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Accounting M&As

Accounting for M&As
Accounting for M&As 850 500 smolinlupinco

Mergers and acquisitions (M&A) transactions significantly impact financial reporting, especially the balance sheet, which will look markedly different after the business combination. Keep reading for basic guidance on reporting business combinations under U.S. Generally Accepted Accounting Principles (GAAP).

Understanding the purchase price allocation process

Under GAAP, the buyer must allocate the purchase price to all acquired assets and liabilities based on their fair values. 

Estimate the purchase price

The purchase price allocation process begins by estimating a cash equivalent purchase price. Of course, this is simpler if the buyer pays 100% cash upfront. (The purchase price is already at a cash equivalent value.) If a seller accepts non-cash terms, however, the cash equivalent price is less clear. An example of this could be accepting stock in the newly formed entity or if an earnout is contingent on the acquired entity’s future performance. 

Identify assets and liabilities

Next, the buyer needs to identify all intangible and tangible assets and liabilities acquired in the merger. While the seller’s presale balance sheet is likely to report tangible assets and liabilities—like inventory, payables, and equipment—intangibles can be more difficult to nail down. They might only be reported if they were previously purchased by the seller. Since intangibles are generated in-house, they’re not often included on the seller’s balance sheet. 

Determining the fair value of acquired assets and liabilities

When a company acquires another company, the acquired assets and liabilities are added to its balance sheet at their fair value on the acquisition date. Any difference between the sum of these fair values and the purchase price is recorded as goodwill.

Generally, goodwill and other intangible assets with indefinite lives, such as brand names and in-process research and development, aren’t amortized under GAAP. Rather, goodwill must be tested for impairment on an annual basis. 

Testing for impairment

It’s also a good idea to test for impairment when certain triggering events—like the loss of a major customer or enactment of unfavorable government regulations—occur. If an impairment loss is reported by a borrower, this may signal that the business combination isn’t quite meeting management’s expectations. 

Straight-line amortization

As an alternative to testing for impairment, private companies may opt to amortize goodwill over 10 years straight-line. Even with this approach, though, the company will need to test for impairment when triggering events occur. 

Occasionally, a buyer negotiates a bargain purchase. In this circumstance, the fair value of the net assets exceeds the fair value of consideration transfer (the purchase price). Instead of recording negative goodwill, the buyer reports a gain from the purchase on their income statement. 

Questions? Smolin can help.

Accurately allocating your purchase price is crucial to minimize write-offs and restatements in subsequent periods. Contact Smolin from the start to ensure every detail of your M&A accounting is correct. We’ll help ensure your fair value estimates are supported by market data and reliable valuation techniques.

Tax Depreciation Rules Business Automobiles

How do tax depreciation rules apply to business automobiles?
How do tax depreciation rules apply to business automobiles? 850 500 smolinlupinco

If you use an automobile in your trade or business, you may question how depreciation tax deductions are determined. The rules are complex. In particular, special limitations apply to business vehicles classified as passenger autos (which include many pickups and SUVs). Often, these limitations result in longer-than-expected wait times to depreciate a vehicle completely.

As you review the details below, remember that the rules are different if you lease an expensive passenger auto you use for business. (Reach out for more details.) 

The cents-per-mile rate includes the cost of depreciation

For passenger autos, separate depreciation calculations only apply if you use the actual expense method to determine your deductions. If you use the standard mileage rate instead, depreciation is already included in that rate. For 2023, the standard mileage rate is 65.5 centers per business mile driven. 

Using the actual expense method to calculate depreciation for passenger automobiles

You must make a separate depreciation calculation for each year until the vehicle is fully depreciated if you choose to use the actual expense method to calculate your allowable deductions for a passenger automobile.

Generally, you can calculate depreciation over a six-year span as follows:

Year 1: 20% of the cost

Year 2: 32% of the cost

Year 3: 19.2% of the cost

Year 4: 11.52% of the cost

Year 5: 11.52% of the cost

Year 6: 5.76% of the cost

Note: If 50% or less of the use of the vehicle is for business purposes, you MUST use the straight-line method to calculate depreciation deductions, NOT the percentages listed above.

Depreciation ceilings

You’re limited to specified annual depreciation ceilings for passenger autos that cost more than the applicable amount for the year the vehicle is placed in service. These ceilings may change annually and are indexed for inflation.

For example, for a passenger auto placed in service in 2023 that cost more than a certain amount, the Year 1 depreciation ceiling is $20,200 if you choose to deduct first-year bonus depreciation. The annual ceilings for later years are as follows: Year 2, $19,500; Year 3, $11,700; and for all later years, $6,960 until the vehicle is fully depreciated.

To account for non-business use, these ceilings are proportionately reduced depending on the amount the vehicle is used for business vs. personal use. 

Reminder: Bonus depreciation will be phased out

Under the Tax Cuts and Jobs Act, bonus depreciation will be phased down to zero in 2027 unless Congress acts to extend it. 

In 2023, the deduction is 80% of eligible property. In 2024, it’s scheduled to decrease to 60%. 

Pickups, Heavy SUVs, and vans

If you have heavy SUVs, vans, or pickups that you use for business purposes over 50% of the time, you may be able to take advantage of more favorable depreciation rules. That’s because vehicles with a gross vehicle weight rating (GVWR) of over 6,000 pounds are treated as transportation equipment for depreciation purposes.

To determine whether your vehicle falls into this category, check the inside edge of the driver’s side door for the vehicle’s GVWR.

Depreciation limits change the after-tax cost of passenger autos used for business

These depreciation limits impact the after-cost tax of your business vehicles. The true cost of business assets is decreased in proportion to the tax savings from related depreciation deductions.

To the extent depreciation deductions are reduced and thereby deferred to future years, so is the value of the related tax savings, thanks to time-value-of-money considerations. Therefore, the true cost of the asset may be that much higher.

Questions? Smolin can help.

As you can see, tax depreciation rules for business automobiles are complex and constantly evolving. If you’re considering purchasing a new business vehicle soon, please contact us for the most personalized, up-to-date guidance.

Listing home vacation rental tax impacts

Listing your home as a vacation rental? Here are the tax impacts to watch for
Listing your home as a vacation rental? Here are the tax impacts to watch for 850 500 smolinlupinco

Whether in the mountains or a waterfront community, many Americans dream of owning their perfect vacation home. If you already own a second house in a desirable area, you might consider renting it out for part of the year.

Before you post that listing, though, take a moment to learn about the tax implications. Taxes for these transactions can be complicated. They are determined based on how many days the home is rented, as well as a few other factors.

Vacation use by yourself and family members (even if you charge them rent) may impact that amount of taxes you pay. Use by nonrelatives will also affect your rate if market rent isn’t charged.

Tax rates for short-term rentals

Did you know that if you rent a property out for less than 15 days during the year, it’s not treated as “rental property” at all? For tax purposes, any rent you receive for this timeframe won’t be included in your income. This can lead to revenue and significant tax benefits in the right circumstances.

There is a drawback to this, though. You can only deduct property taxes and mortgage interest—not depreciation or operating costs. (Mortgage interest is deductible on your principal residence and one other home, subject to certain limits.)

Tax rates for longer rentals

You must include rent received for property rented out more than 14 days in your income for tax purposes. In this scenario, you may deduct part of your depreciation and operating expenses (subject to certain rules). 

However, navigating the numbers can prove challenging. You must allocate which portion of certain expenses are incurred via personal use days vs. rental days, such as: 

  • Maintenance
  • Utilities
  • Depreciation allowance 
  • Taxes
  • Interest

Both the personal use portion of taxes and the personal use part of interest on your second home may be deducted separately. To be eligible, the personal use part of interest must exceed the greater of 14 days or 10% of the rental days. Depreciation on the personal use portion of time is not deductible. 

Losses may be deductible

If allocable deductions are lower than your rental income, you must report the deductions and the rent to determine the amount of rental income you should add to your other income. If expenses exceed the income, it may be possible to claim a rental loss.

The number of days you use the house for personal purposes is important here. If you used the home for more than the greater of 14 days or 10% of the rental days, you used it “too much” to claim your loss.

In this instance, you may still be able to wipe out the rental income using your deductions. However, you can’t create a loss. Deductions you can’t claim will be carried forward, and you may even be able to use them in future years. 

If you can only deduct rental expenses up to the amount of rental income you received, you must prioritize the following deductions:

  • Interest and taxes
  • Operating costs
  • Depreciation

Even if you “pass” the personal use test, you must still allocate your expenses between the personal and rental portions. In this case, though, rental deductions that exceed rental income may be claimed as a “passive” loss (and will be limited under passive loss rules.) 

Questions? Smolin can help.

Tax rules regarding vacation rental homes can be confusing. We only discuss the basic rules above, and additional rules may apply to you if you’re considered a small landlord or real estate professional.

That’s why it’s best to consult with a tax professional before planning your vacation home use. Contact the friendly tax experts at Smolin to learn more.

Running business spouse Tax issues

Running a business with your spouse? Watch out for these tax issues.
Running a business with your spouse? Watch out for these tax issues. 850 500 smolinlupinco

For many spouses who run a profitable, unincorporated small business together, filing taxes can be confusing.

Here are some of the most common challenges to look out for.

Classification: the partnership issue

In many cases, the federal government classifies unincorporated businesses owned by two spouses as a partnership. This means you’ll need to file an annual partnership return on Form 1065.

In order to allocate the partnership’s taxable income, deductions, and credits, you and your spouse must also both be issued separate Schedule K-1s.

Once that paperwork is covered, you should also expect to complete additional compliance-related tasks. 

Calculating self-employment (SE) tax 

The government collects Medicare and Social Security taxes from self-employed people via self-employment (SE) tax.

This year, you should expect to owe 12.4% for Social Security tax on the first $160,200 of your income, as well as an additional 2.9% Medicare tax.

Beyond that $160,200 ceiling, you won’t owe additional Social Security tax. But the 2.9% Medicare tax component continues before increasing to 3.8%—thanks to the 0.9% additional Medicare tax—if the combined net SE income of a married couple that files jointly exceeds $250,000.

You must include a Schedule SE with your joint Form 1040 to calculate SE tax on your share of the net SE income passed through to you by your spousal partnership. In addition, you’ll need to submit a Schedule SE for your spouse to calculate their share of net SE income.

All in all, this can result in a larger SE tax bill than you might expect.

For example, say you and your spouse each have a net SE income of $150,000 ($300,000 total) in 2023 from your profitable 50/50 partnership business. The SE tax on your joint tax return is a whopping $45,900 ($150,000 x 15.3% x 2). That’s on top of regular federal income tax.

Potential tax saving solutions

Option 1: Minimize SE tax in a community property state via an IRS-approved method

IRS Revenue Procedure 2002-69 allows you to treat an unincorporated spousal business in a community property state as a sole proprietorship operated by one of the spouses for tax purposes.

This allocates all of the net SE income to one spouse, so that only the first $160,200 of net SE income from your business will be subject to the 12.4% Social Security tax.

This can dramatically reduce your SE tax bill.

Option 2: Make your business into an S-Corp that pays you and your spouse modest salaries as shareholder-employees

If you don’t live in a community property state, you still have options. By converting your business to an S-Corporation, you can lessen the amount of Social Security and Medicare taxes you’ll owe.

Only the salaries paid to you and your spouse will be hit by the Social Security and Medicare tax, collectively called FICA tax. From there, you can pay out most or all remaining corporate cash flow to yourselves as FICA-tax-free cash distributions. 

Option 3: End your partnership and hire your spouse as an employee

For some couples, running the operation as a sole proprietorship operated by one spouse may make more sense than continuing with a spousal partnership.

In this scenario, you’d hire your spouse as an employee of the proprietorship with a modest cash salary and withhold 7.65% of that salary to cover their share of the Social Security and Medicare taxes. The proprietorship must also pay 7.65% as the employer’s half of the taxes.

As long as the employee-spouse’s salary is modest, the FICA tax will also be modest.

With this strategy, you file only one Schedule SE with your joint tax return (for the spouse treated as the proprietor). A maximum of $160,200 (for 2023) will be exposed to the 12.4% Social Security portion of the SE tax.

Questions? Smolin can help.

If you’re looking for tax-saving strategies for your small business, contact Smolin. We’ll help you determine how to minimize compliance headaches and high SE bills so you can get back to running your business with less tax-induced stress.

Understanding Percentage-of-Completion Method

Understanding the Percentage-of-Completion Method
Understanding the Percentage-of-Completion Method 850 500 smolinlupinco

If your business handles projects that take longer than a year to complete, you’ll need the “percentage-of-completion” method to recognize the associated revenue.

Let’s get into how and why to do this.

Percentage-of-completion vs. completed contract

Individuals and businesses who perform work on long-term contracts—like developers, engineering firms, creative agencies, and homebuilders—typically report financial performance with one of the two following methods:

  • Percentage-of-completion: Revenue recognition is tied to the incurrence of job costs.
  • Completed contract: Revenue and expenses are recorded upon completion of the contract terms.

Per U.S. Generally Accepted Accounting Principles (GAAP), companies that can make a “sufficiently dependable” estimate must use the more complicated percentage-of-completion method.

Those who use this method for reporting typically use the same method for taxes, as well. 

However, the federal tax code makes an exception for certain small contractors with average gross receipts of less than a certain amount over the previous three years.

For 2023, this amount is $29 million, and the number is adjusted annually for inflation. 

Estimating percentage-of-completion

Typically, companies that use the percentage-of-completion method report income sooner than those that use the completed contract method.

To estimate how much of a project is complete, companies usually compare the actual costs incurred to their total expected cost. Job cost allocation policies, change orders, and changes in estimates can complicate the process.

As an alternative, some companies choose to estimate the percentage completed via an annual completion factor.

In either scenario, the IRS requires detailed documentation to support estimates used in the percentage-of-completion method. 

Balance sheet impacts 

If your company uses the percentage-of-completion method, you’ll see an impact on your balance sheet.

You’ll report an asset for costs in excess of billings if you underbill customers based on the percentage of costs incurred. On the other hand, you’ll report a liability for billings in excess of costs if you overbill based on the costs incurred.

Imagine you’re working on a two-year projected valued at $1 million. You incur half of the expected costs in Year 1 ($400,000) and bill the customer $450,000. From a cash perspective, it appears as if you’re $50,000 ahead because you’ve collected more than the costs you’ve incurred. In reality, you’ve underbilled based on the percentage of costs incurred.

At the end of Year 1, you would have reported $500,000 in revenue, $400,000 in costs, and an asset for costs in excess of billings of $50,000. However, if you’d billed the customer $550,000, you’d report a $50,000 liability for billings in excess of costs.

Questions? Smolin can help.

The percentage-of-completion method can be complicated. Still, if your estimates are reliable, this method provides a more accurate picture of the financial performance of your long-term contracts.

If you’d like extra help navigating the percentage-of-completion method and interpreting the insights it provides, contact the helpful team at Smolin.

Tax Rules depreciating business assets evolving. What to expect.

Tax Rules for depreciating business assets are evolving. Here’s what to expect.
Tax Rules for depreciating business assets are evolving. Here’s what to expect. 850 500 smolinlupinco

The Tax Cuts and Jobs Act relaxed the rules for depreciating business assets. Each year, the amounts change in proportion to inflation adjustments. With the remarkably high inflation rate we saw in 2023, this year’s adjustments are significant.

Here’s what you need to know for your small business.

Section 179 deduction amounts

The maximum Sec. 179 deduction is $1.16 million for qualifying assets placed in service in 2023. If your business puts qualified assets worth more than $2.89 million in service, though, that deduction begins to dwindle. 

What assets are eligible?

Eligible assets include depreciable personal property such as:

  • Machinery and equipment
  • Office furniture
  • Fixtures like refrigerators, signs, air conditioners, or heaters
  • Eligible improvements to commercial property like roofs, security systems, and HVAC
  • Computer hardware and peripherals
  • Vehicles (with some restrictions)
  • Commercially available software

Considerations for real estate

You may also claim Sec. 179 deductions for real estate qualified improvement property (QIP) up to the maximum allowance of $1.16 million. To do this, the improvements must be on the inner portion of a non-residential building and must take place after the date the building was placed in service.

However, it’s worth noting that expenditures relating to making a building bigger—such as elevators, escalators, or other internal structural changes—don’t count as QIP. They usually must be depreciated over 39 years.

There’s no separate Sec. 179 deduction limit for QIP, so deductions reduce your maximum allowance dollar for dollar.

Sec. 179 deductions are also allowed for qualified expenditures for security systems, fire protection systems, HVAC equipment, and alarm systems. 

Depreciable personal property used primarily to furnish lodging, like furniture and appliances in certain rental properties, may also qualify.

Heavy SUVs are deducted differently

There is a special limitation for heavy SUVs with gross vehicle weight ratings (GVWR) between 6,001 and 14,000 pounds. If your heavy SUV was put into service during 2022, you may be able to claim 100% of the first-year bonus depreciation percentage.

For tax years starting in 2023, though, the maximum Sec 179 deduction is $28,900. First-year bonus depreciation has been decreased to 80%. This percentage is expected to drop further each year leading up to 0% in 2027.

Exception: These percentage cutbacks will be delayed by one year for certain assets with longer production periods. 

Limitations for passenger autos 

For federal tax purposes, passenger vehicles are defined as cars, light trucks, and light vans. 

Special depreciation limits apply to these vehicles undo luxury auto depreciation rules. 

The maximum luxury auto deductions for used and new passenger autos placed in service during 2023 are:

  • $12,200 for Year 1 ($20,200 if bonus depreciation is claimed)
  • $19,500 for Year 2
  • $11,700 for Year 3
  • $6,960 for Year 4 and thereafter until fully depreciated

Of course, these allowances assume 100% business use and will be further adjusted for inflation in future years.

Heavy vehicles may come with an advantage

Heavy SUVs, pickups, and vans (those with GVWRs above 6,000 pounds) are considered transportation equipment and, as such, are considered exempt from the luxury auto depreciation limitations.

However, at least half of their use must be for business purposes to be eligible for the Sec. 179 deductions and first-year bonus depreciation we discussed above.

If these vehicles are used a significant amount for personal use, their cost must be depreciated using the straight-line method over the course of six tax years.

Otherwise, the business-use percentage of the vehicle’s cost must be depreciated using the straight-line method, and it’ll take six tax years to fully depreciate the cost.

Questions about your business taxes? Smolin can help.

The depreciation rules for business assets can be confusing, but working with a professional can help you get the maximum depreciation tax breaks for your business.

If you want to learn more about what to expect for your specific assets, contact the friendly tax professionals at Smolin.

Overhead allocations: Increasing costs require fresh approach

Overhead allocations: Dealing with increasing costs requires a disciplined mindset and a fresh approach
Overhead allocations: Dealing with increasing costs requires a disciplined mindset and a fresh approach 850 500 smolinlupinco

In the last few years, many overhead costs—like utilities, insurance, interest expense, and executive salaries—have skyrocketed, causing some companies to pass along some of the burden to customers by charging higher prices for their goods and services. 

If you’re feeling the squeeze from these increases, you might be asking yourself if upping your prices is the right move for your business.

Before raising your rates, it’s essential to understand how to allocate indirect costs to your goods or services. Correct cost allocation is critical to evaluating product and service line profitability, which helps you make informed pricing choices for your business.

Define your overhead costs

All businesses face overhead costs. These accounts typically act as catch-alls for any expense that cannot be directly allocated to production. 

Some examples of overhead costs are:

  • Interest expense
  • Taxes
  • Insurance
  • Utilities
  • Equipment maintenance and depreciation
  • Rent and building maintenance
  • Administrative and executive salaries

Generally speaking, your indirect production costs are fixed over the short term, so they won’t change appreciably whether your production increases or decreases.

Calculate your overhead rates

Determining how to allocate these costs to products using an overhead rate is where the challenge comes in. Your overhead rate is generally determined by dividing estimated overhead costs by the estimated totals in the allocation base for a future time period.

Once this is done, multiply your rate by the actual number of direct labor hours for each product to determine the amount of overhead that should be applied. 

For some organizations, this rate is applied across all products produced by the company. While this strategy may be appropriate for a company that makes one standard product for an extended period, it may not be suitable for other types of companies.

If your range of products is more complex and customized, you might want to use multiple overhead rates to allocate your expenses more accurately.

For example, If one of your departments is labor-intensive and another is machine-intensive, setting multiple rates may be the best choice for your business.

Dealing with variances

One issue with accounting for overhead costs is that variances from actual costs are almost always inevitable. If you’re using a simple organization-wide overhead rate, you’re likely to have more variance. With that said, even the most meticulously devised multiple-rate strategies won’t always come in with 100% accuracy.

This can result in large accounts needing constant adjustment, causing some managers to have to deal with complex issues they may not fully understand. 

A situation like this leaves organizations open to dealing with human error or fraud. Luckily, you can drastically limit the chance of overhead mistakes with these four internal control procedures:

  • Address complaints about high product costs with non-accounting managers
  • Evaluate your current overhead allocation and make adjustments as needed
  • Conduct independent reviews of all adjustments to your overhead and inventory accounts
  • Study impactful overhead adjustments over different periods of time to discover anomalies and issues

Have questions? Smolin can help 

While cost accounting can be a challenging process for any manager, you don’t have to deal with it alone. Call the knowledgeable professionals at Smolin, and we’ll help you apply a comprehensive approach to estimating overhead rates and adjusting them when needed.

5-tips-to-prepare-for-year-end-inventory-counts

5 Tips to Prepare for Year-End Inventory Counts
5 Tips to Prepare for Year-End Inventory Counts 1600 941 smolinlupinco

The end of the year is approaching fast. For many, this means time for a physical year-end inventory count—the best way to ensure an accurate amount reported in your company’s perpetual inventory system.

Physical counts may seem tedious and time-consuming, but they can offer valuable insight into your company’s operational efficiency. Fortunately, there are some ways to streamline the process. 

Preparing for your inventory count

Follow the five tips listed below to increase the efficacy of your year-end inventory count. 

1. Use numbered inventory tags

Many companies use two-part tags to count their inventory: one to stay with the item on the shelf, and the other to be returned to the manager following the count. To ensure that the manager can account for every tag issued, use a tagging system to avoid double-counting or omitting items. 

The best way to do this is to number your tags sequentially—whether you order pre-numbered tags or create them yourself is up to you. Either way, you’ll want the tags to be numbered and ready to go well before the count is scheduled to begin. 

2. Preview your inventory

For an efficient inventory count, many companies do a test run a few days before the actual count. This helps to identify and correct any foreseeable problems (such as missing part numbers, unbagged supplies, and insufficient inventory tags). It also helps you determine how many workers to schedule for the project. 

3. Assemble counting teams

To avoid fraudulent counts, it’s helpful to assemble and assign teams to specific areas of the warehouse. (A map often helps workers identify count zones.) Additionally, avoid giving workers inventory listings to reference—encourage them to bring any possible discrepancies to attention rather than duplicating the amount from the listing. 

4. Write off unsaleable items 

If you already know that certain items are going to be written off, such as defective or obsolete items, be sure to dispose of them properly before the inventory count begins. 

5. Pre-count select items

If possible, take some time to pre-count items that aren’t expected to be used before year-end, complete with tagging and storing. If you notice a broken seal on the day of the actual count, those items should be recounted.

Value of inventory

Under the U.S. Generally Accepted Accounting Principles (GAAP), inventory is recorded at cost or market value—whichever is lower. That said, estimating the market value of inventory may require subjective judgment calls. It can be especially difficult to objectively assess the value of work-in-progress inventory, especially when it includes overhead allocations and percentage of completion assessments. 

Because the value of inventory is constantly fluctuating as work is performed and items are shipped and delivered, the best way to capture a static value is to “freeze” operations while the count takes place. This could involve counting inventory during off hours or breaking down counts by physical location. 

External auditors

If your company issues audited financial statements, at least one member of your external audit team will observe the physical inventory count. 

The auditor’s roles include: 

  • Observing procedures, including statistical sampling methods
  • Reviewing written inventory processes
  • Evaluating internal controls over inventory
  • Performing independent counts for comparison
  • Looking for obsolete, broken, or slow-moving items that should be written off

Be prepared to provide your auditors with invoices and shipping/receiving reports, which will be used to evaluate cutoff procedures and confirm reported values. 

Work with an advisor

If you’re concerned about your physical inventory counting procedures, our advisors can help you get it right, including investigating any discrepancies between your inventory count listing and the amount reported in your perpetual inventory system.

Contact us to get started. 

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