Expense reimbursement schemes are extremely common in companies. Employers may underestimate the costs of this type of fraud. Perpetrators of these schemes range from administrative employees buying company supplies to highly compensated executives with million dollar travel budgets. One of my first assignments in the beginning of my career was to audit the expense reports of the officers of a large company. I was amazed at the number of personal expenses improperly submitted on these reports.
In most companies, employees submit expense reports detailing all expenses incurred for business purposes, such as meals with clients, business travel expenses, etc. Usually, the employee is required to explain the business purpose of each expense and provide supporting documentation such as a receipt, cancelled check or personal credit card statement. Typically, the report must be approved by a supervisor in order for the expense to be reimbursed. It is not uncommon for the review of expense reports to be cursory at best, and for companies to allow a wide range of latitude in acceptable forms of documentation to support expenses.
The most common type of expense reimbursement schemes are as follows:
- Mischaracterized Expenses: The most basic type of scheme is to request reimbursement for a personal expense by claiming that the expense is business related. For example, claiming dinner with a friend as “business development.”
- Overstated Expenses: One way employees may overstate their expenses is by altering a receipt or other supporting documentation to reflect a higher cost than was actually paid. Another method is “over-purchasing” business expenses. This is commonly used by employees who travel. For example, an employee will purchase a second ticket to the same travel destination. The second ticket will be more expensive than the first one. Then the employee refunds the second ticket and flies on the first (less expensive) ticket. However, the employee attaches the receipt from the more expensive ticket to the submitted expense report.
- Fictitious Expenses: It is fairly simple for employees to create realistic counterfeit receipts to support fictitious expenses. In addition, some employees will request blank receipts from legitimate companies and fill them in later. In some cases, an employee will even steal blank receipts from a hotel or restaurant, and use them over time to submit fictitious expenses. Another method is to write checks, photocopy them as support and then destroy them. Therefore, the employee never actually incurs the expense. With credit card statements, once the expense report is filed, the employee can return the item and receive a credit to his/her account.
- Multiple Reimbursements: The most common example of this scheme is submitting several types of support for the same expense. For example, an employee might submit an airline ticket stub and a travel agency invoice on separate expense reports in order to get reimbursed for the cost of a single flight twice.
Overall, the best detection method is a detailed review of employee expense reports. Detailed reviews and periodic audits of travel and entertainment accounts will not only detect these schemes, but deter employees from submitting personal or fictitious expenses for reimbursement
By Julia Allen Miessner, CPA/CFFPosted on September 9 2014 by admin
Management teams across the nation are encouraging team building among staff to encourage and promote employee friendships and to boost morale. I commend these organizations for promoting a healthy work environment which provides a social support network at both a personal and a professional level. Positive employee morale can lead to reduced employee turnover, reduced absenteeism and increased company profits.
While management is promoting a sense of camaraderie among employees, it must be careful not to promote an environment which is susceptible to fraud. As employees become comfortable with each other, they may turn to collusion to circumvent anti-fraud controls. Collusion is “secret cooperation for an illegal or dishonest purpose.” (1) Collusion typically occurs between two or more employees, an employee and a supervisor or an employee and a vendor.
The 2014 Global Fraud Study (2) published by the Association of Certified Fraud Examiners (ACFE) found that as more than one perpetrator is involved the losses associated with the fraud rises.
See my article in the September 9, 2014 edition of BV/Lit e-News for more information about what management can do to minimize the occurrence of fraud and its impact on the organization.
By Melissa E. Loughlin-Sines, CPA, CFE, CVA, CFF, ABV
(2) Report to the Nations on Occupational Fraud and Abuse – 2014 Global Fraud Study, ACFE
On June 2, 2014 the U.S. Department of Labor (DOL) reached a $5.25 million settlement with GreatBanc Trust Company (GreatBanc). It was alleged that GreatBanc, as trustee to the Sierra Aluminum Company Employee Stock Ownership Plan (ESOP), allowed the plan to purchase stock from Sierra Aluminum’s co-founders and top executives for more than fair market value. The DOL alleged that GreatBanc failed to adequately inquire into an appraisal that presented unrealistic and aggressively optimistic projections of Sierra Aluminum’s future earnings and profitability. They also allegedly failed to investigate the credibility of the assumptions, factual bases and adjustments to financial statements that went into the appraisal. GreatBanc and its insurers will make $4.77 million in payments to the ESOP and $0.48 million in civil penalties. Additionally, the Company has agreed to follow certain policies and procedures whenever the Company is a trustee or fiduciary to an ESOP that is engaging in transactions involving the purchase or sale of employer securities that are not publicly traded. This includes selection and oversight of the valuation appraiser, analysis and review required on the part of the trustee, and required documentation related to the valuation. Phyllis C. Borzi, Assistant Secretary of Labor for Employee Benefits Security, is quoted saying “Others in the industry would do well to take notice of the protections put in place by this agreement. ESOPs are an important tool to promote employee ownership, not a way to create big cash-outs for owners and top executives.” While these policies and procedures in place for GreatBanc go beyond what the law currently requires, they can give other trustees of ESOPs an idea of what is important to the DOL and potentially avoid DOL scrutiny in the future.
By Cindy Andresen, ASA
Sources: U.S. Department of Labor, Secretary of Labor Thomas E. Perez, EBSA News Release Number 14-1043-NAT, June 3, 2014
Bloomberg BNA, BNA Tax and Accounting Center, July 28, 2014, DOL Settlement Is a Cautionary Tale for ESOP TrusteesPosted on by admin
Let’s say you have built a successful business and are now considering selling it. You have been approached by a company that wants to acquire the assets of the business as opposed to a stock acquisition. If the business is formed as a partnership, an LLC treated as a partnership, or an S corporation, no problem. The gain on sale of the assets will generally be taxed only once – at the individual level. But your business happens to be formed as a corporation (or an LLC treated as a corporation). This is potentially a big problem – gain on sale of the assets is taxed once at the corporate level and then again at the individual level. Is there anything that can be done to alleviate the double tax?
One potential solution is to consider whether there is any personal goodwill of the business owner(s) that is being sold. If the owner has significant industry experience and customer acquisition and retention is based on the owner’s skills and personal relationships with customers, it may be possible to allocate a portion of the selling price directly to the owner. This recognizes that a portion of the assets to be sold represent an asset of the owner(s) – personal goodwill. One of the leading tax cases in this area is Martin Ice Cream Company v. Commissioner (110 TC No. 18). Here the Tax Court found that much of the selling price was for assets not owned by the company, but rather, assets (personal goodwill) of the owner.
The determination as to whether personal goodwill exists in any given case is dependent on the specific facts of each business. Broad generalizations are not very useful. In addition to the question of personal goodwill, consideration should also be given to the value of any non-compete covenant that is expected to be part of the transaction, both corporate and individual. An experienced, qualified business appraiser should be consulted on these matters and a formal appraisal may represent cheap “insurance.”
By Steve Koons, CPA, ABV, ASA, CFFPosted on August 26 2014 by admin
Types of Economic Damages/Lost Profit Cases
Business appraisers, CPAs and Certified Fraud Examiners (collectively referred to as “consultants”) are frequently retained when a party loses money as a result of a business dispute, interruption of business or any of the other causes listed below.
- Business Dissolutions
- Business Interruption
- Breach of Contract
- Breach of Fiduciary Duty
- Franchise Disputes
- Insurance Claims
- Partnership Disputes
- Patent and Copyright Infringement
- Personal Injury
- Product Liability
- Shareholder Disputes
- Wrongful Termination/Death
What is the role of the consultant during the early stages of economic damages/lost profits litigation?
When hired to provide advice in the early stages of an economic damages/lost profit law suit, the consultant can assist the client in various capacities which include the following services. (1)
- Identifying key financial issues
- Assessing the magnitude of various financial aspects of a case
- Analyzing the opposing side’s claims
- Assist with discovery request
- Prepare counsel for deposition and cross examination of opposing side’s experts
- Assist in settlement negotiations and mediation
How does the consultant quantify the damages?
When engaged by the plaintiff or defendant as an expert witness to quantify or defend the amount of damages attributable to an alleged wrongful act, most but not all consultants utilize the Yardstick Approach, the Before-and-After or Sales Projection valuation approaches. (2)
Damages under this method are based on a comparison of the performance of the plaintiff’s company with comparable (guideline) companies in the same industry. Courts perceive industry trends to be an objective indicator of how the plaintiff might have performed absent the defendant’s transgression.
In this instance, damages equal the difference in the plaintiff’s actual performance before and after the defendant’s wrongdoing. Under this methodology, the consultant may elect to quantify a plaintiff’s loss by assessing how much the defendant actually benefited from the wrongdoing.
Sales Projection Method
This method is used by the consultant when he/she chooses to analyze historic trends and forecast how the plaintiff might have performed if not for the defendant’s actions.
The intent of this article was to provide a cursory overview of the manner in which consultants quantify economic damages and lost profits. However, the reader should be mindful that there is no appraisal technique universally accepted within the valuation and legal communities.
By Gary Ringel, Managing Director, Henry & Horne, LLP’s Business Valuation & Litigation Support Services Group
(1) BVA Group website
(2) Ultimately, the court will award damages on a pretax basis because plaintiffs typically owe taxes on compensatory damages. Of course, the court can deny the plaintiff’s claim.
(*) Measuring Lost Profit Economic Damages on a Pretax Basis authored by Robert P. Schweihs.
(*) Blog titled “Economic Damages 101” on Fiske & Company website.Posted on August 12 2014 by admin
A friend of mine had a son and daughter in their early teens. He and his wife both worked during the day. The mother would usually give the children a list of chores to take care of once they got home from school. The chores list would typically have about a dozen items to be done before mom and dad arrived home from work. My friend told me about a particular incident involving his kids’ chores list.
On this occasion the son and daughter worked very hard to get everything on the list completed before mom and dad got home. My friend told me how badly he felt when his wife reviewed the list of chores with the children when she arrived home. The kids, he said, did a great job of successfully completing 11 of the 12 assigned tasks. The mother, however, focused on the one chore the children did not complete. She then made it very clear how disappointed she was in them. The spirits of the kids were crushed.
It seemed the mother could have done the opposite. That is, to tell the kids how pleased she was that they did such a good job in getting the other 11 chores done. My friend discussed with his wife the way she handled the chores list with the children. She realized that she had to take a different approach with her expectations. She changed and the kids responded in a very positive manner.
The example I’ve given above is too often encountered in the workplace. In my years in public accounting and private industry, I’ve observed many instances of supervisors mercilessly berating an employee for an infrequent and insignificant job-related mistake. They overlook the many positives that the employee has contributed in performing their duties for the organization. This type of supervision often leads to valuable employees leaving the company, or doing their work under much stress and anxiety if they stay. Morale suffers as a consequence; and, not surprisingly, production suffers.
My firm makes it a priority to focus on the positive actions of its employees. One way it does this is to eliminate the use of rating scales on its annual employee evaluation forms. For example, there are no performance category scales numbered 1 to 5, with 5 denoting excellent and 1 as very poor, to rate staff performance for the year just concluded. Instead, we have several categories of performance that simply discuss the employee’s “strengths” and the “opportunities” that lie ahead for the employee in the coming year.
This particular form of evaluating the performance of an employee has had overwhelming success in supporting high morale among my firm’s team members and encouraging them to work more productively.
By Don Bays, CPA, ABV, CVA, CFFPosted on August 5 2014 by admin
Billing schemes are a common type of employee fraud. One of the reasons billing schemes are so prevalent, is because they may offer the dishonest employee the ability to steal significant amounts over a long period of time. One billing scheme that we have detected many times is the “Shell Company” or “Fictitious Vendor” billing scheme.
In this scheme, an employee will set up a shell, or fictitious, company for the purposes of committing fraud. The employee will fabricate a name, often similar to the name of another vendor that the company uses. The employee will typically open a bank account in the shell company’s name, so he/she can deposit and cash the fraudulent checks. In order to open the bank account, the employee will often need to file the appropriate paperwork with the state’s corporation commission. These records are public, so employers can perform public record searches to find shell companies set up by their employees. In order to avoid detection, the employee may set the company up under a spouse’s or relative’s name. Maiden names or spouse’s maiden names are often used, as well.
The fictitious entity will also need an address. Often the employee will rent a post office box. However, some employees will list their home address instead. A comparison of employee addresses to vendor addresses in the accounts payable records might reveal shell companies. Also a careful review of all companies with post office box addresses should be performed regularly. In addition, the employee may use addresses of relatives or friends.
After the employee forms the fictitious company and opens a bank account, the employee may then prepare false invoices for services or products. Services are typically easier to bill than goods in a fraud scheme as companies’ often have more accounting controls and scrutiny over inventory and supply purchases. In order for the fraud scheme to work, the employee is usually the person who can authorize the fictitious purchase or the false invoice. The employee will approve payment of the invoice, the check will be sent to the employee’s address. Then the employee will deposit /cash the check via the bank account that was opened.
Proper segregation of duties and formalized procedures will assist in avoiding this type of scheme. For example, one employee submits an invoice with a payment voucher, and another employee approves the payment voucher. However, even in this scenario, a person may approve a fraudulent invoice if it appears reasonable. Sometimes, an employee will take advantage of having a “rubber stamp” supervisor, which is an individual who is either inattentive, overworked or too trusting, and will authorize transactions without proper review. In addition, the employee may actually forge the approval signature.
There are red flags or symptoms of this type of fraud scheme as well as detection techniques used by internal and external auditors and forensic accountants. Some of the most common red flags to look for are as follows:
- Higher than usual expenses
- Excess goods or services
- Unusual or unauthorized vendors added to vendor list
- Unusual vendor names or addresses
- Unusual endorsements on checks
- Vendors with alternate addresses
- Unusual, unexpected or unexplained fluctuations in payables, expenses or disbursements
- Unusual changes in behavior or lifestyle of employee
Have you checked your payables lately?
By Julia Allen Miessner, CPA/CFFPosted on July 29 2014 by admin
Non-compete agreements are often implemented when a business is purchased to prevent the seller from competing with the purchaser. These agreements, referred to as Covenants Not to Compete, contain restrictions which often include a specified length of time and geographic area in which the seller is prohibited from competing with the purchaser. These agreements are considered intangible assets of the Company and need to be valued for purposes of allocating the purchase price of the Company.
One way a valuation analyst could value Covenants Not to Compete and other restrictive agreements is by using a “with or without” method. This method compares the value of the Company “with” the agreement in place – thereby assuming no competition from the seller and “without” the agreement in place – thereby assuming the seller competes with the Company. The “with” model is based on the Company’s projected net income over the period of the covenant. The method uses a discounted cash flow for the period of the covenant. See Table 1
The “without” assumes competition from the seller exists and uses projections based upon that assumption. In determining the projections, the analyst must understand:
- The relationships which exist between the seller and the customers;
- The ability for the seller to maintain those relationships beyond his/her affiliation with the Company;
- Whether or not the relationships also exist with key employees of the Company;
- Do barriers to entry exist which would limit the sellers ability to compete;
- The age, general ability and willingness of the seller to compete;
- The intention of the seller to remain in the geographic area;
- The ability of the Company to prevent a customer from leaving;
- The probability that competition will affect the Company.
The analyst will need to have extensive discussions with Company management to gain an understanding of the above factors. The projections will be subjective based upon the analyst’s understanding of the factors.
Once a value is determined “without”, the value of the covenant is the difference between the value “with” and “without” the covenant in place. See Table 2
A qualified valuation analyst should be consulted when a Covenant Not to Compete or any intangible assets need to be valued.
By Melissa E. Loughlin-Sines CPA, CFE, CVA, CFF, ABVPosted on July 22 2014 by admin
In recent years, the number of companies converting from C corporation status to S corporation status has increased dramatically. One of the main reasons is to avoid double taxation. C corporations are taxed at the corporate level for federal income tax purposes. Additionally, the C corporation shareholders are also taxed on any capital gains realized by the shareholder and on any dividend income distributed from the C corporation. However, the shareholders of an S corporation pay only one level of federal income tax. This is because the S corporation does not pay any federal income tax but rather passes it through to the S corporation shareholders.
If a company meets the eligibility requirements for conversion from a C corporation to S corporation (*) , the next step is to recognize that there is a number of potentially costly tax issues associated with the conversion. One of the primary tax implications is the Built-In-Gains (“BIG”) Tax, which applies if assets are sold or distributed within five years after the conversion (**). BIG Tax requires the corporation to measure the amount of unrecognized appreciation that existed at the time an S conversion was made. In order to do this, the fair market value of the corporation is measured at the effective date of the S election as compared to its tax basis. Fair market value is defined in Revenue Ruling 59-60 as follows (***):
The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.
The amount of unrecognized gain is determined for each separate asset. This includes assets that are not reflected on the corporation’s balance sheet such as goodwill, patents and trademarks. The net of unrecognized built-in gains and built-in losses is the company’s unrecognized built-in-gain. Any of this built-in gain recognized during the five-year period beginning with the first day of the first tax year for which the corporation was an S corporation remains subject to corporate level tax at the highest rate of tax applicable to corporations (currently 35%).
In order to document the assets on hand and keep track of their future sale, a qualified appraisal to determine fair market value is essential. Statutory presumptions applicable to the built-in gains tax effectively require taxpayers to prove their case to the IRS’s satisfaction. All gains recognized by an S corporation during this recognition period are presumed to be recognized built-in gains, except to the extent the taxpayer establishes that a portion of the gain constitutes post-conversion appreciation or that the asset was not held at the beginning of the recognition period. Without a qualified appraisal, the corporation runs the risk of subjecting the entire gain from a sale to corporate level tax during the entire recognition period.
Understanding the potential tax consequences due to a conversion from a C corporation to an S corporation is extremely important and typically requires the involvement of a tax adviser, legal counsel and a business valuation professional.
By Cindy Andresen, ASA
(*) Eligibility requirements can be found in IRC Section 1361 and the corresponding Regulations.
(**) Before 2009, the BIG tax applied to gains recognized during the first 10 years after the S election was effective. In 2009 and 2010 this was shortened to 7 years and temporarily shortened to 5 years in 2011. The American Taxpayer Relief Act of 2012 extended the 5 year recognition period to 2012 and 2013. H.R. 4453 would amend the Internal Revenue Code to make permanent a 5 year recognition period, retroactive to January 1, 2014.
(***) Source: Sec. 2.02, Revenue Ruling 59-60, 1959-1 C.B. 237, Internal Revenue Service.
Sources: Tax Implications of Converting from a C-Corporation to a S-Corporation, by Nicholas P. Hoeft, November 2011
The Tax Adviser, Now is the Time: Converting a C Corporation to an S Corporation or LLC, by Michael F. Lynch, J.D., CPA, David B. Casten, J.D., LL.M., CPA, and David Beausejour, J.D., CPA, August 1, 2012
The Tax Adviser, The S Corporation Built-In Gains Tax: Commonly Encountered Issues, by Kevin D. Anderson, CPA, J.D., March 1, 2012Posted on July 15 2014 by admin
I am often asked to review the provisions in a buy/sell agreement related to the question as to how value is determined. This sometimes occurs when there is a triggering event. Unfortunately, in those circumstances, we simply determine value based on the agreement. Sometimes the resulting value is favorable to one party to the detriment of another. Other times the language of the agreement is subject to interpretation resulting in unnecessary disputes and possibly litigation. There are advantages, disadvantages and pitfalls to avoid in drafting these agreements.
I reviewed a recent agreement that defined the purchase price for triggering events to be determined pursuant to a formula. The benefit to a formula driven approach is simplicity (as long as the formula is well-defined) and valuation certainty. The challenge with a formula approach is that, while the formula may reflect a fair price at the date of the agreement, it may also become quickly out of touch with actual value for a future transaction.
Another agreement had a defined value agreed on by the shareholders with periodic updates required. However, updates are frequently not performed. In addition, it should be clear whether the agreement requires a determination of value of the enterprise or value of the minority interest to be valued.
Certain terms have specific meanings in the finance, accounting and valuation literature, and care should be taken in selecting those terms to avoid misinterpretation or unintended results. Some common terms include:
- “fair market value”
- “fair value”
- “book value”
- “net book value”
- “net income”
- “generally accepted accounting principles”
- “accounting principles consistently applied”
An alternative to a formula approach is a process-driven value determination. As an example, the agreement might provide that the value is to be determined by a qualified appraisal performed by a qualified appraiser. The appraiser could be pre-selected or agreed on by the parties upon a triggering event. If the parties could not agree on the appraiser to be selected, a mechanism could be created to determine the appraiser to be retained. Periodic appraisals could also be performed with either named appraisers or through a selection process.
Other considerations include the options/rights of the parties and the terms of payment for any purchase of equity interests in the Company on a triggering event. Care should be taken that the terms of payment are aligned with the cash flow requirements of the business and the estate planning requirements of the parties.
These are just some of the basic considerations for a properly aligned buy/sell agreement. Now might be a good time to revisit your buy/sell agreement and consider updates.
By Steve Koons, CPA, ABV, CFF, ASA-- Older Entries »
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