At the risk of losing half of you at the mere mention of accounting, I’m going to do it anyway. Accounting can be confusing, but wrapping your mind around a few key concepts can put you far ahead of your competition.

What is Accrual Accounting?

A lot of the confusion in formal accounting comes from the difference between accrual basis accounting and cash basis accounting. Cash basis accounting is what a ‘normal’ person would consider a rational method of tracking things. Accrual basis accounting is what the accountants use.

Under the accrual basis accounting, revenues are reported on the income statement when they are earned. Under the cash basis accounting, revenues are reported on the income statement when cash is received.

Same goes for expenses:

Accrual basis accounting matches expenses with the related revenues when the expense occurs.
And in cash accouting? You guessed it – expenses are booked when the cash is paid.

What Were They Thinking?

The reasoning behind accrual accounting is that it creates an a more realistic income statement (in terms of profitability) during a specific time period. Of course, cash is always KING, and you’ll die without it. But with the income statement we’re looking at a company’s ability to earn a profit.

Accrual Acconnting and the Income Statement

Accrual vs. cash accounting first hits the income statement. Here’s an example:

I start a cat sitting service in June and provide $1,000 of cat sitting services in June, but I don’t get paid until I bill in July. And let’s just say for argument I go on vacation in July and provide no services. There will be a difference in the income statements for June and July under the accrual and cash bases of accounting.

Under the accrual basis, my income statements will show $1,000 of revenues in June and $0 in July. Under the cash basis, it’s just the opposite because cash basis is concerned with when I receive funds, not when I perform services. My June income statement would show no revenues, and I’d have $1,000 in July.

Accrual Accounting and the Balance Sheet

The balance sheet is also affected. Under accrual basis, the June balance sheet will show accounts receivable of $1,000, but under cash basis the $1,000 of accounts receivable will not be reported as an asset until July. (Actually, under cash accounting you wouldn’t have accounts receivable. You either have the cash, or you don’t.)

To extend the example to expenses assume that I buy cat litter for my kitty sitter service business in bulk. Under accrual basis accounting, I would create an asset for the entire amount of litter when I purchase it and expense it out over time as I perform services. This matches the expense to the revenue. Under cash basis accounting, I would expense the entire amount of litter when I purchased it.

Which Method Should You Use?

It depends. The accrual method must be used to match revenues and expenses for financial statements prepared in accordance with Generally Accepted Accounting Principles (GAAP). However, most small businesses can choose whichever method suits their business (and record keeping!) needs best.

Image Credit: jekertgwapo, Flickr

First Wells Fargo, then Goldman. Now, Chase. All three are reporting healthy profits. Record sales. That kind of thing. Yet the economy isn’t picking up. What gives?

There’s something decidedly fishy about banks reporting record numbers after the government sucks off their toxic gunk. Not that the balance sheets aren’t real, they’re just…creative. Bloomberg’s Jonathan Weil describes how a combination of opaque bookkeeping and rapidly changing government regulations allowed Wells Fargo to report sky-high earnings earlier this month. I gather Wells’ case is akin to how Goldman and JP Morgan Chase explain their success:

1. Wells carried over a $7.5 billion loan-loss allowance from Wachovia’s balance sheet onto its own books. Once it took control of the reserve from Wachovia, Wells was free to start dipping into it to absorb new credit losses on all sorts of loans, including loans Wells had originated itself…this may help explain Wells’s surprisingly small loan losses. For the first quarter, Wells said net charge-offs were $3.3 billion, compared with $6.1 billion at Wells and Wachovia combined for the fourth quarter.

4. One week before Wells’s earnings news, the FASB caved to pressure by the banking industry and passed new rules that let companies ignore large, long-term losses on the debt securities they own when reporting net income. Wells didn’t say what its first-quarter earnings would have been without the rule change, which companies can apply to their latest quarterly results.

Read the entire article here.

Many U.S. taxpayers are eagerly anticipating a quick influx of cash from their states as they file income tax returns ahead of the April 15 deadline, but for some, the refund check may not be in the mail.

“We can’t send refunds out if we don’t have the money,” said Ted Farnen, a spokesman for the Missouri Department of Revenue.

Ouch.

Worried about the state of your 401K? We all are. But there’s no need to panic. Chances are, you don’t need to use all of your 401K savings at once. If you take the right steps, your 401K investments will have a chance to recover. Below are five simple steps to help you rescue your 401K:

If you are close to retirement:

1. Delay your retirement. If you’re close to retirement, see if you can put in a few more years of work. This is especially important if your employer matches your 401K contributions.

If you retire in a declining market, you’re withdrawing money from an ever-shrinking 401K coffer. Your previous (bull market) payout calculations won’t work anymore, meaning that you risk ending up with very little very late in life.

2. Recalibrate your 401K withdrawal plan. If you have no choice but to retire, recalibrate your monthly expenses so that you don’t withdraw a larger percentage of your total 401K savings. Live off less for a while, then adjust when the market goes back up.

Everyone should:

3. Keep contributing. It pays to rack up investments, even when the market is losing. When the market goes back up—historically, it always has—the investments you put in during hard times will work in your favor. If your employer matches your contributions, max them out. The tax deduction will also come in handy.

4. Don’t cash out. If the heavy tax penalties don’t make you think twice, the upcoming bull market—whether it takes two years or two months to arrive—will leave you empty-handed. Moreover, the funds are creditor-proof, and can’t be confiscated if you file bankruptcy.

5. Revise your portfolio. If you need the money soon, put is somewhere safe, like a money market fund. If you have a while until you retire, consider diverting your funds into traditional safe bets, like mutual funds or corporate stocks in stable industries. Consult your financial advisor for specific advice. Take an active role in diversifying and/or rebalancing your portfolio. It won’t adjust itself for hard times.

Bonus tip: IRAs can offer more flexibility and fewer fees than 401Ks, depending on your lifestyle needs. A Roth IRA, for example, allows you to take out contributions without taxes or penalties. Further research or financial advice will help you determine with 401K/IRA combination suits you best.

Credit concerns got you down? If you’re worried about your credit score, rest assured there are easy ways to improve it. Try these five tips to boost your credit score:

1. Use credit cards. No credit history is just as bad as a horrible credit history. If credit cards make you nervous, only use yours to pay off a monthly bill, or when you go out to eat. Manageable debt is better than not having a credit score at all.

2. Keep your balances small to nonexistent. Don’t max out your cards unless you can pay them back down quickly. Use half or less of the full balance on each card when you make purchases. Keeping balances near the maximum will negatively affect your credit score.

3. Avoid late payments. Serial late payments can trash your credit score. Pay down the minimum amount each month, if not more. (Note: Many credit card companies will wipe your first late payment off your records if you say it was an accident. After that, you’re on your own.)

4. Avoid acquiring too many credit cards. Not only does this complicate your debt life, but it reflects badly on your credit score. There’s no ideal number of credit cards, but try to keep it below six (including store cards).

5. Do not open more than one credit card at a time (this lowers your accounts’ average age), or close too many credit cards (resulting in less credit available). Both actions reflect poorly on your credit rating.

Honorable mention: Don’t declare bankruptcy–it will ruin your credit for up to a decade.

Michael Rozbruch is a leading expert on resolving individual and small business problems with the IRS. He says tax audits are on the rise and worse – as a small-business owner, you are among the largest source of uncollected taxes. That makes you a target. According to Rozbruch, the growing federal deficit, proposed government bailout plans, and a push to close the $345 billion tax gap are all leading to stepped up enforcement by tax collectors. In this interview, Mr. Rozbruch helps us all avoid the sting of the IRS agent’s vist.

BP:  Thanks for providing your insights, Mr. Rozbruch. Why does the IRS seem to pick on small businesses?

MR:  Business owners tend to be the biggest group of tax evaders, particularly during economic downturns. With small business audits on the rise, it is more important than ever to know what triggers an audit, how to avoid being audited and what to do if the IRS is after you.

BP:  And is it just the IRS we need to be concerned about?

MR:  No. Several states have already started putting more money and personnel into cracking down on tax cheats – large and small – to cut into their growing budget deficits. They have sent letters out to small businesses warning them of the consequences of not collecting or remitting state taxes.

BP:  How important are tax issues to a new business?

MR:  For anyone planning to start and/or grow your business, it is crucial to know how to avoid tax trouble. I know this because I am a business owner myself. Plus, 25% to 30% of my tax relief clients are small businesses with tax problems. I always tell people who are struggling to overcome their tax burdens that knowledge is power and the key to gaining a new lease on your financial life.

BP:  What could trigger an audit?

MR:  The number ONE red flag in triggering a tax audit is claiming false business expenses. Monies from your expenses’ payments must be used for legitimate business-related activities. However, many people end up in tax trouble when they used these monies for personal purposes and falsely characterize them as legitimate business expenses. This can be seen as a failure to report additional income on your tax return.

BP:  What’s one of the biggest mistakes you see small business owners make?

MR:  Generally, owing payroll taxes is the “kiss of death” for many small business owners, whether they operate their entities as a sole proprietorships, corporations (”C” or “S” – doesn’t matter) or LLCs. Many lose their businesses. When it comes to payroll tax debt, the IRS has unyielding power and authority to collect. They have the power to padlock your front doors, putting you out of business, without obtaining a court order. The penalties can add up to about 33% PLUS interest in just 16 days after you have filed the 941 (payroll Tax Return) past the due date and didn’t pay! You can imagine what the debt adds up to if you ignore this for a prolonged period of time.

BP:  So what can a small business do to avoid getting audited by the IRS?

MR:  There are several ways to stay safe.

• Hire a good bookkeeper. You should have a capable bookkeeper that knows double entry accounting. There should always be a debit and a corresponding credit, and they have to go to the right place. So in other words, if you record a sale, you have to debit accounts receivable and credit sales. When you get the cash in, you debit the cash and credit the receivables.
• Hire an expert CPA or EA to prepare your tax return. It’s a small annual investment that can pay off big! I wouldn’t recommend doing your own taxes unless you are a straight W-2 wage earner that takes the Standard Deductions (in other words, someone who doesn’t itemize or have any unreimbursed employee business expenses). Tax preparation tools like TurboTax and TaxCut are great, but people with anything more than a straight W-2 (including anyone with even the smallest business “Schedule C”) should be aware of the limitations of these software programs.
• File your tax return on time. Even if you don’t have the money to pay your tax bill, you can still file your return on time and save 25% on the failure to file penalty right off the bat. What many people don’t understand is that filing an extension just puts off the inevitable, because it’s not an extension of time to pay, it’s just an extension of time to file. So what we tell our clients is that no matter how much is owed, if they enclose a check for $5 or $10 with the return and file it on time, it will reduce their filing penalties. Additionally, it creates a computerized record of account at IRS showing that you sent in a payment with your income tax return (reflecting good faith and credibility on your part).

BP:  What if we do everything right and get audited anyway?

MR:  The best thing to do is get expert representation! Fighting the IRS on your own is a “lose/lose” proposition. You WILL get “creamed”. It’s like to going to court without a lawyer. If you are struggling to overcome your tax burdens, know that there’s a solution to every problem. But you have to be willing to do something about it — you can’t just stick your head in the sand and ignore the audit letters. Hire a Certified Tax Resolution Specialist to help you put together a tax relief action plan. An ethical and experienced tax resolution company can help you reduce your IRS debt by qualify for an offer in compromise settlement – where the IRS will accept a much smaller lump sum for the total dept that’s owed if you can prove that you do not have the future ability to pay the IRS off.

You heard the man, tell the truth, keep good records, and file on time!

Image Credit: swanksalot, Flickr

In the coming weeks, months and years, we will continue to see regulators make a variety of moves – both to deal with the current financial crisis and to prevent such disruptions in the future. In fact, regulators have already begun to and are likely to consider a wide range of issues including the industry’s operating model, Basel II capital and leverage requirements, liquidity management, stress testing, executive compensation, and the role of rating agencies.

However, even as regulators work out the details, there are things companies should be doing to address current challenges and to prepare for and withstand future market disruptions more effectively. Of course, while not every recommended activity applies to companies in every industry, the reality is that most, if not all, segments of the economy are being impacted by this crisis. Companies in all sectors should, at a minimum, be assessing their cash flow needs in light of the current credit markets and be revisiting their strategic and operating plans to determine what adjustments may be necessary to deal with existing conditions.

So what can companies do during this challenging economic time?

* Undertake a detailed review of the organization’s financial condition, with a focus on asset quality, liquidity, capital strength and financing alternatives

* Re-examine and challenge business and operating models in light of recent events and their expected impact on the future structure of the industry, its regulation and the wider economy.

* Understand and evaluate the options available under various government programs and private sector alternatives and determine the viability of such options.

* Review risk governance arrangements; scope and adequacy of risk identification, assessment and mitigation; and risk capabilities within the business and the boardroom.

* Introduce more extreme scenarios into stress testing of financial models, including resulting credit and market risk exposures, so that management and regulators understand where the breakeven points are on solvency, liquidity and capital adequacy, and also understand the key drivers or causes to those breakeven points.

* Undertake a review of the organization’s current risk management practices and opportunities for enhancing them based on the outlook of the operating environment over the next several years.

* Validate with the board of directors the risk/reward trade-off the organization has accepted and understand how it will be affected by different market scenarios.

* Take action to mitigate unacceptable financial risk.

* Review the structure of remuneration of directors and senior personnel in light of regulatory expectations, good practice indications and recommendations issued.

* Assess financing and capital adequacy and options for raising additional capital, if necessary.

* Explore strategic alternatives, including options for mergers, acquisitions and restructuring.

* Review strategic and operating plans and ensure they address all risks and incorporate the lessons learned (and that will continue to be learned) from the current crisis.

Taking the steps to really explore and test the many facets of your company will give you a better understanding of where your strengths and weakness lie and which of them may make you vulnerable to future market volatility. It’s a large undertaking, but one that’s well worth the time and labor expended. For more information about the global financial crisis, visit: http://www.protiviti.com/economiccrisis/

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Randy Marshall is a managing director and leader of the U.S. financial services practice at Protiviti Inc., a global business consulting and internal audit firm.

The future of financial transparency is XBRL, the international language for the electronic communication of business and financial data.  In development by an international non-profit consortium with the cooperation of approximately 450 corporations and government agencies, XBRL (eXtensible Business Reporting Language) is supposed to save money, increase efficiency, and improve the accuracy and reliability of financial data. So what is it?

What is XBRL?

XBRL is essentially digitized financial information. Instead of treating financial data as a block of text (as it appears in an annual financial statement) XBRL assigns identifying tags to each individual item of data. These tags are computer readable, which enables automated processing of the information. People who grew up with computers may find it shocking to learn that this is actually a relatively new development in the financial world. XBRL replaces hordes of interns and junior staffers plugging financials into databases.

Why is XBRL the Wave of the Future?

XBRL increases the speed of handling of financial data, and reduces the chance of human error. It helps companies by reducing the cost of collecting and reporting financial information. It helps consumers of financial data (investors, analysts, financial institutions and regulators) by making it easier to get compare and analyze financial data faster and more efficiently.

One of the best things about XBRL is that it can translate data in different languages and accounting standards. This will make it easier to compare apple sellers to apple sellers (and banks to banks) all over the world.

Will XBLR Replace the Financial Audit?

According to Federal Computer Week Labor Department CFO Sam Mok hopes so:

Currently, too much emphasis continues to be focused on audits as a means to monitor the quality of financial reporting. Audits are not really audits but ratification of financial reports.”

Joe Kull, a director at PricewaterhouseCoopers agrees:

“And they’re costly. We need to be able to better understand the flow of money” in real time to make better decisions” Kull added that while the federal government has made great strides in speeding up financial-reporting cycles, there are still too many restatements.

So soon we’ll have access to real time, super accurate data. The question is who will audit XBLR?

Political Points:
-Democrats mostly voted for it; most Republicans voted against it.
-Hank Paulson says that he’s working on hammering out details at this very moment so that the plan can be implemented ASAP.
-The New York Times reports that many lawmakers signed it because they were afraid of the economic “calamity” that would occur if they didn’t.

The Cost:
-The Senate, when it passed the plan on Wednesday, added renewable energy tax breaks and a new alternative minimum tax exemption of $46,200 for individuals and $69,950 for married couples in 2008. This package costs an additional $150.5 billion.
-The bailout plan starts with a disbursement of $250 billion to buy up banks’ bad assets. President Bush will have authority to sign over the next $100 billion. The final $350 billion will be released after the Treasury requests it. Congress has authority to block this final payment within 15 days.
-If the rescue plan loses money after a 5-year period, the next president has to come up with a way to get back those losses from the financial industry, via taxes, penalties, fees, etc.

Who Wins:
-Banks, who get their balance sheets wiped clean.
-Many old guard Wall Street executives, who remain exempt from government scrutiny.
-700 counties in 39 states who used to depend on federal timber sales to pay for rural services, such as schools (from the AP).
-Mental health patients, who now get health insurance benefits equal to those granted for other medical treatments.
-Disaster-stricken states, who get tax relief.
-Chevy fans, who get a $7,500 tax break for buying the Volt.
-Renewable energy companies, who benefit from tax incentives.
-Certain people with foreclosed homes, who will temporarily be exempt from federal income tax.
-Henry Paulson, Jr., assuming he’s really into power.

Who Loses:
-Whoever has to finance this monster. Taxpayers, barring the plan’s whopping success.
-The oil and gas industry, whose tax breaks are now more limited.
-New school Wall Street executives, who aren’t allowed to be paid nearly as much as their predecessors.
-Fans of the free market, who will find that the real estate and banking markets are now under constant watch.

Conclusion:
It’s a pork-lined executive power ticket for the people who manage federal money. Let’s hope it works.

The country’s onerous bailout bill heads to the Senate today, with added tax provisions. Here’s the tax portion’s evolution, according to the AP:

Last week: Senate passes first tax plan with a 93-2 vote. Provisions:
-Alternative minimum tax relief
-$8 billion tax relief for victims of natural disasters in Texas, Louisiana, and the Midwest.
-$78 billion towards renewable energy incentives and tax-break extensions.

After Republican feedback, the following was altered in the bill:
-No AMT relief
-No disaster provisions
-Revenue offsets for a portion of tax-break extensions and renewable energy incentives

The House saw the bill, and said the tax-break extension and renewable energy portions should be completely offset by the government.

The AP says that if the alternative minimum tax disappears, more than 20 million Americans will get tax relief.

The alternative minimum tax, first implemented in 1969, means extra paperwork, increased complications, double taxation if you live abroad, no state, local or foreign tax deductions, and generally a huge headache if you make between $150,000 and $415,000/year (I would define this as upper middle class). If it sticks around in its current form, its lack of indexation will force it into lower and lower income brackets. Lots of people won’t miss it.

Except for the government. Wikipedia quotes the Washington Post on this point:

By 2008, it would cost the Treasury considerably less to repeal the ordinary income tax system than the alternative minimum tax, according to the Tax Policy Center, jointly run by the Brookings Institution and Urban Institute.

The challenge is to tax higher earners proportionally to their income, without robbing them blind. If you’ve ever faced the dreaded AMT, you know that it makes tax time more confusing and troublesome than it needs to be, with potentially infuriating consequences if you don’t loophole it correctly.

There has to be another way.