Fall 2007 Pennsylvania CPA Journal

Develop Your Personal Brochure with Care

bhayes — Tue, 09 Oct 2007 14:36:00 GMT

By David Maturo

The mission of a resume is not simply to provide a history of your professional experience and qualifications. For practical purposes, a resume is a marketing document, your personal sales brochure that helps you get the job you want.

The market for candidates has been good lately, particularly in accounting and finance, but employers are still very deliberate and selective. The goal of your resume, then, is to get the attention and interest of a hiring manager, and win an interview where you can sell yourself in person.

In most fields - especially in accounting and finance - you differentiate yourself more effectively in your resume through your experience and accomplishments, rather than through creative language and design. Using a nonstandard presentation detracts from the key message that your talents and experiences can fill a real need.

From manager to executive, the current resume standard is two pages, with one-inch margins and plenty of white space. Avoid going over two pages or making it dense with detail. Effective brochures don’t cram information into every bit of available space, so don’t do it with a resume. Use plain white or off-white paper with no designs on it. Pick one typeface, and stick to it throughout the document. An initial review of a resume may take seconds, so make your resume clean, straightforward, and agreeable to the eye.
Following are several additional aspects of a resume that you need to consider.

Summary - Include a summary paragraph that sticks to the facts and includes bullet points that identify key areas of experience or interest. For instance, mergers and acquisition experience would be the kind of key area to highlight; being "results-oriented" would not. Also, avoid listing accomplishments here. Put those in the work experience section.

Work experience - List your experience in chronological order, with your most recent experience receiving emphasis. For each job experience, list the company first, along with a short description if not widely known. Include annual revenue and number of employees to give a sense of company size and complexity.

When describing your experience within a position, do not use the basic responsibilities found on your job description. Hiring managers are familiar with many positions in accounting and finance. Provide accomplishments. Use brief bullet points, not paragraphs, for easy reading. Start with action verbs and end with results generated.

Beyond your most recent experiences, keep the prior positions lean and limited. Experiences older than 10 years are not as relevant. Consider using a "prior experience" section to consolidate those earlier positions. For those with 10 or more years of experience, education is listed after experience, followed by relevant awards, certifications, and associations.

Get personal - A personal section may allow the reader to get to know you briefly, and possibly draw a connection with something in which they have an interest. An avid runner who sees "marathon runner" in a candidate’s personal section has one more reason to spend time with the resume.

Respect your space - Avoid unnecessary adjectives or flowery description. Every competent manager or executive is already assumed to be results-oriented, resourceful, dynamic, highly motivated, hands-on, strategic, and so on. These descriptors are subjective, add no value, and take up space. Real estate on a resume is precious, so avoid redundancy. Accomplishments in your experience section should complement your summary section, but not repeat anything in it. Also, run a basic grammar and spell check to avoid simple mistakes.

General vs. targeted - Build a general resume that best promotes your abilities and interests. Then modify it to highlight those experiences and accomplishments that best match the position for which you are applying. Don’t overdo it, because it may look too tailored. Remember, you can draw connections in a brief cover letter.

Quality control - Ask trusted friends and colleagues for a review. Get a review from an accounting and finance professional, and if you know any hiring managers, ask them for their opinion too.

Keep it up to date - Make adjustments to your resume each time you change positions. Better yet, review and update your resume every six months. This will help you continually refine your career history and focus on where you might be headed.

A resume is a marketing instrument to get your foot in the door, but it is not a replacement for networking. It is only one of the coordinated steps you should take to own your career and move confidently to your next position.

David Maturo is a partner with Attolon Partners LLC, an executive search firm in Philadelphia. He can be reached at dmaturo@attolon.com.

Global Standards Loom Large

bhayes — Tue, 09 Oct 2007 14:31:00 GMT

By Rose Marie L. Bukics, CPA

No event in the recent past has been more significant for the movement toward one global reporting standard than an SEC vote this past June. The unanimous vote effectively endorsed - subject to a 75-day comment period - the use of global financial standards by foreign companies listed on U.S. stock exchanges by eliminating the current requirement for such companies to file a 20-F, reconciling International Financial Reporting Standards (IFRSs) to U.S. GAAP.

This SEC proposal, in addition to other recent watershed events (see table two below), highlights the speed at which events are propelling the financial world to one set of global reporting standards.

What does this mean for accounting educators? It means we have to begin planning now to construct courses where global financial accounting and reporting standards are recognized as the one standard model. A good starting point is to understand how and where the global standards fit into our current curricular structure of accounting courses.

To date, accounting educators and textbook authors relied on two different approaches to the teaching of international standards. The first is to teach international standards as a stand-alone course, focusing solely on the teaching of International Accounting Standards (IASs) and IFRSs currently in effect. The second approach is a comparative one, where the starting point is U.S. GAAP as the standard, with an examination of how international standards are different. The second approach served a very valuable purpose by highlighting the differences between the standards, many of which would appear in the 20-F required by the SEC.

This comparative approach was timely and appropriate given the growing focus on financial information prepared using international standards versus U.S. GAAP. In fact, the identification and explanation of such differences was in the interest of, and actively supported, the movement towards harmonizing the standards.

Time to Consider Change
Review of the 41 IASs (note that IAS 3 through 6 have been superseded) and eight IFRSs issued thus far, as well as the IASB Framework for the Preparation and Presentation of Financial Statements, indicates that the accounting courses most affected will be at the intermediate level, followed by advanced and financial. For example, four IFRSs (2, 5, 7, and 8), 23 IASs, as well as the IAS framework address topics typically taught in a two-semester intermediate course. Table one below is a summary of where international accounting standards would fit in this course by general topic.

The advanced accounting course would be affected by five standards: IFRS 3, business combinations; IAS 20, government assistance; IAS 27, consolidated financial statements; and IAS 28 and 31, investments in other companies.

Conclusion
If the current trend toward international convergence continues, accounting educators need to begin to assess how their current courses will change when international standards take the place of U.S. GAAP and become the worldwide standard.

Table One

Topic / Relevant IAS, IFRS
Financial statement preparation/presentation / IASB Framework, IAS 1, 14, 27, 34
Accounting principles/policies / IAS 1, 8
Income statement/EPS/accounting changes / IFRS 5, 8; IAS 8, 14, 33
Balance sheet / IFRS 5, 7; IAS 2, 10, 16, 17, 19, 23, 32, 36-40
Cash flow / IAS 7
Revenue/expense recognition / IFRS 2; IAS 18, 19
Taxes, leases, and pensions / IAS 12, 17, 19
Asset acquisition / IFRS 2; IAS 28, 38
Related-party transactions / IAS 24

Table Two

A Brief History of Convergence
1998: International Accounting Standards Committee (IASC) completed the Core Standards Project, requested by the International Organization of Securities Commissions (IOSCO).
2000: IOSCO recommends allowing multinational enterprises to use the standards issued under the IASB.
2002: European Union (EU) requires IAS and International Financial Reporting Standards (IFRSs) to be used for all publicly held company financial reports, beginning in 2005.
2002: Norwalk agreement, signed by IASB and FASB, indicates an agreement on the concept of converging standards (this was subsequently updated in 2006).
2005: SEC indicates its intent to eliminate the reconciliation requirement for foreign filers by 2009, but its June 2007 proposal seemingly indicates the movement toward international standards is increasing in speed. SEC has also indicated its intent to consider allowing U.S. companies to select IFRS as well.

Rose Marie L. Bukics, CPA, is the Thomas Roy and Lura Forrest Jones Professor of Economics and Business at Lafayette College in Easton, and is a member of the Pennsylvania CPA Journal Editorial Board. She can be reached at bukicsr@lafayette.edu.

Supercharge Your 401(k) Plan

bhayes — Tue, 09 Oct 2007 14:25:00 GMT

By Matthew Tuttle, CFP

Many firms that sponsor 401(k) plans have a problem. The owners want to put away as much money as possible, but doing so would require large contributions for the employees. The employees enjoy the opportunity to defer their salary and receive some sort of match, but plan assets are not guaranteed. One solution that could solve both problems is a 401(k) and cash balance combination plan.

Many planners associate cash balance pension plans with large companies that use them to reduce employee benefit costs. What many people do not realize is that, in the right situation, these plans can benefit small business owners as well.

Traditionally, small business owners who want to install a retirement plan for their business had two options: defined contribution plans - such as 401(k)s, profit sharing, money purchase, SEPs, and SIMPLEs - or defined benefit plans. Defined contribution plans limit the cost of contributions for employees, but also limit the tax-deductible contribution for the business owner - $45,000 in 2007. Defined benefit plans allow a large contribution by the owner, but they can also mandate large contributions for employees. Cash balance, however, offers another option: potentially large tax deductible contributions for the business owner with low contributions for employees.

Cash balance plans are hybrids that combine the best features of defined contribution and defined benefit plans. Like a defined contribution plan, employees have their own accounts. Contributions are based on compensation, and interest is credited each year, based on a formula specified in the plan document. Like defined benefit plans, the retirement benefit would be the benefit that can be provided by the employees account or a minimum benefit as described in the plan document, whichever is greater.

Combining a 401(k) with a Cash Balance Plan
Combining an existing 401(k) plan with a cash balance plan can help business owners get large tax deductible contributions without necessitating large contributions for employees. The combination can also guarantee minimum retirement benefits for employees, regardless of what the market does.

XYZ Company, for example, has four owners, three top executives, seven family members, and 19 rank-and-file employees. The owners each make $220,000 per year, the executives and family members earn between $45,000 per year and $180,000 per year. XYZ has a 401(k) plan, but it would like a way for owners, top executives, and family members to put away more money without too much of a cost for employee contributions. By adding a cash balance plan on top of the 401(k), the results were as follows:
-- Tax-deductible contributions for the owners - $86,000 per year for each owner
-- Total contributions for owners, executives, and family members - $433,770 per year
-- Total contributions for employees - $67,646
-- Total plan contributions - $501,416
-- Percentage of contributions that go to owners, executives, and family members - 86.51 percent

The above example assumes that XYZ Company has a safe harbor 401(k) plan that makes a nonelective 3 percent of salary contribution to all employees. This allows the top executives to make their full employee contribution of $15,500 each ($20,500 if over 50). Then, a cash balance plan is placed on top of the 401(k), which skews benefits toward the older, higher-paid employees.

In effect, the plan will save the owners about $200,000 per year in taxes, but the cost of the employees’ contribution is less than $70,000. Employees, then, could invest their 401(k) plan assets more aggressively, knowing that they also have a cash balance plan that provides a fixed benefit in retirement.

In the right situation, adding a cash balance plan can help employers supercharge their 401(k) plans. n

Matthew Tuttle, CFP, is president of Tuttle Wealth Management LLC, located in Stamford, Conn. He can be reached at matthew@matthewtuttle.com.

Foreign Corruption Investigations on the Rise

bhayes — Tue, 09 Oct 2007 14:20:00 GMT

By Maria F. Boodoo, CPA

Recently, there have been more reports regarding Foreign Corrupt Practices Act (FCPA) investigations as well as record-breaking fines. In the past, many FCPA fines - based on a 30-year-old law to curtail the bribery of foreign officials and governments for the purposes of obtaining business - were viewed as minute charges that had no affect on the modus operandi. This changed, however, as more emphasis was placed on restoring confidence in the American business system.

The size and number of enforcement actions brought by the SEC and Department of Justice (DOJ) have dramatically increased. According to a Shearman and Sterling LLP report from March 2006, "between 2001 and 2006, the average number of new DOJ prosecutions was over four times the average number in the preceding five years" and from "2002 through 2004, the number of SEC and DOJ new investigations increased steadily from 7 to 19."

The enforcement trend can be attributed to a variety of factors discussed in this column.

Broader Focus on Corruption
The SEC and DOJ have clearly stepped up efforts on the corruption front, particularly corporate corruption. According to the DOJ’s strategic plan for 2007-2012, "fighting public corruption has become one of its top six priorities."1 This is reinforced by the facts of a 40 percent increase in corruption indictments over the past two years and an increase in federal agents assigned to work corruption cases. On the international business front, the DOJ intends to publicize the FCPA rules to companies, develop policies to detect and recover proceeds of foreign corruption, and negotiate forfeiture agreements with the international community.

Voluntary Disclosure of Violations
Companies are increasingly stepping up and voluntarily disclosing potential and actual FCPA violations. A prime example is the case of GE’s acquisition of InVision. Bribery scandals detected in the Far East during due diligence of the acquisition were immediately disclosed by both companies to the SEC and DOJ, which reduced the penalties paid out by InVision and assisted GE in limiting its liability as a successor company. As explained by Assistant Attorney General Alice Fisher, "voluntary disclosure, followed by extraordinary cooperation, can result in a real, tangible benefit to the company."2 On the other hand, firms that fail to self-report, or consistently disregard FCPA, face severe penalties.

For instance, in the case of Vetco Gray UK Ltd., the DOJ took into consideration the company’s prior FCPA conviction when levying a $12 million criminal fine.3 Systemic failure is oftentimes symptomatic of an ineffective or noncompliant FCPA program.

Alternative Legal Remedies
Deferred prosecution agreements, non-prosecution agreements, and plea agreements are pathways chosen by many prosecutors recently to achieve a balance between the deterrence and prevention of corrupt activities and the minimizing of damages from corporate convictions on innocent employees, shareholders, and the market.4 Companies also are turning to these means of settling cases more harmoniously, which often requires them to disgorge profits from the corruption, cease and desist from future FCPA violations, implement a robust FCPA compliance program, and engage an independent compliance consultant/monitor.

Conclusion
The rise in FCPA violations is somewhat akin to the old maxim of a tree falling in the forest: FCPA violations have always existed, but they were often not "heard" due to blatant indifference, willful blindness, or tacit condonation of the improper act. The confluence of the factors discussed above, however, has served to bring "ears" into the international woods to listen for violations and, in some respects, prevent the trees from falling in the first place.

1 U.S. Department of Justice Strategic Plan, "Stewards of the American Dream, FY 2007-2012."
2 U.S. Department of Justice, "Prepared Remarks of Alice S. Fisher, Assistant Attorney General, at the American Bar Association National Institute on the Foreign Corrupt Practices Act," Washington D.C., Oct. 16, 2006.
3 U.S. Department of Justice, "Three Vetco International Ltd. Subsidiaries Plead Guilty to Foreign Bribery and Agreed to Pay $26 million in Criminal Fines," Feb. 6, 2007.
4 Scott A. Resnik and Keir N. Dougall, "The Rise of Deferred Prosecution Agreements." New York Law Journal: Securities Litigation & Regulation, Dec. 18, 2006.

Maria F. Boodoo, CPA, is a senior consultant with FTI Consulting Inc. in King of Prussia. She can be reached at mariaboodoo@yahoo.com.

Reminders Help Client Relations

bhayes — Tue, 09 Oct 2007 14:16:00 GMT

By Jonathan S. Ziss, JD

Insightful lessons can be learned by reviewing professional liability issues. With this in mind, Mather & Co., a division of Bollinger Inc., provides this column. For more information, contact Mather at philadelphia@bollingerinsurance.com.

Client communication begins with the engagement letter, about which one cannot say too much. As we all know, the engagement letter communicates your role in the relationship, what you will do, what you will deliver, what you will be paid. A comprehensive engagement letter is a must. But that is just the beginning of effective client communications.

Once the engagement is under way, the client typically will need to assist the CPA in some way. Whether that is gathering documentation, completing personal tax work sheets, ordering appraisals, or executing authorizations, clients are active participants in your work. As a result, they must do what they are expected to do within a prescribed time frame. Clients, however, often see themselves as passive beneficiaries of your service. This can lead to a dangerous disconnect. They need your leadership and guidance in this area.
You delegate tasks to staff every day, and you supervise and manage those tasks via task lists and a tickler system. Why not manage your clients the same way?

Begin by conditioning their expectations. In the engagement letter, make sure you note that you might need more information or input. This can be a generic reference, but be clear that if the situation arises in which you need their participation, you will let them know in writing what needs to be accomplished and by what date. Include a statement to the effect that you are relying on them to assist you, and that there are certain tasks that a CPA cannot accomplish without them. Also, let them know that the quality and timeliness of their support should be on par with the quality and timeliness that they expect of you. This is a blunt message, but it is clear and it makes sense.

Consider a tickler system for your clients, and not just to collect receivables. For example: "Dear Mrs. Hunter, last month I explained that you need to provide me with an appraisal of the Maryland property. Thirty days have passed, and we have not yet received the report. We need that information to complete the paperwork to file for the charitable deduction. Unless I receive it from you, I will be unable to complete your requested filing." Following up after a prescribed amount of time is critical. Clients, like you, are busy. They may put things to the side with every intention to complete them, but they might get sidetracked or forget.

This sort of client contact has a number of benefits. First, it fosters compliance by motivating clients to action. Second, tickling your clients helps to re-emphasize the engagement letter’s statement of what you expect from your client and what your client should expect from you. A "tickling protocol" also reassures discipline in your internal processes, which reduces managerial stress and uncertainty. Externally, it also serves as a form of soft marketing, reinforcing the fact that you exist, that you care, and that you get things done.

Beyond these benefits, should your relationship go bad, you will have created an evidence trail where you do not have to rely on recollection alone. Also, clear correspondence, whether traditional or e-mail, can provide a fixed point in time from which to reckon when a statute of limitations began to run.

Too much client communication is seldom, if ever, the root of a litigation problem. Too little communication frequently is. So, reach out and tickle your client. You’ll both feel better for the effort.

Jonathan S. Ziss, JD, is a partner with the law firm Margolis Edelstein in Philadelphia, where he concentrates in the area of professional liability. He can be reached at jziss@margolisedelstein.com.

The Expanding CPA Role in Risk Management

bhayes — Tue, 09 Oct 2007 14:13:00 GMT

By Jack Greenberg, CPA

Sarbanes-Oxley looms large over the accounting profession. So large, in fact, that Sarbanes-Oxley compliance and internal controls work may have overshadowed dozens of other risks facing your, or your client’s, enterprise.

CPAs are in an ideal position to identify and analyze different types of risk, and to act as change agents in developing appropriate and effective management response. The CPA’s analytical tools help determine how to define risk and how much to tolerate. What’s more, the sharing of your experience with controls issues with a wider audience can assure that the evaluation of risk becomes an ongoing, integral part of the management process.

Every Business is Risky Business
Risk comes in many forms, and from internal and external sources. People, property, information, reputation, investor confidence, creditworthiness, and countless other organizational elements represent vulnerabilities that must be acknowledged, addressed, and mitigated.

In the past, the usual practice of risk management was solely in terms of insurance. This narrow view is no longer sufficient. Companies must develop what is known as a "portfolio view" of risk, including tangible risks - such as fires and property damage - and those that are intangible:
-- Losing market share to competitive activities and pressures
-- Effect of markets on growth strategies
-- Questions about the character or actions of executives
-- Natural disasters in other parts of the world, and how they affect the ability to do business
-- IT security breach on customer service
-- How terrorist action, here or in another country, could affect domestic markets
-- Elections and government policies

Risks must be identified, inventoried, and prioritized based on each company’s unique risk appetite – the level of risk that management deems acceptable - and risk tolerance - an acceptable level of variation around objectives.

Internal and external CPAs can act as facilitators, providing direction to the management team as it explores risks. Sometimes, the risk can be addressed immediately; other times, it must wait. What is important, though, is that the risk is recognized and addressed in strategic planning.

Ultimately, some risks, like introducing a new product, are worth taking. But such risks are only acceptable within certain guidelines for return on investment. Some risks can be inherent in the type of business or industry segment, while others are the result of organizational structure, management decisions, markets, or clients you serve.

There is no right or wrong way to organize your, or your clients’, risk portfolio. Some organizations pursue strategies with higher risk, and some pursue lower-risk strategies. These levels are determined by a management team and communicated internally and externally.

After establishing and organizing the risk portfolio, processes and procedures can be developed to minimize or even eliminate risk. Some of these efforts can include the following:
-- Internal accounting and audit controls to help prevent fraud
-- Tax strategies to reduce tax burden
-- Documentation guidelines to meet government regulations
-- Strategies to protect sensitive electronic data and networks
-- Contingency plans and backup systems for technology failures

Risk Management Adds Value
Risk management adds value by helping management detail what could go wrong on the way to reaching their goals, and then consider potential compromises. The more effort put into reducing or eliminating the risks that stand in the way of rewards, the greater the value that is created. A proactive approach to managing risk can root out dangers that no one thought much about, and then focus resources on eliminating them. For example, an auto dealer whose sales are dominated by gas-hungry SUVs may not see an earthquake in Mexico as a direct risk to his or her business. In fact, damage to oil production and refining capacity in any oil-producing state can affect domestic gasoline prices, which, in turn, is likely to influence vehicle sales. In this example, risk exists not because you or your client failed to take action, but because something beyond either party’s control has occurred. Risk management is about enabling people and processes to move forward with the greatest opportunity for success in these circumstances.

Every company should evaluate risks on a regular basis to manage exposures. No one is better suited to lead the charge than a CPA who has a strong understanding of how to mitigate risk.

Jack Greenberg, CPA, leads Clifton Gunderson LLP’s Mid-Atlantic Business Risk Services practice. He can be reached at Jack.Greenberg@cliftoncpa.com.

40 Years and Counting: Local Tax Reform Overdue

bhayes — Tue, 09 Oct 2007 13:52:00 GMT

By David A. Caplan, CPA, and Matthew D. Melinson, CPA

The Local Tax Enabling Act (LTEA), or Act 511, is now more than 40 years old. The law provides localities with the ability to levy certain types of tax, including, but not limited to, earned income, gross receipts, occupation, local services, and per capita taxes. While local taxes generally are not significant enough to be the determining issue in a business’s decision regarding location,1 these taxes are among the many factors considered. At minimum, Pennsylvania’s antiquated local tax structure negatively affects the state’s desire to be perceived as business-friendly. Many attempts have been made over the past four decades to amend the law, but most have been unsuccessful at simplifying the tax burden on businesses and individuals.

Earned Income Taxes
Act 1, a proposal to reduce school property taxes by increasing or implementing either a local earned or personal income tax, was voted on in 498 of the 501 school districts in Pennsylvania.2 It passed in only eight. Pennsylvania residents are not keen on local income taxes; in fact, local income taxes are somewhat of an anomaly in the United States. Besides Pennsylvania, only 11 other states have a local income tax; and five of those have the tax collected by the state, not the municipalities. By contrast, Pennsylvania has nearly 2,900 jurisdictions that levy the tax, double the number of all other states combined, with approximately 560 different collectors.3

Act 166 of 2002, a PICPA legislative initiative sponsored by Rep. John A. Maher, CPA (R-Allegheny), defined earned income and net profits for local purposes, following state-level rules under the personal income tax code. This improved uniformity, but different interpretations on certain issues still exist. Additionally, some residents live in areas where the municipality and the school district have different tax collectors. The tax also features a convoluted collection and distribution system, in which required taxes are collected at work but owed to the home jurisdiction. Both of these result in difficulties related to the timely remission of the required dollars to the resident jurisdiction. One recent proposal calls for consolidation of collection at the school district level.4 While this could lead to improvements, centralization of collection at the state or county level would be much better in terms of streamlining and efficiency.

Gross Receipts Taxes
Also subject to much controversy are the business privilege and mercantile taxes, collectively referred to as gross receipts taxes. The Pennsylvania Supreme Court decision in Northwood vs. Upper Moreland ruled that a construction company’s receipts earned on jobs outside of Pennsylvania could not be taxed by the municipality.5 The result has led to inconsistent interpretations among jurisdictions, as some continue to attempt to impose tax on all or part of out-of-state receipts under various methodologies. Another area of conflict is whether credit is permitted for gross receipts tax paid as part of Philadelphia’s business privilege tax. Some collectors disallow the credit under the premise that Philadelphia’s business privilege tax was enacted by different enabling legislation than the LTEA. This is technically true, but Pennsylvania legislators probably did not intend to permit the exact same receipts to be taxed by two different jurisdictions. Localities also differ in interpreting subjectivity to business privilege tax, though Pennsylvania courts consistently rule that there must be a base of operations physically present for a jurisdiction to impose tax.

Nuisance Taxes
A nuisance tax is a minor tax that may cost more to administer, withhold, collect, and legislate than it brings in to support the community. Act 222 of 2004, for instance, introduced the Emergency and Municipal Services Tax, which allowed jurisdictions to convert occupational privilege taxes into this new tax and increase the maximum from $10 to $52 per year. The law, however, did not address specific collection terms, refund procedures, low-income exemption process, and a host of other administrative requirements. The rapid initiation of this tax caused confusion, surprised employees, and resulted in time-consuming paperwork by employers. The situation was corrected by Act 7, which was passed in June 2007 and becomes effective Jan. 1, 2008. Renamed the Local Services Tax, the revisions require a uniform exemption amount of $12,000, require Department of Community and Economic Development to create uniform forms, and mandate pro-rata withholding as opposed to one-time lump sum payments.

There are other nuisance taxes in addition to the Local Services Tax. Per Capita Taxes are imposed on residents at a maximum rate of $10; and some localities impose an Occupation Tax, distinguished from the tax previously known as the Occupational Privilege Tax. The Occupation Tax is a flat tax based upon the specific occupation of the resident. The LTEA provides no maximum for this tax, and hence the tax can differ among jurisdictions, along with amounts per occupation being subjective.

Additional Considerations
As you can see, and have probably experienced first-hand, Pennsylvania’s local taxes are a tangled mess. So, where does Pennsylvania go from here? There are two broad options: fix the current system or repeal Act 511. For the LTEA to be repealed, a substitute form of funding would need to be recommended so municipalities and school districts could balance their budgets without property taxes skyrocketing. A possible solution may be increasing the state personal income tax rate, with the extra funds being earmarked for local funding.

If repeal is deemed undesirable, the current system most certainly needs substantial improvement. The collection process for earned income taxes is cumbersome and inefficient, resulting in lost revenue and inequality throughout the state. School district consolidation for earned income taxes is a step in the right direction, but state- or county-level collection would be better. Gross receipts taxes require increased clarification and uniformity. Local "nuisance taxes" should be repealed, or, at minimum, should not be used as the upside of the seesaw in future tax shifts.

PICPA members can help by contacting their legislators and stressing that local taxes are an important issue. Only through your advocacy and expert testimony can we hope to achieve local tax reform.

1 An exception is gross receipts taxes, which occasionally drive decisions regarding location.
2 Jurisdictions excluded from a voting requirement were Philadelphia, Pittsburgh, and Scranton.
3 Pennsylvania’s Earned Income Tax Collection System, An Analysis with Recommendations, Pennsylvania Department of Community and Economic Development, August 2004.
4 House Bill 1458.
5 Northwood Construction Co. vs. Township of Upper Moreland, 579 Pa. 463, 802 A.2d 1269 (2004).

David A. Caplan, CPA, is a sole practitioner in Lafayette Hill, and is a member of the PICPA State Taxation Committee. He can be reached at dactyl@caplancpa.com.

Matthew D. Melinson, CPA, is a director in the state and local tax practice of SMART Business Advisory and Consulting LLC, and is a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at mmelinson@smartgrp.com.

The Tax-Planning Opportunity of Selling an S Corporation

bhayes — Tue, 09 Oct 2007 13:48:00 GMT

By Larry S. Blair, CPA, JD

The entity of choice for many business owners is the S corporation. It has a number of statutory requirements - including a formal election - and limitations regarding shareholders.

If all the requirements are met, however, the S corporation structure allows for a pass-through of the corporate earnings to the shareholders, thus avoiding a double level of taxation: at the corporation level and then again at the shareholder level. The benefits of an S corporation continue to the point of owners considering an exit strategy through the sale of S corporation stock.

When shareholders sell their ownership interest in a corporation, including an S corporation, the shareholders generally recognize capital gain based on the selling price, reduced by their basis in the shares. The buyer will have the purchase price as its basis in the shares. However, there will be no step-up of the inside basis of the corporate-owned assets in a straight stock acquisition. This transaction normally results in the loss of potentially significant tax benefits to the buyer.

The buyer, in many circumstances, would prefer to purchase the assets owned by the corporate entity. The purchase of the assets results in an increase in the tax basis of the assets, based on the appropriate allocation of the purchase price to these assets. If the seller is a C corporation, the double level of tax will occur. The sale of S corporation stock, though, presents a unique planning opportunity for both the seller and the purchaser of the stock.

IRC Section 338(h)(10) provides an opportunity for the seller and buyer of S corporation stock, in a qualified stock purchase, to elect, from a tax standpoint, to treat the stock sale as an asset sale. The stock sale itself is ignored for tax purposes, and the S corporation is deemed to have sold its assets for an amount equal to the purchase price plus any assumed liabilities. From a seller’s standpoint, all gain from the deemed asset sale flows through the S corporation and is taxed to the individual shareholders on their individual tax returns. The deemed asset sale will, in most cases, result in the recognition of a combination of ordinary income and capital gain, as opposed to all capital gain on a straight stock sale transaction. The selling taxpayer will recognize ordinary income for items such as gain reflected on the deemed inventory sale, depreciation recapture, allocation of purchase price to accounts receivable for a taxpayer on the cash method of accounting, and possibly other items. The seller’s basis in its shares is increased by the amount of income recognized from the deemed sale of the assets. Immediately after the sale, the S corporation is then treated as having been liquidated.

The buyer has the unique opportunity of allocating, with the seller’s agreement, the purchase price to the corporate-owned assets and depreciating or amortizing the assets after the acquisition. This basis increase can be a significant benefit to the buyer, but at a cost to the seller. This tax concept, therefore, presents an important negotiating point in this type of transaction.

To determine the advisability of this type of transaction, compare the tax liability from a straight stock sale versus the tax liability from making a Section 338(h)(10) election. In the straight stock sale, the selling taxpayer would recognize a long-term capital gain that would be subject to the federal capital gain rate and state income tax based on state of residency. The Section 338(h) (10) election results in a combination of ordinary income and capital gain to the selling taxpayer. The comparison of these two tax liabilities will indicate the additional tax cost to the seller and potential increased tax benefit for the buyer.

The analysis of these tax costs and tax benefits could influence how much additional consideration the buyer may be willing to pay the seller for agreeing to make a Section 338(h)(10) election. Often, through appropriate negotiation, the seller can be made whole from a net cash after tax standpoint by getting an increased purchase price, while the buyer can get a significant tax benefit through the increase in basis of the underlying assets.

There are many important considerations that must be reviewed in analyzing a Section 338(h)(10) election. A few include the following:
-- This is a joint election that must be made by the buyer and the seller, and must include all S corporation shareholders.
-- For C corporations that converted to S corporations within 10 years prior to the date of sale, the built-in gains issue is a critical consideration. If the built-in gain tax applies to this transaction, there is a corporate-level income tax. The seller will incur an additional income tax liability.
-- Consider the allocation of the purchase price to the various assets acquired. IRS Regulation Section 1.1060 provides a detailed set of rules as to how allocations are to be made based on the classes of assets purchased. This is important when determining the amount and character of the gain on the deemed asset sale and the category type of the purchased assets.
-- Consider liabilities that may not have matured at the time of acquisition, such as a contingent liability for a pending lawsuit.
-- Payments to seller’s employees may have a significantly different tax treatment if the payment is made before or after the purchase transaction.

This brief overview of the Section 338(h)(10) election points out some of the legal and tax complexities of this area. Advisors who are negotiating the sale or acquisition of an S corporation should be aware of this significant planning opportunity and be in a position to discuss it with their client, whether it be the buyer or the seller.

Larry S. Blair, CPA, JD, is a partner with the law firm of Metz Lewis LLC in Pittsburgh, and is a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at lblair@metzlewis.com.

SFAS 158 Leads Charge for Better Post-Employment Benefit Accounting

bhayes — Tue, 09 Oct 2007 13:44:00 GMT

By John D. Rossi III, CPA, CMA, CFP

When it comes to setting accounting standards, the Financial Accounting Standards Board (FASB) sometimes seems to compromise on issues to avoid delays and excessive pressure from the business and preparer community, especially when it comes to controversial issues. This happened in 1985 with the release of SFAS 87, Employers Accounting for Pensions. Twenty-two years later, with the release of SFAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, FASB doesn’t seem to be cutting any corners.

Prior to SFAS 158, few post-employment benefit arrangements were recognized in financial statements. Almost all information about their financial status was disclosed in the notes. When FASB originally deliberated on SFAS 87, the board expressed a preference for balance sheet recognition of pension assets and liabilities, and no delay in income statement recognition of gains and losses. The FASB was concerned, however, that this approach would be too great a change from past practice, so it compromised with a disclosure approach.

Invariably, criticisms arose among financial statement users and the SEC. Criticisms included the use of smoothing devices on volatility - such as delayed recognition of gains and losses - and the not showing of the funded status of a plan on the balance sheet.

SFAS 158 is the first phase in a comprehensive project to reconsider the guidance set forth in SFASs 87, 88, 106, and 132R, and improve the reporting of post-employment benefit obligation accounting. The goal is to make that information more useful and transparent for investors, creditors, and other users.

SFAS 158 makes four changes to current practices for business entities and sponsors of one or more single-employer defined benefit plans. The most significant change is requiring the recognition of the funding status of the plan - difference between plan assets at fair value and the benefit obligation - on the balance sheet. The second change is the recognition of unrecognized items, net of tax, such as actuarial gains and losses and certain prior service costs and credits in other comprehensive income (OCI). These items would go from OCI to earnings, based on existing requirements and with no change in the basic measurement approach. The third change eliminates the choice to measure plan assets and obligations up to three months before the balance sheet date. Finally, SFAS 158 requires improved disclosure in the notes to financial statements information about the effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. As a result of comments received from the exposure draft, the standard does not have to be applied retroactively.

The next phase in the improvement project is a joint effort with the International Accounting Standards Board. It will be a comprehensive reconsideration of post-employment benefit obligation accounting. Challenges include the results of obligations that are very long-lived and measurements that are based on many complex assumptions. FASB will consider the long-lived nature of post-retirement benefit obligations, and decide if financial reporting standards should provide additional guidance on those assumptions. FASB also will consider earnings versus OCI; immediate recognition versus deferred recognition of certain gains and losses; and possible consolidation of post-employment benefit trusts by the plan sponsor.

FASB acknowledges that accounting for post-employment benefit obligation is in a transitional stage, and that certain pragmatic compromises were made in the past. SFAS 158, however, is the first step in an evolutionary search for a more transparent and useful accounting model. FASB believes the conclusions it has reached are a worthwhile and significant step to improved financial reporting.

John D. Rossi III, CPA, CMA, CFP, is an associate professor of accounting at Moravian College in Bethlehem. He can be reached at mejdr01@moravian.edu.

Control Self-Assessment: Everybody Pitching in with Internal Controls

bhayes — Tue, 09 Oct 2007 13:24:00 GMT

By J. Stephen McNally, CPA

The fifth anniversary of the Sarbanes-Oxley Act has passed, and many continue to argue whether or not the benefits of the legislation outweigh the related costs. Although there is no clear answer to this yet, does it even matter? Establishing and maintaining strong internal controls over financial reporting and disclosure is critical for the success of any organization, public, private, and nonprofit alike. Adopting the principles and best practices promoted by Sarbanes-Oxley, including solid corporate governance, the ethical behavior of management, and the transparency of financial information, will enable senior management to become more accountable for, and aware of, the material information emanating from their companies.

To truly embed internal controls accountability in the fabric of an organization’s business processes, procedures, and culture, management should consider implementing a control self-assessment (CSA) program. Management should not think of this as another Sarbanes-Oxley requirement, but rather they should approach implementation as a more efficient business system.

In this spirit, the following highlights the benefits of having a CSA program and provides insight regarding the key steps to implementing such a program.

Control Self-Assessment
CSA is a management technique that can be used to assure key stakeholders, both internal and external, that an organization’s internal controls system is reliable. CSA is a sustainable process whereby management validates the operating effectiveness of its internal controls via testing. That is, each process owner and individual control owner within an organization performs effectiveness testing to verify that key controls are functioning properly, resulting in the detection or elimination of material misstatements.

Consistent with the requirements of Sarbanes-Oxley Section 404, management must first assess the design of the company’s internal controls system, clearly identifying major processes and the key controls within each. Then each process owner develops test scripts for each key control and engages a team to perform the given tests throughout the year. This allows management to verify that these controls are working as anticipated. A CSA program expands the role of operations management from merely assessing the design of its internal controls to testing and validating the effectiveness of its internal controls throughout the year.

Benefits of CSA
Whether or not your company is required by Section 404 to formally assess the design and effectiveness of its internal controls, creating and maintaining strong internal controls makes good business sense. A CSA program offers many benefits, including accountability for internal controls, sustainability of management’s compliance program, enhancement of training opportunities, decrease of regulatory compliance costs, and creation of a stronger controls environment.

Accountability - A CSA program increases the accountability of operational management over internal controls, in general, and process owner accountability and responsibility, in particular. One of the first steps in implementing a CSA program is to ensure that internal controls processes and procedures are established and clearly defined. Each process owner must understand the "big picture" process owned by his or her department, including each team member’s role and how various control activities performed by the team are linked together. Each process owner is then required to test the effectiveness of their controls, performing defined test scripts, collecting evidence, and verifying whether a given control is working as designed. The process owner is now personally responsible for monitoring and verifying the effectiveness of the department’s internal controls throughout the year, where as in the past, they would simply react to concerns or recommendations coming out of a periodic audit.

An effective CSA program brings the sense of internal controls accountability to each respective member of the process owner’s team. Those who are directly involved in processing transactions or performing the key controls for a given process are in the best position to validate the operating effectiveness of these controls. By including these individuals in the CSA process, they will gain a better appreciation for their roles as control owners, better understand their responsibilities, and become more controls-conscious.

Sustainability - An effective CSA program sustains Sarbanes-Oxley compliance, or similar efforts, by embedding the evaluation of internal controls effectiveness into everyday activities and routines. This sustainability results from several considerations. First, while implementing a CSA program, management is likely to identify opportunities to streamline and improve existing control activities, eliminating redundant efforts and mitigating any deficiencies. Second, the process of implementing a CSA program provides the process owner and individual control owners with a greater appreciation for their particular role within it. Third, an effective CSA program will hold individuals accountable for fulfilling their ongoing internal control responsibilities as well as supporting CSA efforts. Finally, ongoing CSA efforts are likely to generate additional insights on how to enhance and streamline the organization’s internal controls system. As such, implementing a CSA program allows management’s Sarbanes-Oxley compliance program to evolve from a project-driven effort to a sustainable process.

Training Tool - An effective CSA program can be an effective training tool. The process of implementing a CSA program and then performing CSA testing throughout the year helps those who process transactions to understand their role within the big picture, so that they can become more effective at performing their work. CSA also enables operating management, especially each process owner, to better understand their end-to-end process, the linkage between key controls and the roles fulfilled by each member of the team. Finally, CSA documentation can be reviewed by new members of a team so they can quickly get up to speed in regards to their overall role and internal control obligations. An effective CSA program ensures that internal control training, like the compliance effort overall, becomes part of the daily routine.

Cost of Compliance - Sarbanes-Oxley requires management to perform operating effectiveness testing of its internal controls system. To meet this requirement, many companies have engaged external consultants, burdened their internal audit function, or hired new staff. By implementing an effective CSA program, management can reduce or eliminate reliance on third parties, enable the internal audit function to focus on more pressing or strategic requests, and stem further headcount increases purely to facilitate compliance efforts. With a CSA program, effectiveness testing will be performed by many associates throughout the organization as part of their ongoing roles and responsibilities. Because a CSA program is widespread, the burden should not be overwhelming for any one individual.

Stronger Internal Control Environment - An effective CSA program is a win-win scenario because it both enhances the efficiency of the Sarbanes-Oxley compliance process and increases a company’s overall control consciousness. With the widespread involvement of management and staff, the organization will have better trained and motivated employees, especially if CSA responsibilities are measured and rewarded via performance reviews. In addition, CSA testing throughout the year enables management to identify internal control deficiencies and to promptly address any control failures. Indeed, CSA is more preventative than detective, in that staff become attuned to internal controls and begin identifying and correcting issues as they happen, rather than discovering the breakdowns later. An effective CSA program will enhance communications between operational and top management, and provide greater assurance to both senior management and external auditors that the organization’s internal controls are operating effectively.

Implementing a CSA Program
There are nine major steps to implementing a CSA program. These steps encompass defining the nature and extent of the organization’s CSA program, rolling out the program, performing the first round of testing and review, and then incorporating lessons learned before going through the process again. Specifically, these nine steps are outlined below.

Research CSA Models and Best Practices - There is limited formal guidance available regarding how to initiate a CSA program, but an external auditor may be able to provide insight or introduce you to other clients who have implemented such a program. Sarbanes-Oxley conferences and participating in professional organizations, such as PICPA, may also introduce you to contacts with CSA subject matter expertise. In other words, the best guidance will come from those who have already gone down the path of implementing CSA programs. Learn how they structured their program, what worked and what did not, and any specific suggestions.

Define CSA Scope, Principles, and Objectives - Each organization will be unique with regard to the scope, principles, and objectives of its CSA program. As such, there must be solid communication of, and alignment behind, all key aspects of the CSA program between all key stakeholders, including each process owner and individual control owner, internal and external auditors, senior management, and the company’s board of directors.

Define Roles and Responsibilities - One of the most critical steps in developing an effective CSA program is identifying and defining the roles and responsibilities of the key players in the process, including process owners, CSA business testers, and CSA business reviewers. Typically, a process owner should be a subject matter expert with strong project management skills and enough seniority to ensure that CSA efforts are prioritized, despite other demands. The CSA business tester will perform detailed CSA testing and document the results accordingly. The CSA business tester must have an appropriate balance between understanding the process and underlying controls to be tested and being independent enough to have a reasonable degree of professional skepticism. The CSA business reviewer must also have enough understanding of the process to perform an effective review, otherwise external auditors may find issues and will not be able to place reliance on the internal work performed. As such, the process owner is often the logical person to assign as CSA business reviewer for a given process.

After defining these roles within the new CSA program, determine what roles the internal audit function, any centralized Sarbanes-Oxley compliance teams, and others will play, if any. For example, internal auditors may formally assess the CSA work performed and issue an opinion accordingly, or they may simply include the underlying internal controls of a given process within the scope of an overall risk-based audit. Similarly, a centralized Sarbanes-Oxley compliance team may be the formal oversight of all CSA work performed, or may be a resource to operational management in implementing a CSA program. CSA programs can be structured in many different ways, so defining all key roles upfront and gaining alignment from all parties involved in the program is critical.

Schedule CSA Training and Program Roll-Out - After determining the overall structure, principles, and expectations of the CSA program, schedule the training and then formally roll out the program. When doing so, though, consider customizing the CSA training to meet the needs of the given audience. For example, those participants who lack audit experience may better grasp the specific requirements of your new CSA program if you first deliver basic training regarding the nature of internal controls and the objectives of the audit function.

Establish CSA Requirements by Functional Process - Once the process owners and individual control owners understand the key principles behind, and objectives of, the new CSA program, they can establish the CSA requirements for their given process. Specifically, they will need to define the test scripts to be performed for each key control objective within the given process, including predetermined sample sizes, specific test steps, evidence to be maintained, and what constitutes a pass or fail for each test. To the extent that management expects the external auditor to leverage the results of this testing, the sample sizes and frequency of tests should be appropriate.

Perform CSA Testing and Review - During a round of CSA testing, each CSA business tester should review existing internal controls documentation, including key controls and related test scripts, for each assigned area of responsibility. Then they should perform appropriate CSA testing in accordance with pre-established test scripts and formally document the results, maintaining related evidence as appropriate. Each tester, moreover, should discuss any potentially new internal control deficiencies with the process owner or individual control owner. Finally, to complete the round of CSA testing, the process owner or other appropriate individual should review the CSA testing documentation, including a write-up of testing performed, conclusions reached, and any supporting evidence.

Remediate Identified Internal Control Deficiencies - If internal control deficiencies are identified during the CSA process - whether through some concern over the design of the controls or failures identified while testing the effectiveness of these controls - initiate gap remediation efforts as soon as possible. Recognize that there is a difference between having adequate and having best-in-class controls. In other words, maintain a continuous improvement mindset, identifying ways to make internal control procedures more efficient and the internal controls themselves more effective.

Review Lessons Learned and Refine CSA Program - After developing and rolling out a new CSA program, and going through the testing, formally solicit feedback and review the lessons learned. Next, based on this insight, the CSA program can be refined to enhance its benefits to the organization. For example, you may learn that those process owners who lacked prior audit experience struggled while identifying the key controls in their process or while defining test scripts to verify the effectiveness of these key controls. As such, you may want to modify your CSA training and support for that given audience.

Do It Again - An effective CSA program is a sustainable process for monitoring and testing the effectiveness of internal controls. To that end, although you must determine the appropriate frequency of performing CSA testing (such as two or four rounds of testing per year), each process owner and team needs to do it again.

Conclusion
Whether you are motivated by a desire to meet your company’s Sarbanes-Oxley compliance requirements in the most cost-effective manner, or simply because you know that having a strong internal control environment will help your organization operate in the most efficient manner possible, consider implementing a CSA program. By implementing an effective CSA program, you can embed internal control accountability deep into the organization, ensure the sustainability of your internal controls compliance efforts, provide a training tool to ensure new and existing associates conceptually understand the importance of their role, and ultimately reduce the cost of overall compliance efforts. In other words, an effective CSA program will drive a much stronger internal control environment, giving assurance to all key stakeholders, internal and external alike, that the organization’s controls are operating effectively.

J. Stephen McNally, CPA, is finance director and controller for Campbell Soup’s Napoleon, Ohio, operations, and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at j_stephen_mcnally@campbellsoup.com.

I'm an Auditor, Darn It, Not an Investigator, Right?

bhayes — Tue, 09 Oct 2007 13:16:00 GMT

By Paul E. Zikmund, CFE, CFD, and Marge O'Reilly-Allen, CPA, PhD

Recent professional guidance, such as SAS 99, Consideration of Fraud in a Financial Statement Audit, and Public Company Accounting Oversight Board (PCAOB) Auditing Standard 2, has brought more attention to the auditor’s responsibility to uncover the warning signs of fraud, but there is still some ambiguity about where the auditor’s responsibility ends and the fraud examiner’s begins.

Consider this scenario: A staff auditor reviewed various accrual accounts during a routine audit. He uncovered 10 manual entries made after the quarter’s close that lacked sufficient supporting documentation and that significantly reduced the reserve balance for each account. The auditor reviewed the entries in the system and found the same explanation for each reduction: "reduce accrual by $1.5 million, per John Davies, corporate controller." The total amount of reductions came to $15 million, and was material to the financial statements of the company.

The auditor brought this information to the audit manager, who advised him to discuss the entries with the corporate controller. The controller provided verbal support for each entry. The auditor had no reason to disbelieve the controller, so he cited the lack of supporting documentation as an audit finding and completed the report. Six months later, news came out that the controller was adjusting various accrual accounts to manipulate earnings. The auditor was distraught about the situation, and questioned his or her conduct and the audit procedures. The audit manager was asked to explain why the audit team did not pursue the findings and press for supporting documentation. The controller was terminated, and the company underwent an investigation by the Securities and Exchange Commission (SEC). The auditor continued to wrestle with himself: “I’m an auditor, not an investigator….right?” Auditors and forensic accountants share common attributes, but their roles differ significantly. Sometimes it can be difficult for auditors to understand their responsibilities for fraud detection, investigation, and prevention. Generally, companies call in a fraud examiner to conduct an investigation once fraud is suspected, but the auditor is the person who initially finds the red flags of potential fraud.

The key differences between the auditor and fraud examiner can be found in the chart below. The auditor’s role in fraud detection has a long history of confusion and controversy. In 1892, the widely used auditing textbook A Practical Matter for Auditors, by Lawrence Dicksee, expressed the view that the objective of an audit was the detection of fraud, technical errors, and errors of principle. It stated, "the detection of fraud is the most important portion of the auditor’s duties." Shortly thereafter, the auditor’s role in fraud detection started to evolve. In an 1895 British court case (London and General Bank), the court ruled that it was the auditor’s responsibility to report to shareholders all dishonest acts, but that the auditor could not be expected to uncover all fraud committed in a company, although they should conduct all audits with reasonable care. Fast-forward to the 21st Century. The nature of the auditor’s responsibility to detect fraud is still the subject of confusion. For example, a 2003 study of prospective jurors conducted by Camico, a provider of CPA malpractice insurance, found that 74 percent of respondents believe audits are designed to uncover all types of fraud. In fact, according to a 2006 Association of Certified Fraud Examiners (ACFE) Report, Report to the Nation on Occupational Fraud and Abuse, only 12 percent of fraud is initially detected by external auditors, while 50 percent came from employee tips, 20 percent came from internal audits, and 19 percent was detected by internal controls.

Responsibilities
The management of public companies are required by PCAOB Auditing Standard 2 to develop and implement internal controls to prevent, detect, and deter incidents of fraud in financial reporting, and Section 404 of the Sarbanes-Oxley Act requires management to assess and report on the effectiveness of those internal controls on an annual basis.

Section 404 also requires external auditors to evaluate their clients’ antifraud programs and internal controls, and to issue an opinion on management’s assessment of internal controls. SAS 99 requires auditors to plan the audit to provide reasonable assurance that financial statements are free of material fraud. It also provides expanded guidance and recommended procedures for the detection of material fraud. SAS 99 specifies that auditors should adopt an attitude of professional skepticism toward clients, conduct brainstorming sessions to assess the risk of material fraud and how it could be concealed, conduct an assessment of a client’s overall antifraud programs, and look for red flags that may indicate fraud. PCAOB Auditing Standard 2 reinforces this guidance.

Internal auditors also play a role in fraud deterrence. Institute of Internal Auditors Standard 1210.A2 requires internal auditors to possess sufficient knowledge to identify the risk indicators of fraud. Internal audit can assist with the prevention and detection of fraud by evaluating the adequacy and effectiveness of internal controls and by participating in the risk assessment process, which is a key step when evaluating whether internal controls are effective.

So, at what point does an auditor cross over the line into the realm of the investigator? No guidance exists that specifically states what steps an auditor must follow when he or she believes there may be a case of fraud. Often, the matter comes down to knowing when to explore and review more data. At this point, depending on the findings, the auditor decides whether to become an investigator. For example, an auditor who uses ratio analysis to detect unusual patterns or trends in account balances may satisfy the established guidelines; while an auditor who uncovers noticeable deviations and fails to conduct additional analytical techniques or audit procedures to determine the cause of the deviations may not.

If an audit fails to uncover existing fraud, the inevitable question is "Where were the auditors?" There is no shortage of court cases in which audit firms were found at fault for failing to detect or disclose material fraud. The auditor is not always culpable, but some of the primary reasons that an auditor may have failed to detect fraud include over reliance on client representations; failure to maintain an appropriate level of professional skepticism; failure to recognize that an observed condition may indicate a material fraud; lack of experience; or personal relationships with clients.

There is, however, a misperception between what the public thinks auditors should do to detect fraud, and for what auditors are truly responsible.

The Expectation Gap
In a November 2006 report, Global Capital Markets & the Global Economy,1 the CEOs of the six largest audit firms stated "there is a significant expectation gap between what various stakeholders believe auditors do, or should do, in detecting fraud and what auditors are capable of doing at prices companies or investors are willing to pay." The CEOs point out that fraud detection methods recommended under SAS 99 are not perfect, and that auditors are often restricted in their methods to detect the red flags of fraud. As an example, the CEOs cite the limitation of using indirect means during the audit, such as reviews of anomalies and interviews not conducted under oath, to ascertain if the possibility of fraud exists.

Among the recommendations directed at narrowing the expectation gap, the CEOs proposed a constructive dialogue among investors, other company stakeholders, policy makers, and accounting professionals. Some items for consideration include the following:
-- Subject all public companies to a forensic audit on a regular basis
-- Subject all public companies to a forensic audit on a random basis
-- Let shareholders decide on the intensity of the forensic audit
-- Let the audit committee decide on the level of the forensic audit

The CEOs also suggest penalizing those directly implicated for failing to uncover material fraud, rather than the entire auditing firm that employs them.

In contrast to the CEOs’ viewpoint, PCAOB believes auditors should do more to detect fraud. In January 2007, PCAOB released a report, Observations on Auditors’ Implementation of PCAOB Standards Relating to Auditors’ Responsibilities with Respect to Fraud, based on observations made during their inspections of audit work performed by registered public accounting firms. In the report, PCAOB listed some key areas of concern:
-- Overall approach to the detection of financial fraud
-- Fraud-related inquiries
-- Response to fraud risk factors
-- Financial statement misstatements
-- Fraud associated with management override of controls

PCAOB recommends that external auditors improve their fraud assessment techniques and better document their efforts to detect material fraud. In the report, PCAOB’s inspection teams indicated that some auditors still appeared to mechanically check off items on standard audit programs and checklists without gathering additional documentation as evidence of the actual performance of procedures, and that audit planning did not always include brainstorming sessions to assess fraud risk. PCAOB reminds auditors that "careful attention to these requirements is important to best position auditors to detect material misstatements caused by fraud."

Despite the guidance concerning management’s and the auditor’s responsibilities to deter and detect fraud, the expectation gap is persistent because the public expects auditors to find fraud if it exists at all within a company.

Reducing this expectation gap requires an effort from all parties involved. Shareholders need to learn that auditors are neither capable of, nor responsible for, uncovering all fraud within an organization. Fraud, by its very nature, is collusive, and the essence of fraud is concealment. PCAOB should continue to apply pressure for compliance and oversee auditors’ work to ensure they are using the necessary techniques to detect fraud. Auditors face the greatest challenge of all. The warning signs indicating potential fraud must be searched for, investigated, and documented more thoroughly. Auditors also should educate themselves about fraud detection through coursework and training.

Fraud is, and always has been, a significant business risk. All stakeholders share responsibility to uncover fraud and to take measures to reduce the risk of its occurrence. An expectation gap will probably always exist to some degree, but if the incidence of fraud does not decrease, this gap will continue to widen until there is even more government regulation, stricter enforcement actions, and ultimately a system requiring forensic audits on a routine basis. These actions will add to the cost of an audit and create a disruption to the business environment.

1 Global Capital Markets & the Global Economy, Global Public Policy Symposium, Paris 2006

Paul E. Zikmund, CFE, CFD, is a principal with the enterprise risk management and fraud forensic services sector of Solomon Edwards Group LLC in Wayne, Pa. He can be reached at pzikmund@solomonedwards.com.

Marge O’Reilly-Allen, CPA, PhD, is chair of the accounting department at Rider University in Lawrenceville, N.J., and a member of the Pennsylvania CPA Journal Editorial Board. She can be reached at oreillyallen@rider.edu.

Technology Generation Upgrades: Are Educators and Employers on the Same Page?

bhayes — Tue, 09 Oct 2007 13:02:00 GMT

By Susan C. Borkowski, PhD, Rose Marie L. Bukics, CPA, and Mary Jeanne Welsh, CPA, PhD

Information technology (IT) and information systems are pervasive in today’s business environment. CPAs, therefore, have to understand IT processes and controls. What are accounting educators doing to prepare students as they enter an environment in which data moves through computerized accounting packages, intranet portals, or enterprise resource planning (ERP) systems? More importantly, though, are accounting educators and professionals even on the same page with respect to IT education?

Partners and managers at each of the Big 4 accounting firms and at some mid-sized firms were interviewed to determine what technology skills entry-level staff are expected to have and what IT skills they would like to see taught in business schools. Those responses were then compared with the accounting information systems (AIS) courses at 11 Pennsylvania universities. An AIS course is typically where accounting students are introduced to IT controls, including the COBIT (Control Objectives for Information and Related Technology) framework, as well as specific accounting packages. Since students develop IT skills in computer science and management information systems (MIS) courses, we also asked for information about those courses.

Accounting firms seem to be in agreement in their expectations for technology skills of entry-level accountants, and these expectations are shared by new hires, too. Cutting edge technology is important to young accounting professionals, both as they enter the profession and as they progress through their careers. In a Commerce Clearing House whitepaper, based upon a 2006 survey of young accounting professionals, two compelling statistics were revealed: first, close to 70 percent of those surveyed believe access to the right technological resources was critically important to them; and second, 55 percent of young CPAs surveyed believed access to technology as an aid to improving productivity was essential to their work environment.1

AICPA Core Competency Framework
AICPA’s Core Competency Framework defines skill-based competencies for entry-level professionals, and is intended to give educators guidance in developing accounting curricula that can help students develop the professional skills they need.2 The effective use of technology is one core competency, which AICPA states is evidenced by the following skills:
-- Identifying risks associated with technology and automated business processes
-- Accessing electronic databases to obtain decision-supporting information
-- Using electronic spreadsheets and other software for modeling and simulations
-- Assessing technology risk
-- Developing strategic uses of technology
-- Adopting new technology over time.3
Based on our interviews, students who demonstrate these skills as new staff will meet firm expectations.

What CPA Firms Are Saying
In 2000, the American Accounting Association, AICPA, IMA, and the then Big 5 accounting firms published a study on accounting education. When faculty and practitioners were asked to rate specific technology skills for new hires, the most highly rated skill by both groups was "spreadsheet software."4 Much has changed in the profession over the past seven years, but the importance of spreadsheet software has not. All the practitioners we interviewed cited proficiency in Excel as a critical skill, which includes the ability to use some of the more complex functions, not just the ability to create charts and graphs. They noted that if new hires came in knowing Excel, they could "hit the ground running" and focus on learning firm-specific technology.

The managers and partners we interviewed believe new staff usually arrive with the necessary skills in basic business software. Some staff, however, commented that they would have been better prepared if Excel had been integrated into the accounting curriculum and used on a regular basis for projects and assignments.

Staff who work in both assurance and tax said that they did not realize that they would be using Excel on a daily basis. They said they would have been more efficient and delivered better quality work products if they had developed more advanced Excel skills in their accounting programs.

Partners and managers did not recommend that students should develop proficiency in a specific accounting package, since they will encounter many different types. What is more important, they say, is a general understanding of how accounting systems operate, including accounting software structure and controls. Firms provide training in their own technology platforms, and have found that those who have a general understanding of accounting systems could learn the specifics of a package, such as Great Plains, when they encountered the package at a client’s site.

There was less consensus on whether new staff needed to be proficient with database software, such as Access. Only one partner mentioned proficiency with Access as important for new staff. Another said that it was less important than other general business software, such as word processing and presentation software. There was agreement among Big 4 partners that knowledge of ERP systems, such as SAP and PeopleSoft, would be a significant advantage to new staff since many clients use those packages. In fact, one interviewee noted that an entire advanced course could probably be built around just ERP systems. One audit partner said, "understanding how ERPs work would really give a student the perspective on what our clients do and would demystify the black box."

IT controls is another area where students could benefit from more exposure. There is a sense that students learn basic IT operating controls, but not controls such as security, computer operations, program development, and program changes. Students have not had to think about who has access to information or who can make changes to certain programs.

Several managers and partners in firms of various size stated that student exposure to some of the commonly used audit software that drives and supports both the operational aspects of the audit and the management of the audit process itself, would be beneficial. These conversations indicated that exposure to audit management software, such as CCH Pro System FX Engagement or PPC Engagement Manager, would offer insight into the technology used on a daily basis in an audit engagement.

Another critical skill for future auditors to develop is an understanding of how client data can be accessed and filtered to drive and support the audit objective. Whether analyzing client accounts or selecting specific accounts receivable for confirmation, file interrogation tools, such as Audit Control Language, are used by many large firms.

Looking forward, the trend toward the use of XBRL (Extensible Business Reporting Language) and its impact on the preparation and submission of financial reporting data needs to be considered. Long recognized and used outside of the United States, XBRL is gaining acceptance in this country, spurred on by the Security and Exchange Commission’s 2006 voluntary test program initiative. HTML transformed and standardized the presentation of material on the Web, and XBRL, likewise, could have the same effect on how financial statement data is created, stored, accessed, manipulated, analyzed, and reported.

What’s Happening in the Classroom?
Eleven of the largest Pennsylvania universities offering an undergraduate major in accounting were contacted, and we received information from 10 of them. We e-mailed the faculty member identified on each university’s Web site as teaching an AIS course, requesting a copy of the most recent AIS syllabus. If we did not receive a response within two weeks, or if the identity of the AIS faculty member could not be discerned, the same request for an AIS syllabus was e-mailed to the accounting department chair. In that e-mail, the following question also was posed: "How do (university name) accounting majors acquire their Excel expertise? Is it through a first-year computer science course, through a non-credit stand-alone module where the student must pass a competency test, or in the introductory financial accounting course? Or, do you have a different approach? Please provide as much detail as you can about how Excel competency is achieved by your accounting majors."

AIS Course Content
General information about AIS courses was obtained from the 11 schools’ Web sites. Nine schools require an AIS course for the accounting major: two require it in the sophomore year, five in the junior year, and two in the senior year. The remaining two schools offer AIS as an elective to senior accounting majors. Complete information was received from 10 universities, with only partial information coming from the remaining university.

Details about the topics covered, as well as texts and software required, are presented in Table 1. Course characteristics varied, including topics covered, grading criteria, and required assignments. Partners stressed the importance of familiarity with ERP systems, and most AIS courses included some coverage of ERP. Two universities, however, did not include any ERP-related content. Instead, these courses included hands-on use of a traditional accounting system, such as QuickBooks or Great Plains. This is surprising, given the omnipresence of ERP systems in large and mid-sized companies in 2007.

To determine course content, we looked at the textbooks used in the AIS courses. There is a preference for traditional AIS textbooks. Four schools use Hall’s Accounting Information Systems (Hall), three use Romney and Steinbart’s Accounting Information Systems (R&S), and two use Bagranoff, Simkin and Strand Norman’s Core Concepts of Accounting Information Systems (BSS). One uses the nontraditional Enterprise Information Systems: A Pattern-Based Approach by Dunn, Cherrington, and Hollander (DCH), and one course is designed around weekly readings centered on specific topics in lieu of a formal textbook.5 The tables of contents for the four textbooks show the diversity in approach to teaching AIS.

The partners interviewed noted that new staff did not appear to have had much exposure to general IT controls. Our review of AIS textbooks and syllabi suggest their perception is correct. The percentage of course time spent on control issues varies widely, from as much as 40 percent of an AIS course, to as little as 6 percent. There is the possibility that control issues are addressed elsewhere in the accounting curriculum, but our review suggests that this is an area of the accounting curriculum that needs more consideration.
Based on the review of tables of contents, computer crime and ethical issues also do not appear to be major course components of AIS courses. Textbook coverage is limited to a single chapter, with titles such as "Ethics, fraud and internal control" and "Computer crime and ethics" respectively.

Many courses emphasize hands-on experience with traditional accounting and ERP systems in both the syllabi and catalog course descriptions, but traditional examinations are the primary component (greater than 40 percent) of the final grade at eight of the 10 schools. Hands-on experience is crucial to learning and understanding accounting and other information systems, so we thought assignments such as projects and case studies would have accounted for a higher percentage of the final grade.

Excel Competency
There is no uniform approach used by Pennsylvania universities in developing Excel proficiency. As shown in Table 2, Panel A, five of the 11 universities require business majors to take a core computer science course. Four universities require a three-credit general introduction to computers course, which includes an Excel component. The fifth requires a one-credit, Excel-specific course.

An equal number of respondents require a formal competency/proficiency test in Excel and its more sophisticated functions. One of these five allows students to take a proficiency test without taking its one-credit, Excel-specific course. If students fail the proficiency test - which most do, since the test includes a section on pivot tables - then they must complete the one-credit course. Only one school surveyed requires neither an introductory computer course nor a competency exam. Table 2, Panel B, presents more specifics about each school’s approach to acquiring Excel skills.

A number of universities indicated that Excel was used in accounting courses, but we did not get detailed information about advanced Excel functions in course assignments. Most of the accounting textbooks include problems designed to be solved using Excel spreadsheets, but they do not necessarily require the use of advanced functions, such as pivot tables. This requires faculty to develop their own assignments or find supplemental material. The feedback we received from newer staff accountants suggests that students would benefit from more assignments that use advanced functions. This is an area in which educators could benefit from working with practitioners to develop assignments and projects that help students gain the spreadsheet skills they will need.

Conclusion
We all recognize that IT continues to grow in its use and applications, and is constantly changing. This presents a continual challenge for educators to deliver the very best students, with the very best skill sets, to the marketplace. To solve this conundrum, accounting firms and educators need to maintain close and frequent consultation to make sure everyone is on the same page with respect to providing the right exposure to the right technology.

1 Commerce Clearing House whitepaper, http://tax.cchgroup.com/yaps.pdf
2 http://www.aicpa-eca.org/
3 http://www.aicpa-eca.org/library/ccf/default.asp
4 W. Steve Albrecht and Robert J. Sack, Accounting Education: Charting the Course through a Perilous Future (Sarasota FL: American Accounting Association, 2000), p. 57.
5 Nancy A. Bagranoff, Mark G. Simkin and Carolyn Strand Norman. Core Concepts of Accounting Information Systems, 10th edition. (Hoboken, NJ: John Wiley and Son, 2007). Cheryl L. Dunn, J. Owen Cherrington, and Anita Sawyer Hollander, Enterprise Information Systems: A Pattern-Based Approach, 3rd edition. (New York: McGraw Hill, 2005). James A Hall, Accounting Information Systems, 5th edition. (Mason, OH: Thomson South-Western, 2007). Marshall Romney, and Paul J. Steinbart, Accounting Information Systems, 10th edition. (Upper Saddle River, NJ: Prentice Hall, 2006).

Susan C. Borkowski, PhD, is professor of accounting and joint faculty, integrated science, business and technology program at La Salle University. She can be reached at borkowsk@lasalle.edu.

Rose Marie L. Bukics, CPA, is the Thomas Roy and Lura Forrest Jones Professor of Economics and Business at Lafayette College in Easton, and is a member of the Pennsylvania CPA Journal Editorial Board. She can be reached at bukicsr@lafayette.edu.

Mary Jeanne Welsh, CPA, PhD, is chair of the accounting department at La Salle University, and is a member of the Pennsylvania CPA Journal Editorial Board. She can be reached at welsh@lasalle.edu.