Perspectives

The American Institute of Certified Public Accountants defines forensic accounting as “(T)he ability to identify, collect, analyze, and interpret financial and accounting data and information; apply the relevant data and information to a legal dispute or issue; and render an opinion.” (1)

CPAs are often hired by clients and attorneys to conduct forensic accounting procedures in civil matters and to issue a written report on their findings and conclusions.  In addition, they are often asked to testify in court regarding their reports.

I have been doing forensic accounting work for more than 25 years and have testified on several occasions with respect to the forensic procedures I was hired to perform.  I have also had the opportunity to observe other forensic CPAs who  do this type of work.  I have found some common aspects among them that seemed to make these professional men and women highly successful at their jobs as forensic accountants.

If you are in need of a CPA to do forensic accounting work here are some of my tips regarding what to look for in the professional you are going to hire for your case:

•  Forensic Experience – Depending on the complexity of your case, the  previous experience of the forensic accountant may be very  important.   How many  forensic cases has the CPA worked on? One? Two?  Twenty?  What types of cases were they?
• Audit Experience – I have found that some CPAs who have been trained  as auditors and have had a few years of auditing experience, make  very  good  forensic accountants.  This is mostly because of the  “investigative” nature of their audit assignments and their skeptical  mindset.  Has your forensic accountant  had any audit experience?
•  Planning the Work – Does the forensic accountant appear to have a  reasonable  approach to doing their(2)  work?  If the accountant can’t  easily explain their plan of action to you, they may have a difficult time in  the courtroom explaining to a judge or jury the forensic procedures they  performed.
•  Fees – The complexity of your case and the sheer volume of information  to be  considered by the forensic accountant likely will dictate whether  your case is  something that can be completed in two weeks - or two  months.  Generally, the time to be expended may be a difficult estimate  to make by your forensic accountant.  You can, however, in most  instances request  that the accountant  break the engagement up into  segments, or phases.  You then can make the call after, say Phase I,  on whether to move on to Phase II.  This will allow more control over  the ultimate fees you will pay.
•  Timeliness – Can the forensic accountant meet your necessary deadlines  by themselves or with available staff?
•  Honest Assessment of the Case – Does the forensic accountant tell you  of any risks in achieving meaningful results in the work they are going to  perform; or, do they tell you at the outset that they will find what you want  them to find.
•  Testifying Experience–If the forensic accountant will be required to  testify  before a judge or jury, how much experience have they had  in  testifying?  Once?  Twice? Twenty times? Prior experience  testifying by  the forensic accountant  can be of great benefit to your case. 
•  Communication Skills – Does the forensic accountant communicate  clearly, logically, and in a professionally confident and convincing  manner?  Does the  forensic accountant exude confidence? 
•  Composure - Does the forensic accountant have the composure to stand  up against a rigorous cross-examination?  Or, do they get easily  flustered?
•  Appearance - Does the forensic accountant look professional in grooming  and dress when meeting with you?  Will they be perceived by a jury as  dressing respectfully and in professionally good taste for the  courtroom  environment?

I write of the CPAs who do forensic accounting work.  There are others who are not CPAs who can do a quality job as a forensic accountant.  In addition, forensic accountants all started with their first case.  You may encounter one who is fairly new to forensic accounting and testifying; however, you may find they have most of the abilities noted above and can work for you at a reasonable fee.

Don R. Bays, CPA, ABV, CVA, CFF

1 Ronald L. Durkin, CPA, CFE, CIORA, and Henry Stotsenberg, CPA; “Defining the Practice of Forensic Accounting;” CPA Expert, Special edition 1999; American Institute of Certified Public Accountants; aicpa.org. 
2 Note:  Throughout this article the terms of “their” and “they” will usually encompass the terms “his/her” and “she/he,” respectively.

There have been numerous rumors surrounding whether Congress intends to eliminate discounts on transfers of family limited partnership interests and intra-family transfers of business interests. You may recall that the Pomeroy Bill proposed to eliminate these discounts. While this particular bill has not moved forward (and I understand is dead), it could come up in other legislation. The Editor of the AICPA ABVE-Alert recently reported the following email from a colleague:

“According to the latest information I have, the House intends to freeze the applicable exclusion amount at $3.5 million and the maximum gift and estate tax rate at 45% when it returns from the Thanksgiving holiday. The proposed bill, HR 4154, can be found at http://thomas.loc.gov/cgibin/query/z?c111:H.R.4154:. Elimination of discounts for lack of control and lack of marketability are not included in the proposed bill. My contacts also indicated that the Senate will wait for House action and attempt to move a more comprehensive tax bill that addresses issues other than gift and estate taxes. However, the timing of Senate action is uncertain. Additionally, Senators Kyl and Lincoln are continuing to work on reducing the tax rates and increasing the exemption. Senator Lincoln’s staff stated that they are not seeking DLOC and DLOM elimination as revenue offsets to their proposed rate reductions and exemption increase.” 

The House passed HR 4154 on December 3, 2009. The Senate introduced S. 2784 There is no provision in either of the proposed bills regarding elimination of discounts. However, we will have to await the outcome as no action has yet been taken and the federal estate tax is currently repealed. Congress may yet act to repeal the repeal.

Steve Koons, CPA/ABV, ASA, CFF

1 - ABV E-Alert, Volume 11, Issue 6, November/December 2009, American Institute of Certified Public Accountants.

As a forensic accountant, I am involved in many different types of fraud investigations. Fraud in any organization can have a devastating effect on owners and employee.  In particular, fraud in small nonprofit organizations can be especially heartbreaking, as these organizations are often run by volunteers who are friends and neighbors.  Recently there have been dozens of cases of alleged embezzlement from local charities.  An article was featured on msnbc.com on December 22, 2009 “Insider Theft a Big Problem for Small Charities,” which drew attention to the heightened risk of fraud that nonprofits face due to the recession and lack of safeguards in these organizations.

The article spotlighted a grievous case involving a food pantry organization which was forced to close for six weeks leaving needy individuals and families without the food they had come to rely on.  The charity’s former executive director was charged with embezzlement after it was discovered that more than $50,000 was missing from the charity’s bank accounts.  Other recent stories from around the nation include:

• A parent-teacher organization at a Spokane elementary school had nearly $20,000 stolen, (funds raised from selling cookie dough), and another parent-teacher organization in Pennsylvania had to cancel its field trips for the year after $34,000 was stolen by the PTO treasurer.
• The bookkeeper of an amateur hockey association pleads guilty to embezzling more than $934,000 from funds raised to build a hockey rink.
• The former leader of a Marine Corps league in Tennessee has been fired due to the alleged theft of nearly $60,000 from the group’s Toys for Tots campaign.

Small organizations like those above often lack the internal controls to prevent fraud from occurring.  There is typically little oversight, as the volunteers and employees are in trusted positions.   In many cases, the perpetrator plans to “borrow” the money, intending to pay the organization back.  However, as we often find with the fraud cases we have investigated, the fraud escalates as the perpetrator digs a deeper hole, and the funds are not repaid.  In these current tough financial times, volunteers who might not otherwise steal from a charity can feel driven to it due to a loss of job or inability to make mortgage or utility payments.

Small charities often don’t act to prevent fraud, due to the belief that anti-fraud measures would be too expensive or difficult to institute.  However, there are some simple internal controls that charities can institute to help ensure that fraud does not occur in their organization.   The following controls are some basic first steps to take to protect a charity’s assets:

• Always have two people involved in handling money, (whether it be collecting, counting or spending it).  Checks should be signed by two people, for example.
• Whenever money is collected, a receipts log should always be kept.  In addition, receipts should always be given for contributions or other payments to the charity.  If possible the receipts logging or money tracking should be performed by someone different than the treasurer, or the person making the bank deposits.  Then, the deposits can be checked to the receipts logs to ensure that all of the funds were properly deposited into the charity’s bank account. 
• The original bank statements should always be reviewed in a timely manner by someone different from the person in charge of making bank deposits and writing checks.  The bank statement should be reconciled to either the charity’s checkbook or the accounting records, (if the charity has a formalized accounting system.)

During these difficult economic times, small nonprofit organizations are a source of support for many individuals and communities.   These charities must protect not only their financial assets, but their reputation and the trust of their communities and donors. 

Julia Miessner, CPA/CFF

In a split decision by the U.S. Tax Court (Suzanne J. Pierre v. Comm., 133 T.C. No. 2), the court dealt with the issue as to whether a single-member LLC is to be disregarded for transfer tax purposes (i.e., gift tax purposes), thus treating the gift as a direct gift of the underlying property of the LLC. A single-member LLC has the option to be treated as an association taxable as a corporation or as an entity disregarded as an entity separate from its owner. The IRS regulations implementing these rules are known as the “check-the-box” regulations.   If no election is made by the taxpayer, the default rule is that the entity is disregarded as an entity separate from its owner. In other words, the owner of the LLC is treated as the owner of the property.

The basic facts in the case were as follows. The taxpayer received a cash gift of $10 million in 2000 from a wealthy friend (we should all have friends like this!) and wished to provide for her son and daughter. Taxpayer created the Pierre Family LLC on July 13, 2000 and created a trust for each of her children on July 24, 2000.   Funding of the LLC occurred on September 15, 2000 with the transfer of $4.25 million in cash. The LLC was validly formed under New York state law.  Taxpayer then made the following transfers to each of the trusts on September 27, 2000:

• Gift of 9.5% member interest in the LLC
• Sale of 40.5% member interest in the LLC

The value of both the gifts and the sales were based on independent valuations that included a discount for lack of marketability of approximately 37%. The IRS claimed that the entity should be disregarded for gift tax purposes resulting in a direct gift of the cash to the trusts. Taxpayer argued that the LLC should not be disregarded for gift tax purposes.

The full Court reviewed the case and the majority held in favor of the taxpayer. The Court noted that state law creates property rights and the Federal tax law defines only the Federal tax treatment of those property rights. The Court also noted that the check-the-box regulations govern how a single-member LLC will be taxed for income tax purposes, either as an association taxable as a corporation or as a disregarded entity (i.e., a sole proprietorship). To go farther than this classification would be tantamount to redefining the property rights actually transferred. Six judges disagreed with the majority arguing that the plain language of the check-the-box regulations requires the LLC to be disregarded as an entity separate from its owner for gift tax purposes.

The Court did not consider the issue of whether the step-transaction doctrine should be applied thus treating the transfer of the interests were indirect transfers of the underling cash nor whether the amount of the valuation discount was appropriate, leaving these two significant issues to future resolution of litigation.

Steve Koons, CPA/ABV, ASA, CFF

I recently read a short article in a business valuation newsletter regarding outsourcing valuation engagements.  The article pointed out some potential concerns with outsourcing this type of engagement. 

What really seemed interesting to me was the catalyst for the outsourcing.  The article suggested that fee pressures from clients were leading some BV firms to outsource as a cost saving measure. 

I suspect there would be little argument that the valuation service you receive today is generally a more detailed analysis with stronger support and considered an improvement over service performed just a few years ago. It is probably also safe to say that fees have not kept pace with the speed and degree of improvement in these services.

While there may always be someone willing to do the work for less, a word of caution; be careful what you ask for. 

While a well laid out analysis or report may be easy to read and understand, it is only that way because the professional has invested the time to stay current on advances in the industry and has learned to communicate complex topics effectively.  Most of this behind the scenes education is done in an appraiser’s “free time” and never finds its way to a client invoice.

When considering business valuation services, it may be more effective to seek out service based on your intended use, rather than fees first and foremost.  Consider why you are asking a professional to perform the analysis and what the risks might be.  How will the analysis be used, who will be reviewing it, what decisions will be made based on the content? 

When you consider your request from that prospective, who do you want to perform the analysis? 

Brian Christensen, ASA

How do you balance a checkbook?   Does your 6-year-old child know the difference between a “want” versus a “need”.  Does your 10-year-old understand how businesses create products and earn profits? 

I am a volunteer for Junior Achievement, teaching principles of market-based economics and entrepreneurship in elementary schools.  Most people think Junior Achievement is taught in high schools.  However, Junior Achievement has a very strong elementary school program in which students learn the basic concepts of business and economics and how education is relevant in the workplace.  I have been incredibly impressed with the program, which inspires and prepares young people to succeed in our global economy.   I feel that in teaching the Junior Achievement curriculum, I have a positive impact on the students, by providing not just educational information, but motivation to complete their schooling and realize their potential to contribute to their communities. 

Last week, I taught a fourth grade class about the concept of interdependence.  Each student had previously set up their own company, which provided a product or service to their community.  I had the student entrepreneurs visit each “company” to brainstorm how they could share resources and help each other.  I had a coffee shop owner buying cakes from a cake decorator, and a restaurant owner using the services of an architect.  I even had a nail salon providing “puppy pedicures” to a pet shop owner!  By the end of the class, all the businesses became interconnected, as we formed a robust economy, using concepts such as specialization and interdependence.

The students also really enjoy hearing about my career in forensic accounting and the types of cases I work on.   In particular they are intrigued with my stories of fraud investigation.   They now realize that the accounting profession can be quite interesting. 

I encourage other people in the accounting, finance and business world to consider becoming a Junior Achievement volunteer and a positive role model to young students.    The children will greatly benefit from your enthusiasm and life experiences.

Julia Miessner, CPA/CFF

  In the early 1980’s I had just become a partner in a 90-person Phoenix CPA firm.  I thought I had a pretty good idea of how to treat staff working for me – that is, from all the stuff I’d been taught in the management training courses I’d gone to, and from my own experiences in managing staff up to that point.  However, I learned that there is more to supervising workers than giving them instructions and holding them accountable.  I learned there were other ways to deal with subordinates.

 Harold and Julius were two of the senior partners of my firm. They were well known in the business community and were considered icons among Phoenix CPAs.  And just as importantly, they were beloved by our staff.

 I learned a thing or two about dealing with staff, clients, and people in general from observing Harold and Julius.

 Almost every morning of the business week, Harold would make his rounds throughout the offices and work stations of those employees working at my firm.  He would make it a point to give anyone he encountered a big smile and “hello.”    He would ask staff about their kids and parents, and would know everyone by their first name.  Keep in mind this was a 90-person firm. 

 When he gave staff work assignments they were thrilled to be working on Harold’s jobs.  Harold had a fatherly and gentle way of dealing with those who worked on his clients’ jobs.  He always made them feel that he cared for them – not just as employees, but as persons.   Harold vigorously supported everyone who worked for him.  If a client was unhappy with the work of a particular staff person, Harold would stand by his employee while assuaging any concerns the client might have.

 When making a proposal visit to a prospective client’s office, Julius liked to take a new staff person with him.  At the meeting, Julius would tell the representatives of the potential client, “Janie is one of our newest and brightest accountants.  What a great hire she was for our firm.  She is going to assist me on your engagement and I assure you, Janie will do her usual stellar job for you.”  Janie might have been with the firm a month, but she felt like a million dollars after Julius’ introduction.  Julius might have been guilty of a wee bit of exaggerating, but Janie enthusiastically worked for Julius, determined not to let his faith in her down.

 Both Harold and Julius made everyone they encountered feel like they were important as persons as well as very important to the success of the firm.  They treated staff with a caring respect and dignity.  As the old saying goes, staff would have walked through brick walls for the two of them.

 Harold and Julius taught me much about how to treat, not just staff, but peers, superiors, and just folks in general.  I also like to think that as I aged and matured as a professional – and as a person, that I developed some wisdom and my own sense of how to treat others, similar to how I would like to be treated.  I don’t believe in the saying, “Nice guys finish last.”  I do believe, however, that good supervisors will earn the respect of their workers if they treat their staff with respect - and with fairness and understanding.
 
What about you?  I’m not saying that supervisors have to be so congenial to their staff that they are unable to mete out discipline, or deserved criticism when it is required; or, unable to be insistent with workers in order to meet project deadlines.  I’m also not saying that all staff are great workers.  On the other hand, why not treat them like it until they demonstrate otherwise.  And, even then, ask yourself if their mistakes were honest ones – ones done with no pre-meditation or malice in mind?  Is the staff person able to be “rehabilitated,” that is, to be kept as a potentially great employee?

 As a manager or supervisor of staff, how would they say you measure up?  Will they walk through brick walls for you?

 Don Bays, CPA/ABV, CVA

The Census Bureau lists the population of Deadhorse at two. Current demographic information reflects only a few permanent residents. I can see why! This area, which is part of the North Slope of Alaska, is flat frozen tundra. There is not a tree in sight, only oil rigs, oil wells, pipelines, heavy equipment, support buildings, etc., and frozen tundra. Very clean though and all are conscious of the environment.

A Scene in Deadhorse

Large oil reserves were discovered in Prudhoe Bay and the oil fields supply a good portion of U.S. domestic oil production – more than 10%. The oil field companies employ more than 5,000 people in drilling, pipeline operations, cargo transport and other support positions. Employees working on the North Slope are flown in for typically a 1-3 week period of work and typically work 12 hour shifts, 7 days a week. Then they fly home for 1-3 weeks off.

An Active Well Site

 I spent the day in Deadhorse visiting with company management personnel and touring the site. Surprisingly, I was told to drink lots of water. It is actually very arid with normal annual precipitation of only 4 inches. There really aren’t any restaurants or hotels in town as you would normally envision. The workers refer to them as “man-camps.” They are typically modular buildings that contain multiple rooms for housing, TV rooms and small kitchens. Some have large kitchens and serve food cafeteria style. I didn’t stay overnight, preferring my hotel accommodations in Anchorage. So I caught the late afternoon plane.

A "Man Camp" Where I had Lunch

Our valuation work sometimes takes us to interesting places. Two weeks ago I traveled to Anchorage, Prudhoe Bay and Deadhorse, Alaska for a site visit and management interviews in connection with a valuation project. If you’ve seen the television show Ice Road Truckers, you might know that the truckers travel the Dalton Highway (the “haul road” to locals) that ends at Deadhorse, located on the north coast of Alaska and well inside the Arctic Circle. I had never been to Alaska before and really looked forward to the trip.

The flight from Phoenix to Anchorage connects thru SEA-TAC and is a full day of travel leaving Phoenix in the morning on a Wednesday and arriving in Anchorage in the evening. Flying in I saw Mt. McKinley (aka Denali or just “the mountain” to the locals) poking up through the clouds in the setting sun - beautiful. Temperatures in Anchorage were mild and actually unseasonably warm at 25-44 degrees. However, tourist season is over by this time of year and Denali National Park is closed.

I awoke early Thursday but the sun didn’t rise until about 9 a.m., which was a little different. I’m told that in late January the sun doesn’t rise but it is like dusk for maybe an hour. My schedule consisted of a full day of meetings in Anchorage with management, outside auditors, and consultants, organizing information received, and preparing additional documents/information requests and follow-up questions. The city of Anchorage is home to approximately half of the state’s population of about 700,000.

The following day, Friday, started early with a 6 a.m. flight from Anchorage to Prudhoe Bay/Deadhorse. I didn’t know what to expect. My colleagues in Phoenix kidded me about maybe flying in on a single engine Cessna with pontoons or skis and having to jump out with a parachute; or grappling hooks on the ice. There were numerous variations on the theme with some polar bears thrown into the mix. However, we flew on a Boeing 737-400, landed on a modern runway and were not greeted by polar bears on arrival much to the disappointment of my colleagues.

It was snowing as we landed and visability was no more than one-half mile. It was pretty cold for a guy from Phoenix at about 12-25 degrees but the wind was not blowing much. I’m told that that’s when it gets really cold, especially in the middle of winter. My host had loaned me his parka so I was comfortable.

Stay tuned next week for more of my adventures in Prudhoe Bay/Deadhorse, Alaska and pictures!

Steve Koons, CPA/ABV, ASA, CFF

With proper planning and execution, a leveraged ESOP can provide benefits to all parties of the transaction, including the company, the owners, the employees and lenders.

The Company
The most significant benefit for the company is the tax deduction for the contributions to the ESOP, which are essentially returned to the company and available to pay the Bank Loan. This represents a significant tax savings for the company and potentially increases after-tax cash flow compared to conventional debt financing.

The Owners
The Owner/shareholder has created a buyer for a stock of his or her closely held company. In addition, if the selling shareholder meets certain criteria, he or she can take advantage of the 1042 election. Under Section 1042 of the Internal Revenue Code, the selling shareholder can defer the capital gains tax on the sale to the ESOP. If the company and shareholder transaction qualifies, the shareholder can purchase qualified replacement property (”QRP”) within 12 months and defer the taxes.

Many owners of closely held companies have a significant portion of his or her net worth tied up in the company. The sale to an ESOP can allow the owner to diversify his/her investments, while potentially retaining ownership control of the company. These events may also be beneficial to the individual shareholder’s estate plan.

The Employees
The primary benefit for employees is the ability to share in the future growth of the company. Since the value of the company is dependent on its performance, employees may be more motivated to act in ways that maximize shareholder value.

Typically, ESOP contributions are larger than profit sharing contributions. ESOP contributions can even exceed 25 percent of annual compensation in certain situations. The larger contributions essentially accelerate the benefits to the employees compared to other qualified plans.

And, like other qualified retirement plans, the employee does not recognize taxable income when the shares are allocated to the participant’s account. Rather, taxable income is recognized when the participant receives a distribution from the ESOP.

The Lender
We already identified that the company increases the after tax cash flows compared to traditional debt financing. This is a major benefit for lenders in ESOP transactions in the form of reduced credit risk. The tax savings increase after-tax flow and provide a greater chance that the company can pay its debt obligations to the bank in a timely manner. And if necessary, the ESOP transaction also can enhance credit if the selling shareholder pledges the QRP purchased in a Section 1042 rollover transaction as collateral for the Bank Loan. The shareholder is typically not adverse to the use of QRP as collateral, since it must be held for a certain minimum length of time in order to qualify for the tax deferral.

Fair Market Value after a Leveraged ESOP Transaction
While there are many benefits as outlined above, it is relevant to point out that after the ESOP purchases company stock, the value of the shares may initially drop. After the transaction, the company typically has a significant demand on cash for debt repayments. unless the company anticipates significant future cash flow enhancements, the fair market value of the ESOP shares immediately after the transaction is reduced.

The reduced value is often only temporary. If the company does not change significantly over the period the loan is amortized, this initial decrease in value is recouped as the debt is satisfied.

Brian Christensen, ASA