Built-In-Gains Tax on Law Firms

Law firms originally organized as C-Corporations, which elect S-Corporation status, face significant transition issues, including the Built-In-Gains (BIG) tax. Under Internal Revenue Code Section 1374, the BIG tax is designed to preserve double taxation on assets held by a corporation prior to the election. The BIG provision taxes the appreciation on assets disposed and is based on the difference between the fair market value of an asset at the time of conversion and its adjusted tax basis. The highest corporate tax rate is applied to the net recognized built in gains. The BIG provision expires for assets held at least 10 years after the conversion occurs.

Expanded Requirements for Review Engagements

Statement on Standards for Accounting and Review Services (SSARS) No. 10, Performance of Review Engagements, issued by the AICPA in May 2004 amends SSARS No. 1, Compilation and Review of Financial Statements by expanding on previous guidance on analytical procedures and documentation requirements as well as questions to be directed to management about fraud and the inclusion of management’s responses in the representation letter.

SSARS No. 10 places more emphasis on analytical procedures making it more important for CPA’s to develop expectations as to the reasonableness of the financial statements by projecting financial relationships that should exist in light of economic factors, the client’s industry and the client’s company. Trend analysis and ratio analysis are analytical procedures frequently used to compare key financial data with prior period data, budgets and industry forecasts or with non-financial information, which is usually generated independent of the accounting department. Model-based procedures use company operating data and industry or economic information to develop expectations for recorded amounts. Analytical procedures enable the CPA to organize a great deal of information into logical conclusions and to compare amounts recorded in the financial statements to the expectations developed.

The new SSARS, effective for reviews of financial statements ending on or after December 31, 2004, is indicative of the trend toward increased responsibility on the part of management and the CPA profession in light of greater public and regulatory scrutiny.

In a recent fraud survey performed by KPMG, 75% of the respondents indicated that they had experienced at least one instance of fraud. The survey also found that the best sources of fraud detection were tips from employees. The topic of fraud detection was addressed by Toby Keith, CFE, at the AICPA Litigation and Fraud Conference in September 2004. Mr. Keith also reported that tips are the largest source of fraud detection, adding that making tip lines available to suppliers and customers provided a 40% greater response than employee-only lines. The Association of Certified Fraud Examiners (ACFE) has performed similar studies, finding that approximately 40% of frauds were discovered by whistle-blowers.

Management should be mindful of this and create a culture that encourages honesty and facilitates open communication of such tips. Employees who provide information about fraud are protected by section 806 of the Sarbanes-Oxley Act. Sarbanes-Oxley also charges audit committees with the responsibility to monitor and address such tips or other complaints related to accounting, internal controls and auditing.

According to a recent survey conducted by Glass Lewis & Co., more than 900 companies dismissed their auditors in the first seven months of 2004 compared to about the same number for all of 2003. The SEC requires notification of a change of auditors; however, most companies are reluctant to provide a reason for such changes. Nearly 700 of the companies included in the survey gave no reason for the change. In certain cases, companies are required to disclose more information about a change of auditor; however, such explanations are rarely straightforward and often inconsistent with the explanations provided by the departing auditor. Auditor turnover can be an indication of accounting or internal control issues which may be a red flag to potential investors or it could just be that the company rotates auditors periodically or is searching for a reduction in fees. An article in the web-based, TSCPA National Accounting News on August 20, 2004 indicated that the SEC is not planning to increase disclosure requirements at this time; however, the SEC is requesting that companies voluntarily disclose specific reasons for an auditor change, which would provide investors with a clear understanding of the circumstances surrounding the change.

Analyzing data to find trends or anomalies forms an often daunting task when the volume of data reaches tens of thousands of transactions or more. We have become aware of a tool for the analysis of large amounts of data. It is called Intellitrade and has been developed for natural gas and power trading by Enform. The graphical capabilities and data sorting functions of the program make it powerful in situations where large numbers of transactions, with many individual attributes to each transaction exist. The value Intellitrade seems to offer comes in the way it facilitates identification of exceptions. For instance, Enform showed us how the selection of attributes and comparison of those attributes among many trades by many traders singled out one trader as having excessive volumes and no profits in a particular month, leading to the investigation of improper "round trip" trades. Enform may be reached through Chuck Hanebuth, Vice President Business Development, SunGard Enform Consulting, Inc.,713.350.1041 Office,713.438.1000 Fax,281.787.9137 Mobile, Chuck.Hanebuth@sungard.com

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