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The assessment of the effectiveness of internal control over financial reporting is integrated into the audit of the financial statements. The purpose of assessing internal control is to provide assurance of the reliability of the financial statements by third parties. The auditor must have knowledge of a company’s internal control system, which includes documenting separation of duties in the authorization and recording of transactions as well as the separation of duties involving those having custody of assets from those making the entries onto the books. Internal control involves the use of processes that must be monitored in order to assess the quality of the control environment as well as an assessment of a firm’s overall business practices.

The Sarbanes-Oxley Act of 2002 [SOX] greatly strengthened the the regulation of audits of public companies and addressed issues such as corporate governance, auditor independence and internal controls. As a result of SOX, the Public Company Accounting Oversight Board [PCAOB] was created, which regulates auditors of public companies. The PCAOB issued Auditing Standard No. 5 in 2007, which sets forth standards of the audit of internal controls.

In assessing internal control, an auditor of a small company may take into consideration the scale of the risk of misstatement and the internal controls in addressing risk. Commonly-used risk assessment models include materiality judgments based upon a percentage of revenues and/or assets, however, not all internal control reviews rely upon quantitative methods. Other risk areas such as the type of information technology system that is in place may enter into the decision as to whether the internal control environment provides for reliability. This is often referred to as the top-down approach, in which Section 404 of SOX allows an auditor to judge the effectiveness of a company’s internal control system in a manner that is more cost-effective and relies more on management for establishing and maintaining an adequate internal control structure.

The auditor may rely on prior-year’s assessment of internal control, however, this is not a substitute for proper planning. The auditor must be familiar with the industry in which the company operates, its organization, legal or regulatory matters as well as the complexity of the company’s operations. The work of internal auditors or third parties under management’s control may be used in order to evaluate the work the auditor might otherwise perform.

By selecting samples of transactions, the flow of transactions can be documented and the potential for misstatements can be assessed. However, this does not rule out making direct inquiries of company personnel in order to detect possible weaknesses. Other factors affecting the reliability of the system of internal control include the frequency of errors, the competency of personnel, occurrences of fraud whether material or not on the part of management, and whether there is internal oversight.

There are a great number of things that can go wrong in a company, all of which cannot be documented. However, Sarbanes Oxley focuses on the integration of the audit of internal controls with the audit of the financial statements, the purpose of which is the process of monitoring the internal control environment, assessing the IT system, determining risk assessments and other internal control activities that are key elements of auditing internal control. Prior to SOX, the Committee of Sponsoring Organizations, or COSO, was formed in 1985 by an independent private-sector study group that analyzed the factors that lead to fraudulent financial reporting. COSO defines internal control as a means to an end, not an end in itself. It recognizes internal control as affecting an entire organization encompassing the board of directors as well as management and other personnel. The purpose of internal control was set forth as a process whereby the financial reporting of a company can be relied upon and is in compliance with applicable laws and regulations.

The scope of the assessment of internal controls is almost certain to continue to give rise to conflicts over their effectiveness versus the costs of implementing them, and it is required that an auditor is familiar with the rules governing the assessment of internal control as well as those governing the audit of the financial statements. However, the auditor must take into account the policies and procedures of the company and assess the effectiveness of them. As for privately owned companies, AICPA section AU 319 sets professional standards for auditors to obtain an understanding of internal controls and utilizes principles contained in COSO.

We encourage our readers to refer to the handy sidebar located on the right side of the page in order to refer to the rules and regulations governing the auditing of internal control under SOX, PCAOB, and the AICPA.

July 7th, 2011 | Category: webtaxcpa | Leave a comment

Think of cloud computing as a place, where for example, a business cannot actually locate their data on a traditional hard drive or server, but they must rely more heavily upon higher security for critical data located off-site. Data sharing thus becomes manageable provided that data integrity is not breached, and at least according to Microsoft’s Satya Nadella, so-called desktop virtualization is part of Steve Ballmer’s business plan for the company – if not the centerpiece of it. If this is true then this represents a major change to the nature and character of one of the world’s most recognizable corporate names and at least according to the hype will revolutionize the way in which computing is perceived.

From a legal standpoint, there are numerous issues at stake the result of which have enormous impacts on the way in which information is handled. Not the least of which is the fundamental question as to whether cloud computing is innovative. The answer is no. Desktop virtualization already exists in many forms today. One of which is Amazon Web Services, which already provides scalable web services that expand and shrink to fit the users capacity requirements and provides “elastic” IP addresses that Amazon vehemently defends as being effective against those to whom one might not want their IP address exposed. Small capacity users are defined by 1.7 GB of memory and 160 GB of storage is defined as a “small instance” in which the rates vary from around 5 cents per hour for “reserved instances”, to as much as 68 cents per hour for standard “extra large” usage.

Cloud computing development would not a be qualified research and experimentation activity insofar as the definition applies to the research and experimentation tax credit is concerned if it is an adaptation of an existing process for a customer. In the ultimate ‘cloud’, all customers are eventually linked to one cloud, and therefore, any change to the cloud as defined by unifying all other clouds would be considered simply as an adaptation, because all customers are enhanced. Amazon’s cloud concept accommodates only a handful of operating systems, and the Microsoft cloud is one of them. The clash of the titans of Microsoft versus Apple appears to once again be taking to greater heights as a result of access, let alone the almost legendary desktop computing loyalties that boils beneath the surface of the seemingly placid computer industry, where change is supposed to conform to the traditional American business model of being slow and methodical, while taking advantage of every tax and accounting advantage known.

The issue of copyright infringement also comes to mind when one considers the cloud. There are those who argue that the cloud does away with data property rights issues and that anything that is available on the cloud is ‘fair use’ that can be “manipulated”. In the case of Cartoon Network, LP v. CSC Holding Inc., the court struck this down by ruling that a copy of a work that is held for more than a “transitory” period is not legally obtained content and there is only one subscriber to one work. Cloud computing may already been on a collision course with the courts, which will likely consume the attention of the public arena for many years to come. In the new global media paradigm, however, there is no such thing as bad PR, and controversy appears to be as much a corporate marketing campaign as receiving an award for outstanding achievement.

The recent problems that Microsoft incurred with the Vista operating system could have been the last straw in the old Microsoft business plan. The move to cloud computing is on a dollar for dollar basis about as much as it would cost each year for upgrading software and the wear and tear on the hard drive of a typical small business or household PC. The service level might actually improve by finally producing an integrated operating system that employs its own firewalls, spam detectors, and virus protections. The risks to a company of continuing along the same path may be outweighed by the potential benefit of changing the mainstay of the company’s business plan, which in the case of Microsoft is literally defined by its operating system and software.

Cloud computing for many could simply be seen as an option for consumers no longer as willing or able to maintain their grasp of desktop computing, and the preferences for the Microsoft and Apple operating systems seem to be reinforced again. In short, there appears to be no settlement of the lingering issue of there being one cloud for all operating systems. Apple is rolling out their own cloud. Perhaps cloud computing may be best characterized at least for now as a revolution of existing technology. It attempts to revolutionize the simplicity with which businesses and individuals can maintain and access data. However, given the lack of a traditional approach where outcomes are predictable, there are few if any provable cost-benefit projections for cloud computing out there other than estimates of its potential market share in two to three years from now, which is about the typical peak of a marketing campaign from inception to roll out. Cloud computing applications and implications may well one day transcend the notion of computing itself, however, a revolution in desktop computing may be all that can honestly be committed to at this point.

Editor’s note: WEBTAXCPA.COM does not endorse or discourage the use of any product or service mentioned in this article or elsewhere in this or any other website.

June 23rd, 2011 | Category: webtaxcpa | Leave a comment

Prior to 1962, tax privileges had been granted to foreign subsidiaries of US corporations in order to encourage US firms to expand abroad, the assumption being that foreign competitors benefited from similar tax breaks. It was found, however, that a growing number of US firms simply set up foreign companies in so-called tax havens, which operated merely as a shell company. Exclusive rights were often granted by the US parent to export products to the foreign subsidiary is an example of the kind of behavior that led to the suspicion of abuse of the tax laws.

Subpart F of the Internal Revenue Code imposed a tax on US shareholders of US companies if a foreign subsidiary is deemed to be a controlled foreign corporation or CFC and the corporation has undistributed income. This is defined as any foreign corporation in which more than 50% of the total value of the stock is owned directly, indirectly or constructively by US shareholders on any day during the taxable year of the corporation.

In 1976 in the height of the oil crises, Subpart F was relaxed in order to permit US oil companies to engage in foreign oil exploration without Subpart F income being treated as repatriated. The law was amended later on in 1982 to include in Subpart F income that was derived from foreign oil processing, distribution, sales and services. Subpart F has taken direct aim at the banking and insurance industries, when in 1986, exceptions for these sectors were either repealed or severely limited. Then in 1997, Congress allowed an exception for financial services income as long as it was “active” income with a bona fide foreign business presence. In 2004, Subpart F repealed the foreign-based shipping rules, which allowed shipping income to be tax free, and in 2010, the Tax Relief, Unemployment Reauthorization, and Job Creation Act extended the active financing exception through 2011.

Political assertions aside, Subpart F arguably has a direct impact on the domestic US economy. However, the statute has largely remained the same as it was originally enacted in 1962, taking aim at undistributed passive income that would otherwise be taxed at a higher rate. While politicians from either the liberal or conservative perspective debate the neutrality aspects of trade as a motivation for not repealing Subpart F, it is notable that Subpart F is rarely mentioned in the debate on trade and its effects on jobs and the overall health of the economy.

The ability of US firms to compete globally probably has no better example than that of the oil and gas industry, which has been largely excluded from Subpart F. The success of US oil exploration companies may be a blessing as well as a curse given that increased dependence on non US energy sources often comes under scrutiny as being the source of armed conflicts not to mention making it less attractive in many cases to search for domestic sources of energy.

The US shipping industry experienced a slump during the recent recession, however, shipping firms are busily attracting billions in capital for new vessels even while shipping rates have fallen by as much as 50% since their peak in 2008. Though banks have not been eager to loan to shipping companies, larger companies with bigger fleets are attracting private equity money. The consolidation of power into the large shipping companies with a global reach and thus the ability to take advantage of lower tax rates is perhaps a prime motivation for investment, while smaller companies fall by the wayside.

There have been notable occurrences of Subpart F playing a role in the recent financial crises, one of which involved pushing for an exception under the active financing exception to the failed insurance company AIG by Charles Rangel, the former chair of the House Ways & Means committee. Activities related to credit default swaps were excluded from Subpart F, yet the tax benefits that cost the US Treasury billions of dollars in revenue were not enough to save AIG from eventually failing and costing the taxpayers $85 billion. It is widely reported that Rangel collected millions in campaign donations for pushing through this legislation.

It is reasonable to assume that trade and the imbalances inherent in differing tax structures will continue to be the subject of intense scrutiny, and encouraging an understanding of Subpart F is essential for comprehending evolving economic trends. For more please refer to Sections 951 through 964 of the Internal Revenue Code, which is conveniently located on the right hand sidebar at webtaxcpa.com under Federal Tax Law Resources: Internal Revenue Code.

June 13th, 2011 | Category: webtaxcpa | Leave a comment

Reporting is optional for all employers in 2011. Thereafter, “at least” in 2012 reporting is optional for small employers, i.e., those with less than 250 employees. Reading between the lines, this means there is no specific guidance on when reporting health care benefits on Form W-2 will become mandatory.

June 12th, 2011 | Category: webtaxcpa | Leave a comment

Click on both links below to open the PDF’s. You can open them with either Preview if you are using a Mac and with Adobe if you are a PC user.

Exempt Status Reinstatement Under IRC Sec. 6033(j)
The above link is the recent guidance issued by the IRS for exempt organizations who have had their tax-exempt status automatically revoked for failing to file an annual return for three consecutive years. The notice covers the process for applying for reinstatement of tax-exempt status and requesting reinstatement retroactive to the date of revocation.

Transitional Relief for Small Organizations
In addition, this link above will take you to guidance for reinstating tax exempt status for small organizations whose annual gross receipts do not exceed $50,000 in their most recently completed taxable year, and in which their tax exempt status was revoked because they failed to file an annual electronic notice for taxable years beginning in 2007, 2008 and 2009.

Reduced fees for reinstatement of exempt status
The IRS has reduced the reinstatement fee to $100 for small exempt organizations. For more guidance on the reinstatement process for exempt organizations, go here.

Administrative issues
Lastly, here is some general administrative and background information on the reinstatement process for exempt organizations.

We highly recommend opening the documents while also using the handy research links located on the right sidebar of webtaxcpa for researching the Code and the regulations.

June 12th, 2011 | Category: webtaxcpa | Leave a comment

Title 101
Click on the link above to open the document.
Here is a handy reference guide for ways in which title to property may be held, including various key aspects of each.

June 12th, 2011 | Category: webtaxcpa | Leave a comment

April 18th, 2011 | Category: webtaxcpa | Leave a comment

A tax deal was worked out last year that allows 100% of the cost of a new vehicle to be deducted for tax purposes, provided the gross weight is 6,000 pounds or more and the vehicle is used 100% for business. Read more here.

April 11th, 2011 | Category: webtaxcpa | Leave a comment

Well, you knew that it had to happen sooner or later. That is, that I had to surface from a hiatus in posting articles at webtaxcpa due to tax season. And, in order to kick start the posting of articles again, I might bring to your attention the various and sundry ways in which folks try to game the system by claiming the $8,000 first-time home buyer tax credit. Oddly, this article cites examples of busts that occurred in Massachusetts. Given the current economic climate, perhaps this is only the tip of the iceberg.

Mind you, I did not combine the words ‘home’ and ‘buyer’. In other words, just because there is a home does not necessarily mean that the buyer is who they say they are.

Happy tax season to everyone! I hope your plans for 2010 worked out for you.

March 26th, 2011 | Category: webtaxcpa | Leave a comment