Accounting:

Accrual vs Cash

Understanding Financial Statements

Bookkeeping Issues

IRS & Taxes

January 25, 2011

Lexington

Minority & Women

Construction

Training Program

Construction RevenueTwo method of revenue recognition:

Percentage of completion:

recognizes revenue, cost, income over the life of construction contract based on the degree of completion.

Completed Contract:

all revenues, costs and income are recognized only at completion of the construction project, ordinarily at the end of the construction contract.

Percentage of Completion

1. Reasonably reliable estimates can be made of revenue and costs;

2. The construction contract specifies the parties’ rights as to the goods, consideration to be paid and received, and the resulting terms of payment or settlement;

3. The contract purchaser has the ability and expectation to perform all contractual duties;

4. The contract contractor has the same ability and expectation to perform;

Completed Contract

1. The contract is a short duration (not defined). As a result the recognized revenue would not differ under the PC or CC methods.

2. The contract violates any one of the items 1 through 4 above; or

3. The contract’s project exhibits documented extraordinary, nonrecurring business risks.

Things to keep in mind:

Each construction contract is treated as a profit center, with its own revenues, costs and income. Separate budget of each contract.

The Accrual method be used for all reported billings and costs and losses. (GAAP requirement)

Cost allocation is based on direct and indirect costs as well as construction period interest.

Assets are represented by underbillings (estimated cost and earnings exceed billings) where liabilities are shown as overbillings (billings exceed estimated costs and earnings).

Consolidation theory applies to investments in construction projects or ventures.

There are several modifications to revenue recognitions rules for government contractors. These modifications should be reviewed by those engaged in federal government contracting.

Note: The Revenue Recognition for Construction Industry is covered in Intermediate Accounting course in bachelor degree for Accounting program.

Construction Company Direct and Indirect CostsDirect Costs:

all costs that are directly associated with the

project.• subcontractors• hired labor• materials• supplies• tools and equipments• bonds and permit

Construction Company Direct and Indirect CostsIndirect Costs:

costs that cannot be tied to a specific project and need to be allocated to projects.• compensation and salary of supervisors or other

workers that involve in several projects, include benefits and payroll taxes

• general liability insurance• vehicle repair and depreciation• maintenance• subscriptions, memberships fee

Selling, General and Administrative Expenses salary and compensation of sales, marketing and

general office staff, include benefits and payroll taxes

advertising and marketing expenses office supplies and expenses depreciation expense of office equipment office rent expense

Small construction contractors may not account for indirect job costs and will instead treat them as selling, general and administrative expenses

ROI (Return on Investments)

Simple ROI = Gains – Investment Costs

Investment Costs

Another approach: Internal Rate of Return (IRR) Net Present Value (NPV) Payback Period

Note: The ROI is covered in Financial Accounting course in bachelor degree for Accounting, Finance and Business Administration program.

Preparing and Evaluating The BudgetStep: Designing and Preparing

design budget based on company strategic plan quantifiable and reasonable per construction project monthly, quarterly, percentage

Executing monthly comparison actual vs. budget variance

Evaluating end of year analysis compare how the budget result with company strategic

plan

Cash vs. Accrual Accounting MethodCash Basis:

recording income/revenue when received and deduction/expenses when paid.

Accrual Basis:

recording income/revenue when earned and deduction/expenses when incurred.

Matching Principle:

Fundamental concept of accrual basis accounting that offset revenue against expenses on the basis of their cause-and-effect relationship. In states that, in measuring net income for an accounting period, the costs incurred in that period should be matched against the revenue generated in the same period.

Review Accounting System for Financial Record KeepingAccounting Cycle

Revenue Cycle

Review Accounting System for Financial Record KeepingAccounting Cycle

Expense Cycle

Review Accounting System for Financial Record KeepingFinancial Records a company must maintain: Balance Sheet (see example) Profit and Loss (see example) Statement of Cash Flow (see example) Bank Reconciliation Credit Card, PayPal, E-Pay Reconciliation Fixed Assets List

Review Accounting System for Financial Record Keeping All supporting documentation of income and expenses

transactions:ContractInvoiceWork OrderReceiptBank Deposit SlipPurchase OrderBillBill PaymentMonthly Credit Card BillMerchant Credit Card ReportDetail Credit Card Receipt TransactionsProof of Payroll Withholding payment (by mail or electronically)Proof of Corporate Tax PaymentProof Rent, Lease, Insurance, License and Permit payment.

Other Important Documents

Article of Corporation, Article of Organization Any Corporate paperwork submit to Federal, Secretary of State,

City and County. Tax Document with IRS, State, County

Employer Identification Number (EIN) All Account Identification Number

Lease Agreement Loan Agreement Shareholder Agreement Shareholder Minute of Meeting Employee Agreement maintain and up to date the Worker Comp Insurance of

subcontractors !!!!! (specific for construction industry)

Other Concern: going paperless back-up the data data recovery plan data safety and security cloud computing – selective in choosing providers online information (bill, bank statement, etc) electronic payment internet payment scam on electronic and internet payment

The Break Even Point (BEP)is a point at which cost or expenses and revenue are equal.

BEP in unit Sales:

X = TFC

P-V

where:

TFC is Total Fixed Costs

P is Sale Price per unit

V is Variable Cost per unit

The Break Even Point (BEP)

Contribution Margin is the marginal profit per unit.

Contribution Margin

= Sale Price per unit – Variable Cost per unit

= P - V

BEP in Sales ($) = BEP in unit Sales x Sale Price per unit

= TFC x P

P-V

Ratio AnalysisKey Financial Ratios may be classified as:A. Liquidity Ratios: are measures of a firm’s short term ability to

pay maturing obligations.B. Activity Ratios: are measures of how effectively an enterprise

is using its assets.C. Profitability Ratios: are measures of the success or failure of

an enterprise for a given time period.D. Investor Ratios: are measures that are of interest to investors.E. Leverage Ratios : are measures of company’s ability to meet

financial obligation.

Note: The ROI is covered in Financial Accounting course in bachelor degree for Accounting, Finance and Business Administration program.

Ratio AnalysisA. Liquidity Ratios

Working Capital = Current Assets - Current liabilities

Current ratio (working capital ratio) = Current assetsCurrent liabilities

Acid-test ratio= Cash equivalents + Marketable securities + Net receivables

Current liabilities

Cash ratio = Cash equivalents + Marketable securitiesCurrent liabilities

Ratio AnalysisB. Activity Ratios

Accounts receivable turnover = Net Credit Sales Average Gross Receivables

Accounts receivable turnover in days= Average gross receivables

Net credit sales/365= 365 days / Accounts receivable

Turnover

Inventory turnover = Cost of Goods Sold Average Inventory*

* Average Inventory = (Beginning Inventory + Ending Inventory) / 2

Ratio AnalysisB. Activity Ratios (continued)

Inventory turnover in days= Average inventory

Cost of goods sold/365= 365 days / Inventory turnover

Operating cycle= Account receivable turnover in days + Inventory turnover in days

Working capital turnover = SalesAverage working capital

Total asset turnover = Net salesAverage total assets

Ratio AnalysisC. Profitability Ratios

Gross Profit Margin = Gross Profit Net Sales

Operation Profit Margin = EBIT *Net Sales

*EBIT = Earning Before Interest and Taxes

Net Profit Margin = Net Income Net Sales

Ratio AnalysisD. Investor Ratios

EPS* = Profit available to equity shareholdersnumber of shares issued

*EPS = Earning Per Share

DPS* = Dividends paid to equity shareholders number of shares issued

*DPS = Dividends Per Share

P/E Ratio* = Current market share price EPS

*P/E Ratio = Price Earning Ratio

Ratio AnalysisE. Leverage Ratio

Debt / Equity = Total LiabilitiesShareholders Equity

Debt Ratio = Total Liabilities

Total Assets

Time interest earned (TIE) = EBITInterest

Cash Flow to Debt Ratio = Operating Cash Flow Total Debt

Job Costing

Manufacturing Cost:

1. Direct Material2. Direct Labor3. Manufacturing Overhead Cost

a) Indirect Materialb) Indirect Labor

Note: The Job Costing and Allocating Overhead is covered in Cost/ Management Accounting course in bachelor degree for Accounting, Finance and Business Administration program.

Classification of costs:

By nature or element: material, labor, expenses

By functions: production, selling, distribution, administration, R&D, development

As indirect and direct

By variability: fixed, variable, semi-variable

By controllability: controllable, uncontrollable

By normality: normal, abnormal

Job Costing

Job CostingDefinition:

Order-specific costing technique, used in situations where each job is different and is performed to the customer’s specifications. Job costing involves keeping an account of direct costs (labor, machine time and raw materials) and indirect costs (overheads). Since both types of costs are usually closely related ( a job requiring high input of labor and material is likely to consume more power, machine time, supervision time, inspection time, etc.) indirect costs may be applied as an estimated fraction of direct costs. Job costing methods are similar to contract costing and batch costing methods, and are used in construction, motion picture, and shipping industries, in fabrication, repair, and maintenance works, and in sevices such as auditing.

Job Costing vs. Process CostingJob Costing

work is broken into jobs; each job is tracked separately and significantly difference

auto mechanics, carpenters, painters, print shops, computer repair

Process Costing

a large quantity of identical or similar products are mass produced

auto assembly plants, hot dog manufacturing, any large mechanized production facility

Allocating Overhead

Simple Overhead Allocation:treat all annual overhead as a single cost pool, and allocate it to one annual cost driver.

Total Annual Overhead Costs = Overhead Costs

Units of Cost Driver per unit cost driver

Example of cost driver : labor hours, labor dollars

Allocating Overhead

The Activity-Based Costing (ABC) system:

used primarily for allocating overhead that is hard to track to specific products or departments.

Overhead costs are tracked by activities that consume resources.

The ABC system breaks down annual overhead cost into several cost pools based activities, and allocates with several cost drivers.

Allocating Overhead

Lean Accounting Methods:have been developed in recent years to provide relevant and thorough accounting, control and measurement systems without the complex methods of ABC.

Lean Accounting takes an opposite direction from ABC by working to eliminate cost allocations rather than find complicated methods of allocation.

The purpose of Lean Accounting is to support the lean enterprise as a business strategy.

Cash Management Positive Cash Flow (Collection) Negative Cash Flow (Disbursement)

Component of Cash Flow Statement:

(see example)

1. Operating Cash Flow

2. Investing Cash Flow

3. Financing Cash Flow

Cash ManagementCash Flow Practice: Petty Cash Immediate Bank Deposit Bank Deposit Slip Record Bank Ledger Separate Payroll Account and Operation Account (optional) Monthly Bank Reconciliation Monthly Credit Card, Debit Card, E-Pay, Paypal, Merchant Credit

Card, Reconciliation Keep record of wire transfer, electronic payment, online payment,

pay by phone, check by phone, and reflected payment on company financial records adjusted the bank balance.

Input: finance charges, service charges, store credit, refund, late fee, cancelled check fee, insufficient fund fee, deposit return, deposit adjustment, etc.

Secure and protect credit card number, SSN.

Employees vs. Independent ContractorIRS Revenue Ruling 87-41http://www.irs.gov/pub/irs-utl/x-26-07.pdf

The 20 factors identified by the IRS as follows:

1. Instructions: If the person for whom the services are performed has the right to require compliance with instructions, this indicates employee status.

2. Training: Worker training (e.g., by requiring attendance at training sessions) indicates that the person for whom services are performed wants the services performed in a particular manner (which indicates employee status).

3. Integration: Integration of the worker’s services into the business operations of the person for whom services are performed is an indication of employee status.

4. Services rendered personally: If the services are required to be performed personally, this is an indication that the person for whom services are performed is interested in the methods used to accomplish the work (which indicates employee status).

5. Hiring, supervision, and paying assistants: If the person for whom services are performed hires, supervises or pays assistants, this generally indicates employee status.However, if the worker hires and supervises others under a contract pursuant to which the worker agrees to provide material and labor and is only responsible for the result, this indicates independent contractor status.

6. Continuing relationship: A continuing relationship between the worker and the person for whom the services are performed indicates employee status.

Employees vs. Independent Contractor7. Set hours of work: The establishment of set hours for the worker indicates

employee status.8. Full time required: If the worker must devote substantially full time to the

business of the person for whom services are performed, this indicates employee status. An independent contractor is free to work when and for whom he or she chooses.

9. Doing work on employer’s premises: If the work is performed on the premises of the person for whom the services are performed, this indicates employee status, especially if the work could be done elsewhere.

10. Order or sequence test: If a worker must perform services in the order or sequence set by the person for whom services are performed, that shows the worker is not free to follow his or her own pattern of work, and indicates employee status.

11. Oral or written reports: A requirement that the worker submit regular reports indicates employee status.

12. Payment by the hour, week, or month: Payment by the hour, week, or month generally points to employment status; payment by the job or a commission indicates independent contractor status.

13. Payment of business and/or traveling expenses. If the person for whom the services are performed pays expenses, this indicates employee status. An employer, to control expenses, generally retains the right to direct the worker.

Employees vs. Independent Contractor

14. Furnishing tools and materials: The provision of significant tools and materials to the worker indicates employee status.

15. Significant investment: Investment in facilities used by the worker indicates independent contractor status.

16. Realization of profit or loss: A worker who can realize a profit or suffer a loss as a result of the services (in addition to profit or loss ordinarily realized by employees) is generally an independent contractor.

17. Working for more than one firm at a time: If a worker performs more than de minimis services for multiple firms at the same time, that generally indicates independent contractor status.

18. Making service available to the general public: If a worker makes his or her services available to the public on a regular and consistent basis, that indicates independent contractor status.

19. Right to discharge: The right to discharge a worker is a factor indicating that the worker is an employee.

20. Right to terminate: If a worker has the right to terminate the relationship with the person for whom services are performed at any time he or she wishes without incurring liability, that indicates employee status.

Employees vs. Independent ContractorMore recently, the IRS has identified three categories of evidence that may be

relevant in determining whether the requisite control exists under the common-law test and has grouped illustrative factors under these three categories:

(1) behavioral control; (2) financial control; and(3) relationship of the parties.

http://www.irs.gov/pub/irs-pdf/p1779.pdf

Form SS-8 http://www.irs.gov/pub/irs-pdf/fss8.pdf

If, after reviewing the three categories of evidence, it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding (PDF) can be filed with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status.

Be aware that it can take at least six months to get a determination, but a business that continually hires the same types of workers to perform particular services may want to consider filing the Form SS-8 (PDF).

Tax Filling Requirement

Federal/IRS Employer Identification Number (EIN)

http://www.irs.gov/businesses/small/article/0,,id=97860,00.html Electronic Federal Tax Payment System

https://www.eftps.gov

PIN number, Web Password

State Kentucky Department of Revenue

http://revenue.ky.gov/business/

Register A Business, Sales Tax, Withholding Tax (Payroll) Kentucky Unemployment Insurance, Office of Employment and Training

https://kewes.ky.gov

Account Registration (Payroll) Kentucky Secretary of State (exclude self-employed, not incorporated, no employee)

http://sos.ky.gov/business

Tax Filling Requirement

Local (County) LFUCG Division of Revenue

http://www.lexingtonky.gov/index.aspx?page=169 Fayette County Public Schools

http://www.fcps.net/administration/departments/tax-office Other Counties

Kentucky Occupational License Association http://www.kyola.org/

2010 Kentucky Occupational Tax Listing

http://www.kyola.org/Forms/2010OccupationalTaxListing.pdf

LegislationRental property expense reporting. The Small Business Jobs Act of 2010 imposes information reporting on qualified rental expense payments made after December 31, 2010. If a person receiving rental income from real estate makes payments totaling $600 or more in any tax year to a person or corporation, the payor must file an information return reporting those payments.

Covered payments include payments for rent, salaries, wages, amounts in consideration for property, premiums, and other payments.

Legislation

Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010

The Small Business Jobs Act of 2010

Source:http://www.irmamillercpa.com/Home/newsletter-2010

http://learn.intuit.com/files/upload/TrainingGuides/2010FederalTaxUpdate.pdf

http://www.cchgroup.com/webapp/wcs/stores/servlet/content_federal-tax-legislation_default

http://www.aicpa.org/PUBLICATIONS/TAXADVISER/2011/Pages/default.aspx

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