation, this statement shows business owners, company’s management, and internal and external stakeholders’ financing activities in an accounting period, operating expenses, company’s assets, investing activities, gross profit, and provides a general portrait of an organization’s financial condition and bottom line.

These basic financial statements provide a snapshot of a period of time for a company, whether it be a large scale organization or a small business, and  insight into a company’s financial position in a specific period.

Fraud is the intentional misrepresentation or failure to disclose a material fact or facts that results in injury or loss to someone relying on it.

Elements necessary to prove fraud include the following:

• • A material (significant) misrepresentation or omission of fact
  • Knowledge of the falsity (scienter)
  • Intent that the misrepresentation be relied on
  • Actual reliance by another party
  • Resultant damage suffered as a result of reliance

Research shows that there are usually three conditions present when fraud occurs:

1. 1. A situational pressure (a nonshareable financial need)
   2. A perceived opportunity to commit and conceal the dishonest act (viewed as a way to secretly resolve the nonshareable pressure)
   3. Some aspect of the individual’s personal integrity that allows him to rationalize his dishonest behavior

Fraud in the inducement is false representation or failure to disclose of a material fact knowingly made or omitted, justifiably relied upon in the making of the contract, and resulting in injury. It is antecedent fraud that occurs during the negotiation, precedes the making of the contract, and induced the other party to enter into the contract, and may be in the form of an act, an omission, a concealment, or a nondisclosure. A contract signed under fraud in the inducement is voidable at the option of the defrauded party. It is less serious than fraud in the execution and applies to common law and commercial paper only. (It does not apply to securities fraud.)

A full-time student is an individual who is enrolled at and attends an educational institution during each of five calendar months of the taxable year of the taxpayer for the number of course hours which is considered to be a full-time course of study. The enrollment for five calendar months need not be consecutive. School attendance at night does not constitute a full-time course of study; however, a full-time course of study may include some attendance at night. Full-time status is determined by the number of hours at each particular college or university that is considered a full-time class load.

Regulation Section 1.151-3(b)

A general partner is a party who is publicly known and who actively engages in the management of the business and participates to the fullest extent in the profits and losses of the partnership. A general partner has apparent and actual authority to bind the partnership and has joint and several liabilities. A general partner has unlimited liability for partnership debts.

Generally accepted accounting principles (GAAP) are basic accounting principles and standards and specific conventions, rules, and regulations that define accepted accounting practice at a particular time by incorporation of consensus and substantial authoritative support.

The Financial Accounting Standards Board (FASB) Accounting Standards Codification (Codification) is the source of authoritative generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. In addition to the SEC’s rules and interpretive releases, the SEC staff issues Staff Accounting Bulletins that represent practices followed by the staff in administering SEC disclosure requirements, and it utilizes SEC Staff Announcements and Observer comments made at Emerging Issues Task Force (EITF) meetings to publicly announce its views on certain accounting issues for SEC registrants. (FASB ASC 105-10-05-1)

Accounting and financial reporting practices not included in the Codification are nonauthoritative. Sources of nonauthoritative accounting guidance and literature include, for example, the following:

• • Practices that are widely recognized and prevalent either generally or in the industry
  • FASB Concepts Statements
  • American Institute of Certified Public Accountants (AICPA) Issues Papers
  • International Financial Reporting Standards (IFRS) of the International Accounting Standards Board
  • Pronouncements of professional associations or regulatory agencies
  • Technical Information Service Inquiries and Replies included in AICPA Technical Practice Aids
  • Accounting textbooks, handbooks, and articles

The appropriateness of other sources of accounting guidance depends on its relevance to particular circumstances, the specificity of the guidance, the general recognition of the issuer or author as an authority, and the extent of its use in practice. (FASB ASC 105-10-05-3)

The Government Accounting Standards Board (GASB) is the body authorized to promulgate standards of financial accounting and reporting for governmental units. It was created by the Financial Accounting Foundation (FAF) in 1984 as successor to NCGA and is recognized by the AICPA Code of Professional Conduct as an authorized body whose pronouncements must be followed in order to conform to the Compliance with Standards Rule and Accounting Principles Rule (ET 1.310.001 and 1.320.001).

The GASB’s authority derives from Appendix A of the AICPA Code of Professional Conduct.

The GASB is an independent authoritative body created in 1984, under the oversight of FASB and the Governmental Advisory Council of the Financial Accounting Foundation (FAF) and is authorized by the AICPA Code of Professional Conduct as a promulgator of generally accepted accounting principles (GAAP).

Gross income is all revenues from whatever source derived minus certain exclusions, which are specifically provided by law. It includes both earned income (salary, wages, tips, professional fees, business or farm income, and other compensations received for personal services performed) and unearned income (interest, dividends, rents, royalties, capital gains, unemployment, and some Social Security benefits).

Some sources of income are not included in gross income, such as welfare, Veterans Administration (VA) disability, workers’ compensation, insurance benefits, damages for injury or illness, child support, gifts, inheritance, life insurance proceeds received because of a person’s death, and some scholarships.

IRC Section 61

Guaranteed payments are payments made by a partnership to a partner for services rendered or for the use of capital, to the extent that such payments are determined without regard to the income of the partnership. Such payments are treated as though they were made to a nonpartner and are either deductible or capitalized by the partnership depending upon the nature of the transfer. This treatment is for purposes of determining gross income and deductible business expenses only. For other tax purposes, guaranteed payments are treated as a partner’s distributive share of ordinary income. Guaranteed payments are not subject to tax withholding as are payments to partnership employees.

The payments are generally deductible by the partnership on IRS Form 1065 as a business expense. They are included in Schedules K and K-1 of the partnership return and are reported by the individual partner on Form 1040, Schedule E, as ordinary income, in addition to the appropriate distributive share of the other ordinary income from the partnership.

Guaranteed payments made to partners for organizing the partnership or syndicating interests in the partnership are capital expenditures and are generally not deductible by the partnership. However, these payments generally must be included in the partners’ Schedule K-1 as guaranteed payments.

A partner includes the guaranteed payments in income in the partner’s tax year in which the partnership’s tax year ends.

Sometimes guaranteed payments can come in the form of “guaranteed minimums.” This payment is the amount that the minimum payment exceeds the partner’s distributive share of taxable income of the partnership before taking into account the minimum payment.

Head of household is a special filing status between married filing jointly and single. Head of household is the filing status of a taxpayer who is unmarried or considered unmarried on the last day of the tax year, who is not a surviving spouse, who maintains a home (i.e., provides over 50% of the cost of keeping up a home), and who had a qualifying person live in his or her home for more than half the year (not including temporary absences like school). A taxpayer can determine whether someone is considered a qualifying person for purposes of the Head of Household filing status by using Table 2-1 in IRS Publication 17, Your Federal Income Tax for Individuals.

Exception: A dependent parent need not live with the taxpayer as long as the taxpayer maintains the household that the parent lives in (provides over 50% of the support for the household).

A holder is a party that has possession of a negotiable instrument that is drawn, issued, or indorsed to that party or was issued to bearer or indorsed in blank. The holder has the right to transfer (negotiate) the instrument, to discharge it, or to take payment. Both personal and real defenses are good against a holder. (Personal defenses are not good against a holder in due course.)

A holder has the right to (1) seek payment, (2) seek redress from secondary parties if the instrument is not paid (dishonored), or (3) negotiate the instrument to someone else (as payee or indorser).

The holder in due course (HDC) is the party who (1) holds (is a holder of) an instrument and takes the instrument (2) for value, (3) in good faith (according to the subjective test) and (4) without notice (knowledge) of any claim, dishonor, or defense against it (U.C.C. 3-302):

HDC = H + V + GF(s) + w/o N (c,d,d)

(The subjective test for good faith is “pure heart, empty head,” i.e., did the particular person asserting HDC status take the instrument honestly and without notice? The objective test would ask would a reasonable person have known?)

HDC rights are greater than those of the transferor.

Rights of HDC: HDC takes the instrument free from all title claims to it by any party and free from all personal defenses; only real defenses are good against HDC (e.g., instrument is void due to incapacity, illegality of subject, duress, etc.; is voidable due to infancy, fraud in the execution; unauthorized signatures; fictitious payees and wrongdoing agents; material alteration; discharge in bankruptcy). (U.C.C. 3-305)

Only HDC is entitled to the distinct benefits of negotiability. Following are the steps to attain the status of holder in due course:

• • The instrument must be negotiable.
  • The party asserting the rights must be a holder, i.e., he must take by negotiation.
  • The holder must satisfy the requirements for holding in due course.
  • Any defense asserted must be a personal defense (as contrasted with a real defense) (i.e., HDC is immune to personal defense).

Requirements for holding in due course:

• • Must be a holder, i.e., the payee or a transferee who takes via negotiation of a negotiable instrument
  • Must take the instrument for value (U.C.C. 3-303):
    • by paying or performing the agreed consideration (Note: an executory promise does not qualify as value unless it is irrevocable, i.e., contractual.)
    • by acquiring a security interest
    • by taking the instrument in payment of, or as security for, an antecedent debt
    • by giving one’s own negotiable instrument in exchange
    • by giving an irrevocable commitment to a third person
    • by withdrawing the value of the instrument from the bank account (e.g., “cashing in” a certificate of deposit)
  • Must take the instrument in good faith (honestly) and without notice (knowledge) that the instrument is overdue, has been dishonored, or that any party has a defense against or claim on it.

A holding period is the period of time property has been owned for income tax purposes. The holding period determines if gain or loss from the sale or exchange of a capital asset is long term or short term. Generally, when the basis of the asset carries over in a tax-deferred transaction, the holding period of the transferee tacks onto the holding period for the transferor. All assets that are received from an estate are long-term assets in the hands of the beneficiary regardless of the actual time of ownership.

Implied warranty is one of the three types of warranties (implied, express, and warranty of title) provided by the U.C.C. (Uniform Commercial Code) on the sale of goods. It is a guarantee that rests so clearly on a common factual situation or set of conditions that it is automatically imposed on the goods by operation of law without any agreement or consent of the parties. It can be excluded or modified only by specified procedures.

Types of implied warranties:

• • Merchantability—Goods shall be fit for the purpose for which they are sold; applies only to merchants who deal in the type of goods being sold. To be merchantable, goods must:
    • pass without objection in the trade under the contract description.
    • be of fair average quality as described (applies to fungible goods only).
    • be fit for the ordinary purpose for which such goods are used.
    • be within the variation of an even kind, quality, and quantity within each unit and among all units.
    • be adequately contained, packaged, and labeled as required by the agreement.
    • conform to the promises or affirmations of fact made on the container or label (if any).
  • Fitness for a Particular Purpose is imposed on the seller if:
    • the seller has actual or constructive knowledge of the particular purpose for which the buyer needs the goods.
    • the seller must furnish or select the goods.
    • the buyer must rely on the seller’s skill or judgment to select or furnish the goods.

Can be disclaimed if in writing and conspicuous; must mention “merchantability”; terms such as “as is” or “with all faults” act as an exclusion; can be excluded by course of dealing, course of performance, or usage of the trade.

The U.C.C. has reduced or eliminated the requirement of privity.

Contrast warranty to common law negligence and strict liability.

Interest must be imputed or charged on debt obligations issued where no interest is provided for or if the rate of interest is less than the interest rate that would be reasonable to charge the debtor under the circumstances; that is, a market interest rate. If the face amount of the note does not represent the present value of the exchange, then interest is imputed. These debt obligations include:

• • noninterest bearing notes or
  • notes with unrealistic low interest rates.

Income tax is a federal, state, or local tax based on income (domestic or foreign).

To be independent is to be free from conflicts of interest and bias, self-governing, impartial, not subject to control by others, not requiring or relying on something else, not contingent, and acting with integrity and objectivity (i.e., with judgment that is unimpaired and without bias or prejudice).

Independence Rule (ET 1.200.001): “A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council.” (ET 1.200.001.01)

Independence is the cornerstone on which the audit, or attest, function of the accounting profession is based. It is the independence of the auditor that assures the public of the fair presentation of the audited financial statements. The audit opinion is the “Independent Auditor’s Report” (AU-C 600.A98 requires that the word “independent” appear in the title of the report).

The auditor’s independence recognizes the need for fairness—fairness to the owners and managers of the company and also to creditors and those who may rely wholly or in part on the auditor’s report.

Independence is the ability to act with integrity and objectivity and not to compromise one’s judgment or conceal or modify an honest opinion. Auditors (both external and internal) must be capable of acting in an honest, unbiased fashion, maintaining the ability to use judgment free from influence by or subordination to the will, opinion, and judgment of others.

The CPA must be independent not only in fact but also in appearance. This means both that a true conflict must not exist (the fact of independence) and that the appearance, or impression, of conflict must not exist (the appearance of independence). Hence, there must not be a compromise to the perception of the independence of the CPA in the mind of a reasonable observer, no matter how innocent the questionable circumstances may truly be. Any appearance of the lack of independence would erode the public’s confidence in the profession as quickly as the fact of a lack of independence.

The “reasonable person” concept is applicable, i.e., whether or not a reasonable person, having all the facts and the normal strength of character, concludes that a specific relationship is lacking in independence, represents a conflict of interest, or is a threat to a CPA’s integrity or objectivity.

The indorsee (or endorsee) is the party to whom/which indorsement is made on a negotiable instrument. The indorsee becomes the payee on the instrument. (The spelling beginning with an “i” instead of an “e” is the common legal spelling.)

In-kind distributions are goods or services that are received as a result of performing or exchanging work. For instance, if Joe Smith works for the Amalgamated Widget Factory and is paid in widgets rather than cash, this constitutes an in-kind distribution. The amount received from this type of transaction is includible in income at the fair market value of the goods received. This is often referred to as “bartering.”

In the general equity sense (financial accounting), insolvency is a financial condition whereby an entity is unable to meet its obligations as they become due. It may be simply a cash flow problem (e.g., insufficient funds to cover checks). This is a more general definition than that used in voluntary bankruptcy. It is used in cases of involuntary petitioning under Chapter 7. It is simpler, less demanding, and more easily proven than insolvency in the bankruptcy sense.

In bankruptcy, insolvent is the financial condition in which debts exceed the fair value of nonexempt assets. It is the definition used in the Bankruptcy Act in all cases except involuntary petitioning under Chapter 7. Insolvent is a stricter, more demanding definition than in the equity sense.

The installment method is a method of accounting enabling a taxpayer to spread the recognition of gain on the sale of property over the payment period. Under this procedure, the seller computes the gross profit percentage from the sale (i.e., the gain divided by the contract price) and applies it to each payment received to arrive at the gain to be recognized.

Insurance is a contract under which, for a stipulated consideration (premium), one party (the insurer) will indemnify (compensate) the other party to the contract (the insured) or a third-party beneficiary for loss from specified causes.

Among other possible uses, insurance:

• • is a method of spreading risk among a large group;
  • covers loss of property interest due to fire, theft, etc. and from the negligence of the insured and the torts of employees of the insured (e.g., arson); and
  • compensates for loss of earning power (accidental injury, health, disability, business interruption, unemployment, retirement, and life insurance) and for liability for loss to a third party caused by the insured (auto, personal injury, and property damage).

Intangible assets are nonphysical and nonfinancial assets (lacking physical substance) whose value derives from the rights that their ownership confers (e.g., goodwill). The evidence of existence of an intangible asset is elusive, value is often difficult to estimate, and useful life is often indeterminable. It may confer operating, financial, or other income-producing benefits; is recorded at cost (acquisition cost if purchased, cost to develop, maintain, and defend if generated internally); and is amortized in a systematic and rational way (straight-line) over the periods that are estimated to benefit (except goodwill, which is evaluated periodically for impairment).

Classification is based on several characteristics:

• • Identifiability: separately identifiable or lacking separate identification (only goodwill is unidentifiable)
  • Manner of acquisition: purchased or developed internally
  • Expected period of benefit: limited by law or contract, related to human or economic factors, or of indefinite or indeterminate duration
  • Separability from entire enterprise: rights transferable without title, salable, or inseparable from the enterprise

Assets usually included in this term are the long-lived intangible assets usually acquired as operational assets, patents (legal life = 17 years), copyrights (legal life = author’s life plus 70 years; accounting life = 40 years), trademarks, franchise rights, and goodwill.

Internally generated intangible assets (e.g., patents) are capitalized according to FASB ASC 730-10-05. Development costs are expensed, and only costs associated with registration, maintenance, and legal defense are capitalizable (e.g., legal fees, registration fees, costs of models and drawings, and costs of successful court defenses).

For tax purposes, acquired intangible assets that are defined as IRC Section 197 intangibles can be amortized over 15 years.

The U.S. recognizes four kinds of intellectual property protection:

1. 1. Patents
   2. Trademarks
   3. Copyrights
   4. Trade secrets

Patents give owners exclusive rights for 17 years from the date of patent to manufacture, use and sell the patented product within the United States.

Trademarks (e.g., marks, logos, insignias) associated with a company’s goods can be registered and thereby protected in the United States from duplication by another company for 10 years. Unlike patents, trademark registrations can be renewed.

Copyrights grant an author (or holder of a copyright) the exclusive right to publication of written or artistic work. Such publication rights can be granted to other parties at the discretion of the copyright holder.

Trade secrets are those processes (tools, plans, methods of operation, etc.) that are closely held by a given company to provide a business advantage. The regulation of trade secret rights in the United States is within the jurisdiction of state rather than federal laws.

Intellectual property right protection varies greatly by country. International companies are therefore advised to thoroughly research intellectual property rights and enforcement standards prior to conducting business in a foreign country.

Internal controls are the policies and procedures established by management to provide reasonable assurance that its objectives will be achieved. These policies and procedures are categorized several ways:

• • Accounting controls
  • Administrative controls (management controls)
    • Formal policies and directives such as board of director’s resolutions, office manuals, and written instructions
    • Informal policies and procedures such as oral directions from a supervisor
    • Implicit policies and procedures such as unwritten and unspoken operating habits and standards

Intraperiod tax allocation is apportionment of the income tax expense for the current accounting period (as determined by application of the liability method to achieve interperiod tax allocation) among the components of the income statement: operating income, income from discontinued operations, accounting changes, prior-period adjustments, and other direct adjustments to capital accounts. Intraperiod tax allocation affects only the reporting, not the recording, of income tax expense. The tax effect is reported along with the particular item which gives rise to the effect.

FASB ASC 740-20-05-1

The aggregate of items of tangible personal property owned by the business (to which the firm has legal title) intended either for internal consumption in the production of goods for sale or for sale is considered inventory. The balance of costs applicable to goods on hand, including raw materials (for use in the production process), intermediate products and parts still in the production process (work-in-process), and finished goods is also considered inventory.

The major objective of accounting for inventories is to facilitate the determination of income. This is achieved through the proper valuation of inventories—the measurement of the value of the current assets and inventories, and the measurement of the related expense and cost of goods sold.

The basis of inventory accounting is cost. Inventories are valued at acquisition or production cost, which is generally held to be the sum of the purchase price plus indirect acquisition costs (freight, insurance, and handling) for purchased goods and the sum of direct materials, direct labor, and allocated factory overhead (i.e., the appropriate general and administrative costs that are clearly related to production) for manufactured goods. Selling, general, and administrative costs not directly related to production should be expensed rather than included in the valuation of inventory, which involves the use of judgment.

Standard costs may be used for inventory pricing so long as they are adjusted at reasonable intervals to reflect current conditions.

Valuation (pricing) of inventories involves:

• • determination of physical quantity (number of units) and
  • unit cost (in dollars).

Unit cost depends on the choice from among various alternative pricing (cost flow) assumptions:

• • last-in, first-out (LIFO),
  • first-in, first-out (FIFO),
  • weighted average, and
  • specific identification.

Consideration must also be given to the cost principle (i.e., the lower-of-cost-or-market rule (LCM)).

Inventories must be compiled periodically (physical count) and valued and compared to the amounts recorded in the accounts. Accounting records can be maintained under a periodic or perpetual system.

FASB ASC 330-10

IRC Section 1244 stock is corporate stock (either common or preferred) that qualifies under IRC Section 1244. If an individual taxpayer generates a loss by sale, exchange, or the stock becoming worthless, such loss can be treated as an ordinary loss rather than a capital loss. Section 1244 stock is also known as small business stock.

To qualify as small business stock, the stock must be issued by a domestic C corporation that was a small business corporation that invests 80% of its assets in the active conduct of a trade or business and that had assets of $50 million or less when the stock was issued. The stock must have been issued for money or property. To remain qualified as Section 1244 stock, the corporation must generate more than 50% of its gross receipts from nonpassive sources during the 5 years ending before the date the stock sustains its loss.

IRC Section 1245 assets are assets, primarily consisting of equipment used in a trade or business, and some specified real property, subject to the provisions of Section 1245 of the tax law. Section 1245 denies the long-term capital gains treatment accorded to noncapital assets by Section 1231 because the gain is considered to be a recovery of some or all of the depreciation of ACRS-MACRS allowances (i.e., accelerated depreciation) that were previously deducted. Any gain on Section 1245 property will be treated as ordinary income to the extent of all depreciation or ACRS or MACRS deductions taken previously. Any gain that is not recaptured as ordinary income is treated as Section 1231 gain.

Section 1245 assets include tangible and intangible personal property, including equipment used in trade and business and all ACRS or MACRS property other than real property for which a straight-line recovery election was made, and many types of real property.

IRC Section 179 is a provision of the tax law that allows the taxpayer to elect to expense up to a certain amount of tangible depreciable personal property placed in service during the year.

The basis of the asset(s) is reduced by the amount of the IRC Section 179 property expensed. The amount expensed cannot exceed the taxpayer’s aggregate taxable income from trade or business activities.

The maximum amount that can be deducted for most Section 179 property placed in service in tax years beginning in 2018 is $1,000,000. This limit is reduced by the amount by which the cost of Section 179 property placed in service during the tax year exceeds $2,500,000. For property placed in service in tax years beginning after December 31, 2017, Section 179 qualified real property is qualified improvement property (as defined in IRC Section 168(e)(6)), and certain specified improvements to nonresidential real property placed in service after the nonresidential real property was first placed in service. Computers and related peripheral equipment placed in service after December 31, 2017, in tax years ending after December 31, 2017, are not listed property.

An IRC Section 444 election is an election by some business types—partnerships, personal service corporations, S corporations, and electing S corporations—to have a taxable year that ends on a date other than the organization’s required tax year. This election is made on IRS Form 8716, Election to Have a Tax Year Other than a Required Tax Year.

Partnerships and S corporations making a Section 444 election must make required tax payments for the amount they would have owed had they used the required tax year, if these payments exceed $500. Personal service corporations making a Section 444 election must make minimum distributions to employee-owners by the end of a calendar year falling within a tax year in order to avoid certain deduction deferrals for amounts paid to employee-owners.

Generally, a partnership’s required tax year is the tax year of its owners, unless it can establish a business purpose for having a different tax year. An S corporation or personal service corporation must generally use the calendar year unless they can establish a business purpose for having a different tax year.

According to IRS Publication 538, a partnership, S corporation, or personal service corporation can make a Section 444 election if it meets all of the following requirements:

• • It is not a member of a tiered structure (as defined in Regulation Section 1.444-2T).
  • It has not previously had a Section 444 election in effect.
  • It elects a tax year that meets the deferral period requirement.

Itemized deductions are deductions from adjusted gross income (AGI) that must be listed separately (on Schedule A of IRS Form 1040) and must meet certain specified limitations, usually a percentage of AGI that must be exceeded before an amount is allowable. They are an alternative to the standard deduction and are not necessarily dollar-for-dollar deductions.

For tax years beginning in 2018, the major categories of itemized deductions are as follows:

• • Medical expenses
  • Taxes (specified types of taxes, never federal income tax)
  • Interest expense (primarily mortgage)
  • Charitable contributions (within limits)

“Joint and several” is a legal phrase used in definitions of liability, meaning that an obligation (to pay or to perform) may be enforced against all liable parties jointly or against any one of them separately.

Joint tenancy is concurrent or multiple ownership of real property, created when equal interests to the same property are conveyed to two or more persons in an instrument expressly stating the joint tenancy (a will can create a joint tenancy). Joint tenancy requires four unities: time (all tenants take their interest at the same time), title (all tenants take their interest from the same source, such as a deed or will), interest (every tenant has an identical interest in the property), and possession (every tenant owns the undivided whole and does not own a fractional interest). Joint tenancy conveys the right of survivorship.

LIFO is a cost flow assumption that matches the latest (most recent) costs to current sales revenues. It is based on the assumption that the newest units with the most current acquisition costs are sold first and thus current costs are used to determine cost of goods sold. As a result, the units left in ending inventory are the oldest units. LIFO requires identification of inventory layers at different unit costs and can be used with either the periodic or perpetual inventory system, with slightly different results. It matches current costs against current revenue—as costs are rising, reported income will be lower than under FIFO or average cost. It recognizes the flow of costs versus the usual physical flow of units (cash outflow is recognized in the reverse order as cash inflows). The criticism of this method is that it produces an inventory value that is not at current cost.

If LIFO is used for income tax purposes, it must also be used for reporting purposes. A change from LIFO to any other cost flow method is considered a special change in accounting principle that is given retroactive treatment.

LIFO is not recognized for IFRS (International Financial Reporting Standards).

Liabilities are probable future sacrifices of economic benefits arising from present obligations of the entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. (SFAC 6.35–.42 and .192–.211)

Essential characteristics, all three of which must be present, are as follows:

1. 1. A present duty or responsibility to one or more other entities entails settlement by probable future transfer or use of assets at a specified determinable date, on occurrence of a specified event, or on demand.
   2. The duty or responsibility obligates the entity, leaving it little or no discretion to avoid the future sacrifice.
   3. The transaction or event obligating the entity has already occurred.

Most liabilities stem from human inventions—financial instruments, contracts, laws—that are commonly embodied in legal obligations and rights with no existence apart from them. Liabilities permit delay—delay in payment, delay in delivery, etc.

Liabilities are changed both by the entity’s transactions and activities and by events that happen to it.

“Valuation accounts,” which increase or decrease the carrying value of assets, are part of the related asset and are not liabilities, or assets, in their own right.

In governmental accounting: Liabilities are defined as present obligations to sacrifice resources that the government has little or no discretion to avoid. (GASB Concepts Statement 4.17)

A lien is a creditor’s legal right to have a debtor’s specified property as security for a debt and to take possession of the property, following prescribed legal procedures if the debt is not paid. Property taxes become a lien under statute against the property that is being taxed.

An artisan’s lien is a common-law security device whereby a creditor can recover for work done on personal property of the debtor. If the debtor fails to pay for the work performed, the creditor can retain possession of the property and sell it in satisfaction of the lien. (This is a “possessory” lien.)

A mechanic’s lien arises from the making of improvements to real property. This is a statutory lien controlled by state law whereby the lienholder (creditor) generally is required to file a written notice of the lien within a specific time period.

A mortgage lien is a lien securing a note payable that has as collateral real assets.

“Limited liability” is said of an individual who cannot be held legally responsible for the debts or other liabilities of another party. This is usually said of corporate shareholders. Corporate shareholders are liable only to the extent of their investment in the corporation; they are not liable either for the debts of the corporation or the acts of the officers, directors, or employees of the corporation. Limited partners also have limited liability.

A limited partnership is a partnership created by statute (not common law) consisting of at least one general partner and one or more special or limited partners. It is regulated by the Uniform Limited Partnership Act (ULPA) in most states. In most states the limited partnership must be registered with the state in order to operate and sell limited partnership interests in the state.

A liquidating distribution is a return of capital received because of a partial or complete liquidation (going out of business) of a corporation. The basis of the stock on which liquidating distributions are paid is reduced by the amount of the distributions. Any amount received in excess of basis in the stock is a taxable capital gain. In a liquidation that results in cancellation of the stock, a capital loss can be claimed in the year the final distribution is received if total distributions are less than the taxpayer’s basis. Reporting liquidating distributions is done on Schedule D of IRS Form 1040.

Liquidating dividends are distributions to shareholders from other contributed capital accounts rather than retained earnings. A liquidating dividend represents a return of the shareholders’ investment, rather than a return on the investment.

A long-term contract is a contract for the construction of a specific project over an extended period of time (more than one accounting period), such as ships, airplanes, bridges, roads, and buildings. Accounting issues include revenue/profit recognition and valuation of construction-in-process. There are two alternative GAAP methods available: completed-contract and percentage-of-completion.

FASB ASC 605-35-05-5

Management advisory services (MAS) are a consulting function of providing advice and technical assistance to help the client improve the use of capabilities and resources to achieve its objectives.

Accountants on MAS engagements need not maintain independence but must comply with ET 1.300.001 regarding professional competence, due professional care, planning and supervision, and sufficient relevant data.

MAS engagements are subject to AICPA Statements on Standards for Management Advisory Services (SSMAS).

Example: Financial instruments considered to be marketable securities include preferred or common stock, government or corporate bonds, certificates of deposit, Treasury bills, and commercial paper.

Restricted stock is not considered marketable.

Material indirect financial interest is involvement, other than direct ownership (i.e., ownership of common or preferred stock or convertible debt), that exceeds 5% of the member’s net worth. Independence is deemed to be impaired. The concept of materiality is relevant to the consideration of indirect financial interests. A “member” is considered to include the member, his firm, and family members.

Immaterial indirect financial interests are allowed, e.g., ownership of mutual fund shares that hold investments in the entity and limited business transactions with the entity-client. Examples of limited business transactions include having a checking account at the client financial institution that is fully insured by a state or federal government deposit insurance agency. There is no exception to this rule. (ET 1.200.001 and 1.240.010)

Examples of indirect financial interest include the following:

• • Member is a trustee of any trust or executor or administrator of any estate that has or is committed to acquire any direct or material indirect financial interest in the entity/client
  • Member has any joint, closely held business investment with the entity or with any officer, director, or principal stockholder thereof
  • Member holds stock in a bank that holds loans to the client
  • Ownership of shares of a mutual fund that hold shares of the client
  • Member has lessor relationship with the client. (ET 1.260.040)
  • Litigation between the member and the client
  • Member is owed fees by the client

ET 1.240.010

Information is material if omitting it or misstating it could influence decisions that users make on the basis of the financial information of a specific reporting entity. In other words, materiality is an entity-specific aspect of relevance based on the nature or magnitude or both of the items to which the information relates in the context of an individual entity’s financial report. Consequently, the FASB cannot specify a uniform quantitative threshold for materiality or predetermine what could be material in a particular situation.

SFAC 8.3, QC11

Materiality judgments are concerned with thresholds.

Example: You would ask the following questions:

• • Is an item of information, an omission, misstatement, or error large enough, considering its nature and the attendant circumstances, that it is probable that the judgment of a reasonable person relying on the information would have been changed or influenced?
  • Is the item important enough to matter?

The relative, rather than absolute, size of the item determines whether or not it is material in a given situation. The auditor’s consideration of materiality is affected by the interaction of quantitative and qualitative factors.

The concept of materiality is pervasive. It is related to the relevance and faithful representation of information and is critical to audit judgments regarding audit risk and disclosure.

Ownership of an interest in an entity or business organization, whether as a shareholder, partner, limited liability company (LLC) member, or otherwise, contains a membership right, separate and distinct from the economic right attached to such interest. The membership right entitles the holder to participate in management, to vote, and to inspect the books and records of the entity. Generally, a transfer of the membership rights entitles the transferee or assignee to become a “substituted” owner, which may trigger consent requirements for the transfer in entities such as partnerships and LLCs.

The modified accelerated cost recovery system (MACRS) is a depreciation method specified in the tax law applied to assets acquired after 1986. MACRS replaced ACRS (accelerated cost recovery system) and prescribes asset lives and rates of depreciation for classes of assets.

Under MACRS, the cost of business tangible property is recovered over a 3-, 5-, 7-, or 10-year period. The cost of this property is recovered by means of 200% declining balance with a switchover to the straight-line method to provide the maximum depreciation deduction and also uses the half-year convention. Farmers are required to use 150% declining balance. The cost of business real property is recovered over a 27.5- or 39-year period by means of the straight-line method and also uses the half-month convention.

National Association of State Boards of Accountancy – NASBA serves as a forum for the nation’s 55 State Boards of Accountancy, which administer the Uniform CPA Examination, license more than 750,000 Certified Public Accountants and regulate the practice of public accountancy in the United States.

Negligence is the failure to exercise the ordinary reasonable care required under the circumstances. In a civil tort, no knowledge of error or falsity or reckless disregard need be proven (ordinary or simple negligence as distinguished from gross negligence).

When applied to accountants, negligence involves the following:

• • Failure to follow GAAP/GAAS
  • Failure to do what duty requires to be done (e.g., failure to investigate further missing or suspicious data)
  • Disregard of warnings or suspicious comments, behavior, or documents

Negotiable means freely transferable for value by indorsement or delivery from one party to another. It is the legal right of the transferor to transfer better rights than he or she has (i.e., the subsequent holder acquires greater rights because he or she takes free of most defenses; the critical concept of the law of commercial paper).

U.C.C. 3-104(1) and 112

N = SWUPPPS: The five requisites of negotiability (if any requisite is lacking, the instrument is nonnegotiable) are:

1. 1. must be signed (S) by the maker or drawer (the signature can be a stamp that is intended as a signature),
   2. must appear on the face (“within the four corners”) of the writing (W) (the instrument); adding “Pay to the order of X” to the reverse side does not cure the defect (if these words are lacking on the face),
   3. must contain an unconditional (U) promise or order to pay (P) a sum certain (S) in money (and no other promise, order, power, or obligation is given by the maker or drawer),
   4. must be payable (P) on demand or at a definite time, and
   5. must be “payable (P) to order of or to bearer” (these are the magic words of negotiability; must be present as shown: “Pay X” or “Pay to X” does not meet this requirement and does not convey negotiability).

Commercial paper contains no other promise except the payment of money. Instruments that are payable in goods (e.g., bill of lading) can also be negotiable if they meet the listed requisites.

Once a writing is negotiable, it is always negotiable. An indorsement can limit (qualify or restrict) the transferability of the instrument but cannot eliminate it.

A negotiation is a subsequent transfer of an instrument in such a way (by proper means) that the transferee becomes the holder. It can be achieved in two ways:

1. 1. By delivery alone (for bearer paper)
   2. By indorsement and delivery (order paper)—the party to whose order the instrument is payable must “sign” the back of the instrument.

U.C.C. 3-202

The transferee who takes a negotiable instrument by negotiation becomes a holder, and provisions of Article 3 of the Uniform Commercial Code (U.C.C.) govern. The transferee who takes a non-negotiable instrument or who takes a negotiable instrument (order paper) without proper indorsement takes by assignment and is an assignee, not a holder, and contract law governs.

Net investment income is investment income minus deductible investment expenses (other than investment interest).

IRC Section 163(d)(4)

Noncompliance with laws and regulations by a client describes violations of laws or governmental regulations perpetrated by the entity or by the management or employees acting on behalf of the entity. Noncompliance by clients does not include personal misconduct by entity personnel unrelated to business activities.

Determination as to whether a particular act is noncompliant is usually beyond the auditor’s professional competence and is generally based on the advice of counsel.

Auditors consider noncompliance with laws and regulations from the perspective of the relation to or effect of the noncompliance on the audit objectives rather than from a per se legal perspective. The auditor is most likely to be familiar with and to detect noncompliance with laws and regulations that has a direct and material effect on the determination of financial statement amounts (e.g., manipulation of tax laws or regulations regarding revenue accrued under government contracts).

The responsibility of the auditor to detect and report noncompliance is the same as for errors and fraud—the independent auditor has the responsibility to design the audit to provide reasonable assurance of detecting noncompliance by the client that is material to the financial statements.

When the auditor concludes, based on information obtained and, if necessary, on consultation with legal counsel, that noncompliance with laws and regulations has or is likely to have occurred, the auditor should consider the effect on the financial statements as well as the implications for other aspects of the audit.

Examples of noncompliance with laws and regulations include lapping and kiting of checks between bank accounts.

In the context of external auditing, objectivity is remaining impartial in judgments in order to get more quality information. To be objective is to be intellectually honest and free of conflicts of interest. Objectivity is the ability to maintain an impartial attitude in both fact and appearance based on one’s actions and relationships.

The quality of objectivity is required of all CPAs, not just those in public practice. It is a state of mind that is essential to the maintenance of the public’s trust:

“A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services.” (ET 0.300.050.01)

“In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.” (ET 1.100.001.01)

The Occupational Safety and Health Act (OSHA) legislation created the Occupational Safety and Health Administration (also OSHA), which develops standards for job health and safety designed to protect employees from occupational injury or illness. OSHA is an example of social regulation.

Primary criticism of OSHA is the use of the “feasibility standard” (workers should be protected from injury or illness “to the extent feasible,”), meaning if it is technologically and economically possible, without regard to the cost-benefit standard.

Officers are the highest-ranking employees in a corporation, such as the chief executive officer (CEO), chief financial officer (CFO), and chief operating officer (COO).

An order is a direction to pay (as related to commercial paper) that is more than an authorization or request, addressed to one or more parties (drawee) identifiable with reasonable certainty. It must be unconditional. Contrast to promise.

U.C.C. 3-102

An order for relief (or automatic stay) is a court order that freezes all litigation and collection efforts on the part of the creditors or any other party against the debtor. It is the essence of bankruptcy laws, to allow for the reorganization or liquidation of the debtor and equal treatment of all creditors.

Parol evidence is a legal rule of contract interpretation that states that extrinsic (oral or written) evidence (i.e., outside the contract) is not admissible to add to, alter, or vary the terms of a written contract. All preliminary negotiation should have been merged into the writing.

Despite the parol evidence rule, oral evidence may be admitted as proof:

• • of fraud, misrepresentation, duress, undue influence, lack of consideration, or illegality of the subject matter (constitutes proof, which destroys the contract).
  • of an oral condition precedent to the written contract: proof that the parties agreed orally to a condition that had to be fulfilled before the contract became effective.
  • to explain an ambiguity or omission: evidence cannot contradict the terms of the contract but can explain them.
  • of a subsequent modification (oral or written) made to the contract. (Oral modification is acceptable if it is supported by consideration and does not violate the statute of frauds.)

A partner is an individual, estate, trust, corporation, or other entity that owns a capital or profits interest in a partnership. A partner’s taxable income for a tax year includes his distributive share of certain partnership items for the partnership’s tax year ending with or within the partner’s tax year. A partner must report his distributive share of partnership items on his tax return whether or not it is actually distributed. These items are furnished to the partner on Schedule K-1 (IRS Form 1065). See the instructions for Form 1065 for more information. A partner is not considered an employee.

To determine the allowable amount of any deduction or exclusion that is limited, a partner must combine any separate deductions or exclusions on his or her income tax return with the distributive share of partnership deductions or exclusions before applying the limit.

In general, a partner cannot deduct partnership expenses paid out of his or her personal funds unless required to do so by the partnership agreement. These expenses are usually considered incurred in and deductible by the partnership. If a partner is required by the partnership agreement to pay, out of his or her personal funds, an employee who performs part of the partner’s duties, the partner can deduct that payment as a business expense.

Partners must treat partnership items on their individual tax returns as they are treated on the partnership return. If a partner treats an item differently on his or her individual return, the IRS can automatically assess and collect any tax and penalties that result from adjusting the item to make it consistent with the partnership return. However, this does not apply if a partner who is not part of an existing large partnership files IRS Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request, with his or her return identifying the different treatment.

A partner’s basis in a partnership interest is commonly referred to as the “outside basis.” The adjusted basis of a partner’s partnership interest is ordinarily figured at the end of a partnership’s tax year. However, if there has been a sale or exchange of all or part of the partner’s interest, or a liquidation of his or her entire interest in a partnership, the adjusted basis is figured on the date of the sale, exchange, or liquidation.

A partner’s original basis is increased by:

• • additional contributions to the partnership,
  • an increased share or assumption of partnership debt,
  • the partner’s distributive share of both taxable and nontaxable partnership income, and
  • the partner’s distributive share of the excess of the deductions for depletion over the basis of the depletable property, unless the property is oil or gas wells whose basis has been allocated to the partners.

The original basis is decreased (but never below zero) by:

• • the amount of money and the adjusted basis of property distributed to the partner by the partnership,
  • the partner’s distributive share of the partnership losses (including capital losses),
  • the partner’s distributive share of nondeductible partnership expenses that are not capital expenditures,
  • the amount of the partner’s deduction for depletion for any partnership oil and gas wells, up to the proportionate share of the adjusted basis of the wells allocated to the partner, and
  • the partner’s share of any Section 179 expenses, even if the partner cannot deduct the entire amount on his or her individual income tax return.

A partner’s interest in a partnership is generally a profits interest or a capital interest. A profits interest only entitles the partner to share in the income or loss from the partnership each year. A capital interest allows the partner to exercise a claim against the assets of the partnership in the event of a liquidation. A partner can acquire an interest in partnership capital or profits as compensation for services performed or to be performed.

The fair market value of a capital interest must generally be included in the partner’s gross income in the first tax year in which the partner’s interest can be transferred or is not subject to a substantial risk of forfeiture.

A partner’s interest (capital) in the partnership is often confused with a partner’s basis in the partnership. These two concepts are not the same. The adjusted basis of a partner’s interest is determined without considering any amount shown in the partnership books as a capital, equity, or similar account.

Example: Enzo contributes property that has an adjusted basis of $400 and a value of $1,000 to the partnership. His partner contributes $1,000 cash. While under the partnership agreement each has a capital account in the partnership of $1,000, which will be reflected in the partnership books, the adjusted basis of Enzo’s interest is only $400 and the adjusted basis of his partner’s interest (capital in this case) is $1,000.

A partnership is an association of two or more persons to carry on as co-owners of a business for profit. Partnerships are governed in the various states of the United States by the Uniform Partnership Act (UPA). A partnership may be general, limited, or joint venture.

Characteristics of a partnership include the following:

• • Voluntary association of persons as individuals (the partnership has no separate legal identity under common law, but under the UPA it is now an entity for most purposes)
  • Simple agreement without governmental sanction
  • A fiduciary relationship (mutual agency—each partner is an agent for the others and for the partnership)
  • Co-ownership
  • Mutual agency of partners
  • Joint and several liability

A partnership does not pay income tax. It is a pass-through entity, so profits and losses of the partnership pass through to its partners. A partnership does file an informational tax return using IRS Form 1065, U.S. Return of Partnership Income.

For taxable years after 1986, the Tax Reform Act of 1986 divided all income and losses into three categories: passive, active, and portfolio. Active and passive income and losses both relate to a trade or business. These two types of income differ in the following ways.

If a taxpayer materially participates in a trade or business on a regular, continuous, and substantial basis, the income or loss resulting is active. To be considered materially participating in an activity, a taxpayer generally must qualify under one of seven tests provided by the IRS.

If the taxpayer does not materially participate in trade or business, the income or loss resulting is passive. All rental activities are generally considered passive activities, whether or not the taxpayer materially participates in the activity, although there are exceptions for certain real estate rental activities.

The passive loss rules limit the amount of losses from passive activities that can reduce income from nonpassive (active and portfolio) sources. Generally, losses from passive activities in excess of passive income may not reduce nonpassive income. Passive losses that cannot offset other types of income are suspended losses and must be carried forward.

“Payable at a definite time” is terminology of commercial paper: payable on or before a stated date, or at a fixed period after a stated date, or at a fixed period after sight, or at a definite time subject to acceleration (allowing the payee to demand full payment immediately) or extension (allowing the payment date to be at some later specified time). (U.C.C. 3-109)

The instrument is not payable at a definite time if it is payable only upon the occurrence of an act or event that is uncertain as to the time of occurrence (e.g., upon the death of an individual or upon consummation of a sale).

Perfection is an additional act (after attachment) that may be required to make a security interest effective against third parties. It is a security interest that cannot be defeated in insolvency proceedings or in general by other creditors. The requirements of perfection depend on (1) the nature of the collateral, (2) the use of the collateral, and (3) the relationship between the debtor and the secured party.

There are three methods of perfection, each used under different circumstances:

1. 1. Perfection by Attachment Alone—A purchase-money security interest (PMSI) in consumer goods is perfected by attachment alone, with no further steps necessary. The goods must be other than fixtures or a motor vehicle (car, boat, or airplane). It is good against the debtor, against creditors of the debtor, and against the trustee in bankruptcy. It is not good against a bona fide purchaser for value of the collateral from the debtor. (Filing would be required.)
   2. Perfection by Possession—(from common law, preserved by the Uniform Commercial Code (U.C.C.)) filing is not required if the creditor has possession of the collateral; always used when financial instruments (stocks, bonds, chattel paper, other documents) are used as collateral. (The creditor must take possession of negotiable instruments because if the instrument is negotiated the holder in due course would prevail over the secured creditor!) Possession of goods also perfects the security interest in the goods; however, possession impairs the use of the goods by the debtor and is usually not practical.
   3. Perfection by Filing a Financing Statement—giving public notice to third parties of the creditor’s security interest in the collateral by written notice (financing statement) filed in public records. Filing must be in accordance with state law; filing is ineffective if improper or filed in the wrong place. Filing is effective for five years.

U.C.C. 9-302

A personal service corporation (PSC) is a corporation that has as its principal business the performance of personal services that are substantially performed by employee-owners. (IRC Section 269A(b)(1))

Personal services means services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, and consulting.

There are several tax implications if a corporation is considered a personal service corporation, including the following:

• • Restrictions on tax years available (IRC Section 441(i))
  • Taxed at a flat 21% rate (IRC Section 11(b)(2))

It is interesting to note that the definition of a personal service corporation is different for these two purposes:

1. 1. For the flat 21% tax rate, a corporation is a PSC if “substantially all” of the activities of the corporation are performing personal services and the corporate stock is owned by employees who perform these services. “Substantially all” means 95% of the employees’ time. (IRC Section 448(d)(2))
   2. For restrictions on the taxable year allowed, a corporation is a PSC if the “principal activity” is personal services and they are “substantially” performed by owner-employees. Personal services are considered the “principal activity” if more than 50% of the total employee compensation is for these activities. They are “substantially” performed by owner-employees if related compensation is at least 20% of total employee compensation. (IRC Section 441(i)(2); Regulation Section 1.441-3)

Power of attorney is a legal instrument that authorizes one party to act for (as the agent of) another. It is a form of express agency. Under such an instrument, the principal cannot delegate to another (the agent) that which the principal is not legally permitted to do. (The principal may delegate that which the principal is not physically able to do, such as in the case of a principal who is a handicapped individual.)

To have someone else represent the taxpayer before the IRS in connection with a federal tax matter, the taxpayer can file IRS Form 2848, Power of Attorney and Declaration of Representative, with the IRS office where the taxpayer is appearing.

Preferred stock is ownership interest (class of stock) that carries preferences or specified priorities when compared to common stock; it is usually nonvoting and senior to common stock in dividend and liquidation preference and participation rights (to specified limits). It has characteristics of both debt and equity and may have other features, such as convertibility to other securities, call features, and redemption. Preferred stock is a “security.”

While preferred stockholders generally must be paid before common stockholders, preferred stockholders are paid after creditors.

Dividend preference is usually expressed as a percentage of the par value of the preferred stock but may also be expressed as a specific dollar amount per share. Preference may be cumulative or noncumulative, as well as participating, nonparticipating, or partially participating (where it is participating along with common stock in the receipt of dividends in excess of the stated preferred dividend).

The Public Company Accounting Oversight Board (PCAOB) was established by Congress to oversee public company audits. Congress formed the group to protect the interests of investors and further the public interest in the preparation of audit reports. The PCAOB also oversees the audits of broker-dealers.

Qualified business income (QBI) is best thought of as the ordinary, non-investment income of the business; in other words, the revenue the business was designed to generate through operations, less the applicable expenses. Interest or dividend income and capital gains from the sale of property are therefore not included in QBI. Also excluded from QBI are the salary or wages paid to the taxpayer either as W-2 wages from an S corporation or guaranteed payments from a partnership.

A qualified small business is a small trade or business other than one involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business in which the principal asset of the trade or business is the reputation or skill of one or more of its employees.

A qualified small business is a C corporation that generally cannot own real property exceeding a value of 10% of its total assets or portfolio stock or securities exceeding in value 10% of the total assets over liabilities.

During substantially all of the taxpayer’s holding period of the stock, at least 80% by value of the corporation’s gross assets (including intangible assets) must be used by the corporation in the active conduct of one or more qualified trades or businesses.

The following corporations are not qualified small businesses:

• • A domestic international sales corporation (DISC) or former DISC
  • A corporation with respect to which an election under IRC Section 939 is in effect
  • A regulated investment company
  • A real estate investment trust
  • A real estate mortgage investment conduit
  • A cooperative

The qualified trade or business term excludes any banking, insurance, leasing, financing, investing, or similar business, any farming business (including the business of raising or harvesting trees), and business involving the production or extraction of products of a character for which percentage depletion is allowable, or any business of operating a hotel, motel, restaurant, or similar business.

As of the date of the issuance of its stock, the corporation’s aggregate gross assets cannot exceed $50 million valued at the amount of cash and the aggregate adjusted basis of the other property held by the corporation.

Noncorporate investors are allowed to exclude 50% of the gain on the sale of qualified small business stock held more than five years. The balance of the gain is taxed at 28% for an effective rate of 14%.

IRC Section 1202

The Lifetime Learning credit is available for qualified tuition and fees required for the enrollment or attendance at an eligible institution. Charges and fees associated with meals, lodging, student activities, athletics, insurance, transportation, and similar personal, living, or family expenses are not included. It is not available for the purchase of books.

Expenses of education involving sports, games, or hobbies are not qualified tuition expenses unless this education is part of the student’s degree program.

A corporation issuing IRC Section 1244 stock must qualify as a domestic small business corporation, which generally means that it must be a domestic corporation and that its aggregate capital must not exceed $1 million at the time the stock is issued to its shareholders.

The corporation must also satisfy a gross receipts test as an active business. This test requires that the corporation, during the period of its five most recent years ending before the date the loss on its stock was sustained, derive more than 50% of its gross receipts from sources other than passive investment income.

The benefits of IRC Section 1244 are only available to individuals who acquire the stock by issuance from a domestic small business corporation, and are not available to a subsequent transferee of the stock.

A recourse debt is any liability to the extent that any person, or related person, has an economic risk of loss for that liability.

In a partnership, a partner’s share of a recourse debt equals that partner’s share of the economic risk of loss. A limited partner generally has no obligation to contribute additional capital to the partnership and, therefore, does not have an economic risk of loss in partnership liabilities and has no recourse debt in the partnership.

A partner’s basis in a partnership includes a partnership recourse debt only if, and to the extent that, the debt:

• • creates or increases the partnership’s basis in any of its assets,
  • gives rise to a current deduction to the partnership, or
  • is a nondeductible partnership expense that is not a capital expenditure.

The term “assets” includes capitalized items allocable to future periods, such as organizational expenses. The adjusted basis of a partner’s interest in a partnership does not include accrued but unpaid expenses or accounts payable from a cash basis partnership.

If a partner’s share of partnership liabilities increases, or a partner’s individual liabilities increase because the partner assumes partnership recourse debt, this increase is treated as a contribution of money by the partner to the partnership. If a partner’s share of partnership liabilities decreases, or a partner’s individual liabilities decrease because the partnership assumes the partner’s individual liabilities, this decrease is treated as a distribution of money to the partner by the partnership.

By definition, the alternative minimum tax (AMT) is an extra tax imposed in addition to the regular tax liability. The regular tax for this purpose is the regular tax liability (as defined in IRC Section 26(b)) reduced by only the foreign tax credit. It does not include investment tax credit recapture.

IRC Section 55(c)

The regular tax liability is computed without regard to the AMT, the environmental tax, corporate penalty taxes including the accumulated earnings tax, the personal holding company tax, the built-in gain tax on S corporations, and the tax imposed on the passive income of S corporations.

IRC Sections 55, 59A, 532, 541, 1374, and 1375

In government accounting, reimbursement is an interfund transaction which repays one fund (Fund 1) for expenditures (or expenses) initially recorded in that fund but properly attributable to another fund (Fund 2). Reimbursement is not an interfund transfer. Reimbursements should not be displayed in the financial statements. The transaction increases expenditures (or expenses) in the reimbursing (paying) fund (Fund 2) and decreases expenditures (or expenses) in the reimbursed (receiving) fund (Fund 1).

GASB 1800.102

Related Parties (RIC)