accounting

Preparing Year-End Inventory Counts

Preparing for Year-End Inventory Counts
Preparing for Year-End Inventory Counts 850 500 smolinlupinco

Year-end is approaching quickly. If your business operates according to the calendar year, it’s time for a physical inventory account. While this task can feel tedious and time-consuming, it’s also a key chance to further develop your business’s operational efficiency.

As you prepare to undertake the count, let’s review some best practices that will help you make the most of the process. 

The Importance of Accuracy

Accuracy is crucial for many reasons. After all, why bother going through the process of a physical inventory count only to wind up with inaccurate numbers? In addition, you’ll need a trustworthy estimate of ending inventory in order to accurately estimate your company’s annual profits. 

For your income statement

For manufacturers, retailers, and myriad other businesses, the cost of sales is a major expense on the income statement. Calculating it is simple at the basic level. Simply subtract your ending inventory from the beginning inventory plus purchases during the year. 

However, things can become far more complicated without an accurate count. If the inventory balance for the end or the beginning of the year is incorrect, it’s impossible to determine how profitable your company truly is. 

For your balance sheet

When it comes to your company’s balance sheet, inventory is a major line item. In fact, inventory is often viewed as a form of loan collateral by lenders. Plus, stockholders review inventory-based ratios to evaluate the financial strength of your organization. 

And, of course, determining the amount of insurance coverage you’d need in the event of a major loss isn’t possible without an understanding of your true inventory. 

Importance of a Physical Count

Many companies use a computerized perpetual inventory. In it, value increases as you purchase goods (or raw materials are transformed into finished goods.) By contrast, it decreases as those goods are sold.

While this is a great first step, this method doesn’t always lead to an accurate count. This is why it’s so crucial to conduct physical counts at key times of the year as part of a strong internal control system.

In addition to double-checking the system’s accuracy, a physical count also signals to potential thieves and fraudsters that your company takes theft seriously and keeps a firm watch on its assets. 

Challenges Involved in Estimating Inventory Values

Your balance sheet might include inventory that consists of finished goods, works-in-progress, and raw materials, depending on the nature of your company’s origins. Under U.S. Generally Accounting Principles, inventory items are recorded at the market value or the lower of cost.

Subjective judgment calls could be involved when it comes to estimating the market value of inventory, particularly if your business creates and sells finished goods from raw materials. For works-in-progress, assessing value objectively can be particularly challenging because it includes overhead allocations. Percentage of completion assessments could also be needed.

Prepping for the count

Completing some tasks before you begin counting will help the entire process run more smoothly. Steps include:

  1. Create (or order) inventory tags that are prenumbered
  2. Examine inventory ahead of time and look for potential challenges that should be addressed prior to counting
  3. Create two-person teams of workers and assign them to specific count zones
  4. If any inventory items are defective or obsolete, write them off. 
  5. If any items are slow-moving, count them ahead of time and separate them into sealed, clearly marked containers. 

Additional procedure for companies that issue audited financial statements 

Arrange for at least one member of your external audit team to be present throughout your physical inventory count. However, don’t expect them to help with the counting.

Instead, they’ll be responsible for: 

  • witnessing your procedures (including any statistical sampling methods employed)
  • evaluating inventory processes
  • assessing internal controls over inventory
  • running an independent count to compare counts made by your employees with your inventory listing 

Questions? Smolin can help.

Over the years, we’ve witnessed the best (and worst) practices you could imagine when it comes to physical inventory counts. If you’re looking for more specific guidance on how to conduct a physical inventory count at your company—or simply additional recommendations on how to manage your inventory more efficiently year-round—we can help.

Contact your accountant to learn more.  

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.

Hit the jackpot? Tax bill

Hit the jackpot? Here’s what it means for your tax bill.
Hit the jackpot? Here’s what it means for your tax bill. 850 500 smolinlupinco

Everything comes at a cost—even “free money.” If you’ve won a sizable cash prize recently, congratulations! But be prepared. Your good fortune will likely impact your tax bill. Contacting your accountant or wealth advisor as soon as possible is probably in your best interest. 

Money earned from gambling 

Whether you win at a tiny bingo hall or a major casino, the tax rules are the same. 100% of your winnings must be reported as taxable income on the “Other income” line of your 1040 tax return. 


When it comes to reporting winnings for a particular wager, you’ll need to calculate your net gain. For example, if you bet $50 on the Super Bowl and win $140, you should report $90 of income rather than the full $140.

What about losses? They’re deductible, but only as itemized deductions. You can’t take the standard deduction and deduct gambling losses. Even so, they’re only deductible up to the amount of gambling winnings reported. In other words, losses can be used to “wipe out” gambling income, but your forms can’t report a gambling tax loss.

Still, it’s worth keeping a thorough record of your losses during the year. Hang onto any checks or credit slips and be sure to document the place, date, amount, and type of loss. It may also be helpful to keep track of the name of anyone who was with you. 

Note: If you’re a professional gambler, different rules apply. 

Lottery winnings

Did you know that lottery winnings are taxable? Hitting the jackpot is rare, but getting audited by the IRS for failing to follow tax rules after winning isn’t.

Winners are required to pay taxes on cash prizes and the fair market value of non-cash prizes, too, like vacations or cars. Your exact federal tax rate may vary, but it could be as high as 37% depending on the amount of your winnings and your other income. State income tax may also apply.

For non-cash prizes, you’ll need to report your winnings in the year the prize is received. If you take a cash prize in annual installments, you should report each year’s installment as income for the year you receive it. 

Winnings over $5,000

If you win over $5,000 from the lottery or certain types of gambling, 24% will be withheld for federal tax purposes. The payer (agency, casino, lottery, etc.) will send you and the IRS a Form W-2G listing the federal and state tax withheld and the amount paid to you. Hang onto this form for your records.

If a federal tax rate between 24% and 37% applies to you, the 24% withholding may not be enough to cover your federal tax bill. In this instance, you may need to make estimated tax payments. If you fail to do so, you could be assessed a penalty. You might be required to make state and local estimated tax payments, too. 

Since your federal tax rate can be up to 37%, which is well above the 24% withheld, the withholding may not be enough to cover your federal tax bill. Therefore, you may have to make estimated tax payments—and you may be assessed a penalty if you fail to do so. In addition, you may be required to make state and local estimated tax payments.

Questions? Smolin can help.

This article only covers the basic tax rules. Additional rules could apply in your situation. You may also have additional concerns after winning a large sum of money, such as updating your estate plan.

If you want to stay in compliance with tax requirements, minimize what you owe, and manage your winnings more effectively, we’re here to help. Contact us now. 

could you benefit health savings account

Could You Benefit from a Health Savings Account?
Could You Benefit from a Health Savings Account? 850 500 smolinlupinco

The cost of healthcare is rising. As a result, many people are on the hunt for a more cost-effective way to pay for their medical bills. 

If you’re eligible, a Health Savings Account (HSA) may offer a way to set aside funds for a future medical “rainy day” while also enjoying tax benefits, like: 

  • Withdrawals from the HSA to cover qualified medical expenses aren’t taxed
  • Earnings on the funds in the HSA aren’t taxed
  • Contributions made by your employer aren’t taxed to you
  • Contributions made by you are deductible within certain limits 

Who is eligible for an HSA? 

HSAs may be established by, or on behalf of, any eligible individual.

If you’re covered by a “high deductible health plan,” you may be eligible for an HSA. In 2023, a health plan with an annual deductible of at least $1,500 for self-only coverage or at least $3,000 for family coverage may be considered a high-deductible plan.

In 2024, these numbers will increase to $1,600 for self-only coverage and $3,200 for family coverage.

Deductible contributions are limited to $3,850 for self-only coverage in 2023 and $7,750 for family coverage. (Again, these numbers are set to increase in 2024 to $4,150 for self-only coverage and $8,300 for family coverage.)

Other than for premiums, annual out-of-pocket expenses required to be paid can’t exceed $7,500 for self-only coverage or $15,000 for family coverage in 2023. In 2024, these numbers will climb to $8,050 and $16,100, respectively. 

If an individual (or their covered spouse) is an eligible HSA contributor and turns 55 before the end of the year, they may make additional “catch-up” contributions for 2023 and 2024 up to $1,000 per year.  

Limits on deductions

Deductible contributions aren’t governed by the annual deductible of the high deductible health plan. You can deduct contributions to an HSA for the year up to the total of your monthly limitation for the months you were eligible. 

The monthly limitation on deductible contributions for someone with self-only coverage is 1/12 of $3,850 (or just over $320) in 2023. For an individual with family coverage, the monthly limitation on deductible contributions is 1/12 of $7,750 (or just under $646). 

At tax time, anyone eligible on the first day of the last month of the tax year will be treated as eligible for the entire year. This is relevant to computing the annual HSA contribution.

That said, if the individual is enrolled in Medicare, they’ll no longer be eligible per the HSA rules and can no longer make HSA contributions. 

Taxpayers may withdraw funds from an IRA and transfer them tax-free to an HSA—but only once. The amount allowed varies, depending on the maximum deductible HSA contribution for the type of coverage that is in effect at the time of transfer. 

The amount moved between the accounts will be excluded from gross income and thus won’t be subject to the early withdrawal penalty of 10%. 

HSA Distributions

Distributions from your HSA account that you use to pay for qualified medical expenses of those covered aren’t taxed. Typically, the qualified medical expenses in question would qualify for the medical expense itemized deduction.

However, funds withdrawn from your HSA for other reasons are taxed. Unless the person covered by the HSA is over 65, disabled, or dies, they will also be subject to an extra 20% tax. 

Questions? Smolin can help.

HSAs offer a very flexible option for providing health care coverage. However, as you can see, the rules can be quite complicated. 

If you have questions about tax rules regarding your HSA or the most favorable way to manage the funds within it, please reach out. The friendly accountants at Smolin are always happy to walk you through your options and help you determine the most tax favorable way to manage your money. 

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.

New Report Identifies High Risk Areas Financial Reporting

Don’t Get Caught Off Guard: New Report Identifies High-Risk Areas for Financial Reporting
Don’t Get Caught Off Guard: New Report Identifies High-Risk Areas for Financial Reporting 850 500 smolinlupinco

In July, the Public Company Accounting Oversight Board (PCAOB) published a report highlighting opportunities for improvement when it comes to audits for public companies. 

As private companies experience challenges similar to those of public companies when reporting their financial outcomes, this report may also be useful for internal accounting personnel and external auditors in pinpointing high-risk reporting areas that require extra scrutiny. 

Previous data

The PCAOB examined sections of public companies’ financial statement audits and published those findings in the recent PCAOB Spotlight report, Staff Update and Preview of 2022 Inspection Observations. Several of the discrepancies for 2022 stem from intrinsically complex areas with higher risks of material misstatement. 

The seven most noteworthy statement deficiency areas were: 

  1. Revenue and related accounts
  2. Inventory
  3. Information technology
  4. Business combinations
  5. Long-lived assets
  6. Goodwill and intangible assets
  7. Allowances for loan and lease losses

Auditors should take advantage of this information to outline and perform more effective audits. 

Meanwhile, in-house accounting personnel and managers can leverage these findings to increase the accuracy of financial reporting, reduce the necessity of audit adjustments, and streamline engagement with external auditors.  

Concerns over crypto transactions

Cryptocurrency transactions stand out as an area of particular concern in the PCAOB report.

These transactions may involve:

  • Investing in cryptocurrency
  • Selling or purchasing cryptocurrency in exchange for U.S. dollars
  • Mining crypto in exchange for a “reward” or other payment 
  • Trading cryptocurrency assets 
  • Selling goods or services for cryptocurrency 
  • Purchasing services and goods with cryptocurrency 

Material digital asset holdings and engaging in significant activity related to digital assets create unique audit risks for companies, as demonstrated by the collapse of FTX. 

These risks may be attributed to a lack of transparency regarding the parties engaging in the transactions, as well as the purpose of them. High levels of volatility, fraud, theft, market manipulation, and legal uncertainties also play a role.

To mitigate these risks as much as possible, the PCAOB encourages using specialists and technology-based auditing tools in certain scenarios. 

Key takeaways

Both private and public companies are encouraged to take proactive measures to keep financial reports transparent and accurate, such as: 

  • Ramping up internal audit procedures in the high-risk areas identified by the report
  • Increasing management review and staff supervision 
  • Providing accounting personnel with additional training 

Companies should anticipate that external auditors will want to hone in on these areas and prepare for this by providing extra documentation to back up account balances, reporting procedures, and accounting estimates for high-risk items. 

Have Questions? Smolin can help.

If you need help navigating high-risk audit items or determining how the PCAOB findings may affect your company’s audit process, we’re here for you. Contact the team at Smolin to learn more.

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.

Is QuickBooks Right for your Nonprofit?
Is QuickBooks Right for your Nonprofit? 1275 750 smolinlupinco

Nonprofit organizations are created to serve nonfinancial or philanthropic goals rather than to make money or build value for investors. But they still need to keep track of their financial health, paying attention to factors like:

  • How much funding is coming in from donations and grants
  • How much the organization is spending on payroll
  • How much it’s spending on rent and other operating expenses

Many nonprofits use QuickBooks® for reporting their results to stakeholders and handling their finances more efficiently. Here’s an overview of QuickBooks’ specialized features for nonprofits.

Features of QuickBooks for nonprofits

Terminology and functionality. QuickBooks for nonprofits incorporates language used in the nonprofit sector to make it more user-friendly for nonprofits.

For example, the software comes with templates for donor and grant-related reporting. Accounting team members can also use it to assign revenue and expenses to specific funds or programs.

Expense allocation and compliance reporting. Many nonprofits often receive donations and grants with particular requirements regarding the expenses that can be applied. 

These organizations can use QuickBooks to establish approved expense types and track budgets for specific funding sources. They can also use the software to satisfy compliance-related accounting and reporting regulations.

Streamlined donation processing. Everyone likes convenience, and donors to nonprofits are no exception. The easier it is to donate to a nonprofit, the more likely it is that people will do so. 

QuickBooks allows for electronic payments from donors. The software also integrates with charitable giving and online fundraising sites, enabling nonprofits to process in-kind contributions, such as office furniture and supplies.

Tax compliance and reporting. Failure to comply with IRS reporting regulations could cause an organization to lose its tax-exempt status. QuickBooks provides a customized IRS reporting solution for nonprofits, which includes the ability to create Form 990, “Return of Organization Exempt from Income Tax.”

Donor management. With QuickBooks, nonprofits can store donor lists. This function includes the ability to divide the data according to location, contribution, and status.

Using these filters can make connecting with and nurturing donors who meet specific criteria easier. One example is reconnecting with significant donors who’ve stopped making regular contributions to your organization.

Data security. Data security is critical to building trust and encouraging donors to support your organization again in the future. 

QuickBooks protects donors’ personal identification and payment information by allowing the account administrator to limit access for viewing, editing, or deleting donor-related data. 

With QuickBooks, team members can only access and share data with the administrator or owner’s permission.

Not just for for-profit businesses

QuickBooks may be known as an accounting solution for small and medium-sized companies, but it also provides solutions for the nonprofit sector. 

From streamlined processes and third-party integrations to security management and robust reporting, Quickbooks can help nonprofits improve their financial management and fulfill the mission of their organization.

Have questions? Smolin can help

If you’re unsure of whether QuickBooks is right for your organization or you require other accounting services, contact the knowledgeable team at Smolin, and we’ll help you choose the best option for your nonprofit.

Understanding Deferred Taxes
Understanding Deferred Taxes 1275 750 smolinlupinco

Navigating deferred taxes can be a confusing process, and the accounting rules for reporting deferred taxes can sometimes seem arbitrary and nonsensical when viewed through the lens of real-world economics. Here’s a brief article to help simplify this complex subject.

What are deferred taxes?

Companies are required to pay income tax on taxable income as defined by the IRS. On their Generally Accepted Accounting Principles (GAAP) financial statements, however, companies record income tax expense based on accounting “pretax net income.” 

In any particular year, your taxable income (for federal income tax purposes) and pretax income (as reported on a GAAP income statement) may differ substantially. Depreciation expense is typically the reason for this temporary difference.

The IRS allows companies to use accelerated depreciation methods to lower taxes that are paid in the early years of an asset’s useful life. Many companies may also choose to claim Section 179 deductions and bonus depreciation for the year an asset is put into service. 

An alternative route that many companies take for GAAP reporting purposes is to use straight-line depreciation. At the beginning of an asset’s useful life, this typically causes taxable income to be dramatically lower than GAAP pretax income. That said, as the asset gets older, this temporary depreciation expense is reversed. 

Understanding differing depreciation methods

Using differing depreciation methods for tax and accounting purposes causes a company to report deferred tax liabilities. In simple terms, this means that by claiming higher depreciation expense for tax purposes than for accounting purposes, the company has momentarily reduced its tax bill but must make up the difference in later tax years. 

Deferred tax assets can come from other sources like operation loss carryforwards, tax credit carryforwards, and capital loss carryforwards.

How should deferred taxes be reported on financials?

When a company’s pretax and taxable incomes differ, it is required to record deferred taxes on its balance sheet. 

This can go one of two ways. If a company pays the IRS more tax than an income statement reflects, it records a deferred tax asset for the future benefit the company is entitled to receive. If the opposite occurs and the company pays less tax, it must record a deferred tax for the additional amount it will owe in the future.

Like other liabilities and assets, deferred taxes are classified as either current or long-term. 

No matter their classification, though, deferred taxes are recorded at their cash value (that is, with no consideration of the time value of money). Deferred taxes are also based on current income tax rates. The company can revise its balance sheet, in which case change flows through to the income statement if tax rates change.

Unlike deferred tax liabilities which are recorded at their full amount, deferred tax assets are offset by a valuation allowance that reflects the potential of an asset expiring before the company can utilize it. Determining the amount of deferred tax valuation allowance to log is at the discretion of management is highly subjective. It’s important to note that all changes to this allowance will flow through to the company’s income statement.

Today, or later on down the line?

For financial statement users, it’s critical not to lose sight of deferred taxes. A company with significant deferred tax assets may be able to reduce its tax bill in the future and save much-needed cash on hand by claiming deferred tax breaks. 

On the other hand, a company with considerable deferred tax liabilities will have already taken advantage of tax breaks and may need additional cash on hand to pay the IRS in future tax years.

Questions? Smolin can help 

Still unsure of how deferred taxes might affect your business? If you would like to discuss any of these issues or gain a better understanding of tax rules for businesses, our CPAs can help. Contact us to get started. 

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