What the AICPA’s new SOC 2 guidelines mean to your organization

If your organization provides services that include handling valuable data, the success of your business may depend on your ability to demonstrate effective internal controls. To meet this need for assurance, the American Institute of Certified Public Accountants (AICPA) introduced Service Organization Controls (SOC) reporting in 2011. While SOC reporting included three different reporting options: SOC 1, SOC 2 and SOC 3, SOC 2 was designed specifically to meet an entirely new type of assurance — assurance over controls not related to financial reporting.

Now, just three years into SOC 2 reporting, the AICPA has made a comprehensive effort to improve SOC 2 reporting standards. Why did SOC 2 need a comprehensive overhaul? How will these changes affect your organization?

Smart Business spoke with Brian Beal, manager of business process assurance services at Sensiba San Filippo LLP, to discuss what service organizations need to know about the changes to SOC 2.

Why were SOC 2 standards updated and why was the update important?

While the original SOC 2 provided a critical assurance tool, users of SOC 2 found it too difficult to administer and understand. A SOC 2 evaluation could cover any or all of five Trust Service Principles (TSPs), which included security, availability, processing integrity, confidentiality and privacy.

Some organizations may have only desired a report to cover one of the TSPs, but other organizations needed assurance in multiple areas. While the TSPs could have shared many common test criteria, the initial SOC 2 procedures required time-consuming redundancy in testing these criteria, meaning that testing for multiple TSPs could be extremely costly and drain resources.

Additionally, end users of SOC 2 reports found them to be voluminous and difficult to understand. If the reports were too complex for readers, it was difficult for them to achieve their original objective, which is to provide assurance to users of the reports.

What were the biggest changes to SOC 2?

The new guidelines have made SOC 2 reporting simpler, more efficient and more useful. First, the list of five original TSPs has been shortened to four, as privacy follows the generally accepted privacy principles (GAPP) and is being revised separately. Next, redundancy in testing has been significantly reduced as more than 120 testing criteria have been reduced to 28 core ‘criteria common to all principles.’ Now, each TSP starts with the same basic 28 principles. Testing for availability requires three additional criteria, while processing, integrity and confidentiality each require six additional criteria. Whether you are testing for one TSP or multiple, the testing process will now be less painful.

In addition to simplifying the testing process, the format of the actual report will change as well. A new risk assessment element can now be used to identify risks and correlate those risks with the criterion being examined. Risks will be documented within the SOC 2 final report in order to show how each control is specifically mitigating the risk identified. The result is a clearer, more valuable report for both service organizations and stakeholders.

How will the changes improve the evaluation process?

The nature and intent of the SOC 2 report hasn’t changed. The new guidelines simply seek to clarify and solidify the array of control criteria. The process should now be simpler, reports should be more consistent and the entire process should provide greater value to both service organizations and stakeholders.

What actions do I need to take?

The 2014 version of SOC 2 is already published and supersedes the previous version for periods ending on or after Dec. 15, 2014, while the AICPA is encouraging early implementation. Be sure your next SOC 2 report is utilizing the newly released standards. The process and the result should be significantly improved.

Insights Accounting is brought to you by Sensiba San Filippo

Updated language may be needed in retirement plan during restatement

Every six years, the IRS requires that all retirement plan sponsors restate their prototype or volume submitter retirement plan documents for any law changes since the last restatement period. The current restatement period started May 1, 2014, and runs through April 30, 2016.

If a business’s plan operates under a prototype or volume submitter document, it’s important for the business to work with its service providers to ensure its document is restated timely.

Now is a great time for businesses to make any voluntary plan design changes to their plans. By going through this procedure, it will eliminate the cost of doing a separate amendment later.

Since the last restatement period, several significant law changes have occurred.

One change in particular is causing companies to closely examine their retirement plan documents to determine what may need to be changed.

A 2013 U.S. Supreme Court decision repealed Section 3 of the Defense of Marriage Act (DOMA) and determined that it was the states’ responsibility to define the term “marriage.”

Smart Business spoke with Andrea McLane, manager, Rea & Associates, about the importance of keeping your organization’s retirement plan up to date with changes that have been made in the law.

What did the DOMA decision involve, and what was the outcome?

The Supreme Court’s DOMA case involved a same-gender couple that had been married in Canada, but lived in New York.

When one spouse died, the other inherited her estate and sought to claim the federal estate tax exemption for surviving spouses.

The IRS denied her claim and ordered her to pay $363,053 in estate taxes. It was appealed to the U.S. Supreme Court, and Section 3 was overturned under the equal protection basis.

Section 3 of the DOMA decision originally barred married same-gender couples from being treated as married under federal law. Only that section was ruled unconstitutional.

What do businesses need to know about DOMA and their retirement plans?

By holding Section 3 of DOMA unconstitutional, qualified retirement plans must now treat the relationship of same-gender married couples as a marriage in order to maintain the plans’ tax-qualified status. The term ‘spouse’ includes an individual married to a person of the same-gender if the individuals are lawfully married under state or foreign law.

If a business’s retirement plan defines a spouse by reference to Section 3 of DOMA or only as a person of the opposite gender, it must adopt an amendment by the later of Dec. 31, or the restatement period as it was defined.

In addition to ensuring the plan document reads properly, plans must recognize same-gender marriages for all plan purposes.

Therefore, businesses must be certain that participant-related documentation, such as beneficiary forms, loan or hardship requests, etc., follow the proper procedures, recognizing the marriage and obtaining spousal consent where required.

What if a business fails to amend its retirement plan documents by the deadline?

Actually, many businesses don’t realize that they need to periodically amend their plan documents by a certain date.

The IRS offers a special voluntary compliance program for businesses to restate their plan without the plan being disqualified.

There is a user fee, which gets larger as the number of participants increases.

Insights Accounting is brought to you by Rea & Associates

Improving your cash flow through effective tax planning

If you have an interest in real property as an owner or tenant, a cost segregation study may be one of the tools to increase your cash flow or help manage your tax liability.

“These studies have saved both businesses and individuals hundreds of thousands of dollars,” says Walter McGrail, senior manager at Cendrowski Corporate Advisors LLC.

Smart Business spoke with McGrail about these studies to better understand how companies might best utilize them.

What is the focus of the analysis?

A cost segregation study identifies and reclassifies personal property assets to shorten the depreciation time for taxation purposes, which reduces current income tax obligations.

The primary goal of a cost segregation study is to identify all construction-related costs that can be depreciated over a shorter tax life than the building.

Generally speaking, personal property assets identified in a cost segregation study might include items that are affixed to the building but do not relate to its overall operation and maintenance.

What are the phases of the study?

The process will usually begin with a meeting between management and the firm conducting the study.

During the next phase, or the scope phase, the engineering professionals and tax accountants walk through all areas of the property with a site representative to develop a general overview.

Engineers also examine the architectural renderings or blueprints to produce an in-depth analysis. In addition, a review will be done on any construction contracts and capital expenditure budgets and reconciliations.

Next, the tax accountants take the engineers’ work and put it in format acceptable to the IRS. A report with documentation supports how the cost recovery was arrived at and takes into account any stipulations on allocations.

How is the amount of benefits determined?

First, the benefit is dependent upon the income tax savings generated from depreciation deductions claimed for income tax reporting purposes.

The costs incurred by a taxpayer in any capital expenditure program or property acquisition are recoverable as deductions in arriving at federal and state taxable income. Costs attributable to depreciable assets generate annual depreciation deductions reducing taxable income.

Second, the tax savings occurs for both federal and state income taxes. Depreciation deductions generally result in tax savings of approximately 40 percent of the deduction claimed.

Third, cost segregation studies identify categories of costs that have a shorter cost recovery period for income tax.

The actual savings is the reduction in current tax payments with resulting increases in taxes payable in subsequent periods, i.e., the ‘time value of money’ attributable to a sound treasury cash management program.

As with any treasury cash management program, a businesses’ cost of capital is the appropriate discount rate to measure the ‘present value savings’ of deferring cash charges for income taxes.

The higher an entity’s cost of capital, the more significant the present value savings attributable to deferring such tax payments.

What are the benefits of this study?

These studies have helped maximize tax savings and increase cash flows on current, future or past property purchases by maximizing tax deferrals.

Put another way, the benefit is the ‘present value savings’ attributable to the deferral of income taxes achieved via the acceleration of depreciation deductions resulting from shorter cost recovery periods identified during the study.

Generally, the depreciable tax life of most commercial buildings is 39 years. Recovery periods for personal property and land improvements range from five or seven and 15 years.

A cost segregation study identifies items that can be classified properly into categories with shorter tax recovery lives, which allows individuals and businesses to save hundreds of thousands of dollars through effective tax planning and improve cash flow. ●

Insights Accounting is brought to you by Cendrowski Corporate Advisors LLC

What international business leaders need to know to launch in the U.S.

International businesses see the U.S. as fertile ground to broaden their reach. If their business model and value proposition is one that appeals to the masses, it can be a wise move to make. There are, however, a number of things to consider before bringing a franchise concept to America.

“What many companies don’t realize is how franchising operates in the U.S. and how that differs from how it operates overseas,” says Larry Schwartz, Director and Senior Consultant with the Franchise Services Group at RBZ.

“There is crossover, but there are many unique aspects to franchising here versus most other countries. A lot of companies are simply unaware of the many regulatory issues and industry standards unique to the U.S. franchise industry.”

Smart Business spoke with Schwartz about the steps inbound franchisors need to take before opening their doors in the U.S.

What is the first step when bringing a franchise business to the U.S.?

The first and most important thing to be done is to assemble a team of franchise experts to start and complete the entire process. One of those professionals should be a franchise attorney who will prepare your Franchise Disclosure Document (FDD).

The FDD is required by the Federal Trade Commission, as well as state regulatory agencies. It provides a prospective franchisee with detailed information about the franchise and its entity, the history of the company, the business model, the principals and executive team and their backgrounds.

It also contains information about how your business operates, who your competitors are, the obligations and expectations of parties to one another, risk factors, financial information, etc.

It’s meant to protect the prospective franchisee and help them understand where they’re investing their money.

Who is the best person to draft the FDD?

A U.S. transactional franchise attorney should always draft the document.

In addition, as the international franchisor, you must decide which states you want to expand into. There are additional requirements in 14 states, including California, which requires the FDD be provided to the Department of Business Oversight.

This group looks for certain criteria to be met in order to approve the franchisor to sell and operate franchises in the state.

You need to know which states you want to be in so you can file the necessary paperwork. You’ll also need to set up a U.S. bank account. An audited financial statement of the new U.S. entity must also accompany the FDD.

Can overseas vendors and suppliers support U.S. franchisees?

They may be able to do a great job providing products and services where the franchisor is based, but it’s highly unlikely they are going to be able to provide those same products and services in the U.S.

So you’ll need to seek the advice of a professional consulting firm to assist you in establishing a vendor/supplier network on behalf of your new franchisees.

It’s also prudent to establish a U.S. based training program and determine what that program looks like, who is going to conduct it and where it’s going to be held.

How can master franchise licensees help your efforts?

You need to think about how you’re going to market your franchise opportunity in the U.S. as well as support franchisees. Most often, a master licensee pays a fee to the franchise entity for the exclusive right to develop and support the franchise within a specified market or markets.

Master Licensees act as your agent in the U.S. The Master benefits by being compensated a portion of the franchise and royalty fees paid to the franchisor and is highly incentivized to develop his/her market.

What are the keys to success for inbound franchisors?

Is there a market for your product or service that is in the U.S.? Will the brand and business model resonate well with consumers? Are you evaluating the competitive landscape the right way to make sure you are not entering a market that is oversaturated?

Are you selecting the right market and building the right infrastructure? If you have all those components, you are likely to be successful. ●

Insights Accounting is brought to you by RBZ

Understanding your first financial statement audit

While early stage businesses are frequently financed by a close group of owners, success often creates opportunities that necessitate outside funding.

Whether your business is experiencing rapid growth that is putting pressure on cash flow, or you are taking new technology to market and need an influx of outside equity, attracting outside funding will require establishing credibility in your financial statements.

So what can a business do to provide the necessary assurance to potential investors? The answer is an independent financial statement audit.

Smart Business spoke with Ernie Rossi III, Audit Partner-in-Charge at Sensiba San Filippo LLP, who helps growing Bay Area businesses navigate many different challenges including preparing for audits, and learning more about financial statement audits, how they work and what they can provide to businesses and investors.

What is an audit and why is it beneficial?

First and foremost, an independent audit provides assurance to third parties about the financial statements prepared by management. For management, playing the role of advocate creates an inherent conflict when it comes to sharing information with third parties — management has a vested interest in the result.

This is where a financial audit can provide tremendous value. A financial audit provides an objective, independent, third-party opinion on management’s financial statements. While an audit might seem like an onerous requirement, in reality, it can be the key that unlocks the door to outside funding and new opportunity.

How does the audit process work?

The audit process is designed to efficiently analyze the financial statements so that an auditor can issue an opinion.

From the standpoint of management, the desired result is an ‘unqualified opinion,’ meaning the auditor concludes that the financial statements provide a true and fair representation in accordance with the appropriate financial reporting framework.

If the audit process cannot resolve significant questions regarding representations of management, an auditor may issue a ‘qualified opinion’ or even an ‘adverse opinion.’

While an audit requires independence and objectivity, it also requires coordination and cooperation between management and the outside auditor. Financial audits generally have five phases including planning, risk assessment, audit strategy, evidence gathering and finalization.

What are the roles of the auditor and management?

In the strictest sense, the role of the auditor is to take financial statements and perform procedures so that he or she can determine whether the statements are fairly represented.

Auditors cannot be involved in the actual preparation of audit schedules supporting the financial statements, but they can provide templates, feedback and advice for management to help them prepare for a successful audit.

Management’s role in an audit is to provide the auditor with a complete, closed set of books for the audit period. While an auditor can provide guidelines for what he or she will need in order to complete the audit, management is ultimately responsible for preparing the required information.

Some companies have the knowledge and resources to prepare for an audit internally, but many organizations utilize outsourced controllers, CFOs or other accounting firms to help them prepare for an audit.

What should be considered when selecting an auditor?

It is generally a good idea to work with an auditor who understands your company and your industry. Industry knowledge helps auditors best assess areas of risk so they can focus the audit in the right areas to effectively minimize the risk of material misstatements.

Finally, and most importantly, find an auditor who is willing to make the audit a joint effort, not an adversarial relationship. Auditors must remain independent; they can’t be advocates for management, but they also don’t have to make the process combative. These engagements can be mutually beneficial.

The who, when, why and how of machinery and equipment appraisals

Executives often wonder why they need to have machinery and equipment appraised, but these appraisals are important components of business today.

“Typically, appraisals are performed because of buy/sell agreements, mergers and acquisitions, business valuations, partnership dissolutions, insurance, bankruptcy, property taxes, financing and Small Business Administration lending. Other reasons would be divorce, estate planning or other estate issues, retirement planning, cost-segregation analysis and litigation support,” says Theresa Shimansky, a manager at Cendrowski Corporate Advisors LLC.

Smart Business spoke with Shimansky about how machinery and equipment appraisals are typically handled.

What is the useful life of an appraisal?

Generally, an appraisal is good for three years, but it depends on the current market, economy and industry. An appraisal’s useful life also depends on the availability of the type of equipment being appraised. The value can drastically change with economic factors such as supply and demand.

Is a machinery and equipment appraisal beneficial when buying or selling a business?

Absolutely. Buyers want to know the breakdown between real and personal property. This is a cost segregation analysis or study. Appraisals are completed for many reasons, but most importantly for tax reasons — breaking the assets into different categories for depreciation purposes.

What information and documentation will an appraiser require?

The appraiser will need to know the manufacturer, model, serial number and age of the equipment. This information typically can be found on a plate attached to the equipment. Mostly, it will be visible; however, sometimes locating this plate can be tricky. For example, restaurant equipment will occasionally have a kick plate covering the information plate. Machines may have the plate attached inside a compartment or near the motor, while others may not have one at all. When a machine does not have a plate, it is helpful if the owner has the original manual or sales invoice that should list most of the information.

The appraiser also needs to know about the condition, special features and upgrades. Important questions to keep in mind are:

  • Does it work well?
  • Has it had any major repairs or is it in need of any?
  • Is it maintained according to manufacturer specifications? The appraiser may request to see maintenance logs or ask about special attachments or upgrades.
  • Is its software up to date?

An appraiser will evaluate and photograph each piece of equipment. When this is not possible, appraisers will note in the report which equipment could not be visually inspected and explain they are relying on the representations of similar machines’ condition and other pertinent information.

What is a ‘qualified appraisal’?

A ‘qualified appraisal’ is clearly defined in Internal Revenue Service (IRS) Publication 561, where the appraisal:

  • Is made, signed and dated by a ‘qualified appraiser’ in accordance with appraisal standards.
  • Does not involve a prohibited appraisal fee.
  • Includes, but is not limited to, a description of property, condition, date of value, terms of the engagement agreement, qualifications of the appraiser, method used to determine value and basis for value.

Generally, an appraisal is considered qualified if it follows the Uniform Standards of Professional Appraisal Practice, developed by the Appraisal Standards Board of the Appraisal Foundation.

What should you look for in an appraiser?

When searching for an appraiser, only use a ‘qualified appraiser.’ This is an individual, as defined by the IRS, who has earned an appraisal designation from a recognized professional organization for demonstrating competency in valuating property. Also, qualified appraisers regularly prepare appraisals for which they are compensated, and demonstrate verifiable education and experience in valuating the type of property being appraised.

A global revenue recognition standard for customer contracts, at last

After a dozen years of collaboration and controversy, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) finally have agreed on how and when companies should recognize revenue.

Considered the “crown jewels” of accounting convergence efforts, Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, and International Financial Reporting Standards 15 are expected to produce a major shift in how companies report the top lines in their income statements.

But many are unsure exactly how the changes will pan out, as the new standard ushers in a sea change and a learning curve.

Smart Business spoke with Mostafa Popal, partner of Assurance Services at Weaver, about these reporting updates.

What changes with recognizing revenue?

Companies will follow a single set principle-based approach for reporting of revenue from contracts with customers — a shift from industry-specific guidance of today. The new guidance is a five step principle-based approach with a core principle being to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

With the new rules, for example, companies must determine the expectation of collecting payments owed to them by recording revenue only to the extent that it’s ‘probable’ they won’t have to make a significant reversal in the future. They also must adjust the transaction price to reflect the time value of money, if the timing of the agreed payments provides customers or entities a significant benefit of financing the transfer of goods or services to the customer.

In addition, detailed footnote disclosures are required to break down revenues by product lines, geographical markets, contract length, services and physical goods.

Are there exceptions to these new rules?

Exceptions include insurance contracts, leases, financial instruments, guarantees and nonmonetary exchanges between entities in the same line of business to facilitate sales. These transactions remain within the scope of existing industry-specific generally accepted accounting principles.

Who will be affected, and when?

All companies can expect some change, but certain industries will be more affected, such as engineering and construction, industrial products and manufacturing, pharmaceutical and life sciences, retail and consumer, software and technology, and telecommunications.

For public companies, the new guidance is effective for annual reporting periods beginning after Dec. 15, 2016 (including interim reporting periods). Early implementation is not allowed. Private companies have the option of taking an extra year to implement the new rules.

So, what are the first steps for companies?

Despite having more than two years before the new standard becomes effective, most companies should gear up for adoption now, especially if they choose to utilize the retrospective approach. This would require them to present not only the current year under the new standards but also prior years need to be presented as if the standard had been in effect all along.

Companies can also make a simpler transition, the cumulative approach, which would apply the standard only to the current year figures. However, companies would still have to make some adjustments to deferred numbers and include disclosures to explain lack of comparability.

The approach companies take depends on the expectations of their financial statement readers and what industry peers utilize.
In addition, companies must look at whether their infrastructure can capture the information they will need to comply with the new standards. This cost could range from minimal to significant.

Where can firms get help with the new rules?

The FASB and IASB have formed a Joint Transition Resource Group for Revenue Recognition to field questions and concerns as companies prepare to adopt the new guidance. The American Institute of CPAs has also established 16 industry task forces that are developing a new accounting guide containing helpful tips and illustrative examples for applying the new standard.

The new global standard is expected to provide a universal accounting language for revenue recognition, but it relies heavily on judgment for companies to come up with their figures, which can differ from company to company, country to country and CFO to CFO. You need to continue to work with experts for helpful hints and considerations for applying these new rules in your industry.

Insights Accounting is brought to you by Weaver

Updating your books all year long can make closing time a breeze

If there’s ever a time your company’s well-kept balance sheet is worth its weight in gold, it’s at year-end. That, of course, is when it’s crunch time to close the books, but the process can go much smoother if you follow some timely procedures throughout the year.

For instance, expenses charged on company credit cards can be tracked better if entered throughout the year.

“You don’t want to dump all those expenses into one bucket of miscellaneous throughout the year,” says Trista Acker, CPA, CFP, senior manager at Rea & Associates. “If you do, you’ll have no idea where you are really spending your money.”

Smart Business spoke with Acker about how to streamline processes when closing the books at year-end.

What are some keys to save time on your year-end financial reporting?

The key to accurate financial statements is your balance sheet. A good suggestion is to get your balance sheet out, work your way down and make sure that you tie all those balances to supporting documentation or calculations and that all those balances make sense.

In addition, bank reconciliations should be done monthly, make sure that your accounts receivable have been reviewed, writing off all bad debts and tie out loan balances to amortization schedules. Another process that could be done throughout the year is to update the depreciation schedule, making sure that new assets are added to the schedule and old ones are deleted. You want to make sure you properly record your gains or losses from sales or purchases.

It can be a real timesaver at year-end if you make the necessary adjustments throughout the year. It is easier to track it as it happens rather than trying to recall what you did months later. There’s also a greater chance of error the longer you wait.

What is one of the more common areas where mistakes can be made?

A company credit card is one area where errors often occur. Individuals may have a company card and may not allocate expenses to the appropriate accounts until the end of the year.

Then they will have to go back through a whole set of credit card statements and try to account for the charges.

But if you keep up with the bills monthly as you sit down to pay them, it will be a huge timesaver at year-end and will give you a clear idea of what’s been happening all year.

You should also look at your payroll. Companies should be reconciling their payroll on the books to their actual payroll registers at least quarterly if not more frequently to ensure gross wages are accurate. You may be able to download your payroll information from a third-party provider right into your software, which will save time and enhance accuracy.

Are there some other suggestions to make the process easier?

Try to distribute some of your tasks throughout the month instead of trying to do everything within 10 days at the end of the month. Spread it out so that you’re taking a look at your receivables on the 20th of the month and taking care of those at that time. Then a few days later you can sit down and do your billing. Another five to 10 days later you can be doing your bank reconciliation.

That way you’re not cramming everything and rushing through. You can be more focused on what you are looking at instead of thinking how to get it done.

What other advice can you give to get the books in the best shape?

Have a checklist for your monthly close. This will help you ensure you haven’t forgotten something as you take care of tasks throughout the month. Set a deadline for completion of monthly closes, to make sure tasks get completed.

If you keep up on your books consistently throughout the year, the year-end should go smoothly and quickly. Don’t hesitate to meet with your CPA or your tax planner before year-end because there is a lot of opportunity for planning or for suggestions to make things go smoother.

Insights Accounting is brought to you by Rea & Associates

Entity choice is an important decision for any inbound franchise business

You’ve built a successful business model and now you want to bring it to the U.S. Whether your goal is to take a large chunk of the market and build a lasting U.S. presence, or just funnel profits back to your home country, there are tax implications you need to consider.

These decisions may not be exciting, but they are very important choices to make as you seek to bring your operations to the U.S., says Stephen Rickert, CPA, a partner at RBZ’s International Franchise and Tax Services Group.

Ideally, your answers will help you make the right call on decisions such as forming a corporation or a limited liability corporation.

“This is always an important choice and there is no one right answer for every franchisor,” Rickert says. “It’s a complicated decision with a lot of moving parts.”

Smart Business spoke with Rickert about what LLCs offer inbound international franchisors in the way of both flexibility and saleability.

Where does the conversation begin with inbound franchisors?

As an entrepreneur, you are proud of the business you have created, but you may not have given much thought to tax implications or entity choice.

You just want to open up your yogurt store and start selling as fast as you can. It’s really important, however, to have the proper professional guidance from the start so you don’t have to unwind problems that are created innocently.

We need to look at the reasons why you are coming to the U.S. so you can make the right decisions going forward. It’s not always a question that has been given a lot of thought, but the answers can go a long way toward determining your future.

In a corporate environment, it may be more difficult to repatriate profits back to your home country if that is your plan. But if funds are to be invested in the U.S. to grow your franchise business, this could be a good choice.

What other factors matter for the franchisor looking to build a strong U.S. presence?

Most new franchisors set up as LLCs. One of the reasons is to take advantage of the single layer of taxation that LLCs offer.

Another is the fact that LLC owners (called members) can draft the LLC governing document in such a way as to facilitate even the most complicated of economic relationships. It is simply better suited to those relationships than a corporation with several types of shares and convertible debt.

There is very little ‘corporate’ type maintenance required, meaning the owners can decide for themselves how the business is to be managed and what powers management has.

An LLC will generally require foreign owners to be pulled into the U.S. tax system, but if you’re looking to build something lasting in the U.S., that becomes less of an issue.

Are there drawbacks to choosing an LLC?

The LLC structure is still relatively new and so there are some attorneys who prefer and will recommend corporations over LLCs due to the long legal history surrounding corporations. In addition, many foreign governments have yet to form solid opinions on how to tax their residents when they receive income from U.S. LLCs.

There is less information to disclose with a corporation, making tax filings easier. There are times when an LLC can mesh very nicely for tax purposes with their home country’s tax system, but in other instances, it’s not such a good mix.

How does entity choice affect the future sale of your business?

It’s very easy to sell the assets of an LLC. Most buyers want to buy assets. If you were to say, ‘Oh, I can only sell my stock,’ a lot of buyers are going to say, ‘No thank you.’ Why? Because they don’t want to buy past liabilities. When you have an LLC, if the end game is to sell the assets of your business at some point, it opens up a world of potential buyers.

Selling or distributing assets from a corporation can lead to a tax nightmare. At the end of the day, taxes are only part of the conversation. But they are an important part and need to be considered before you make your move.

Insights Accounting is brought to you by RBZ

How to run a construction company so it yields more bottom line profit

If you are manufacturing widgets, your production environment is pretty much a controlled one. Temperatures in the plant are consistent year-round, as is the speed of your production line. Other factors are well within accepted levels also.

But think of the construction company. There are unforeseen conditions, the size and scope can be staggering and the quality of workers can vary.

“A construction company does not have that luxury of consistency. Therefore, every job is unique and presents its own challenges,” says Kent Beachy, CPA, CIT, CCIFP, principal and director of construction services at Rea & Associates.

To build a more profitable construction company, taking into account these challenges takes a four-part approach.

“You first estimate, then you do the work, then you account for it and then you analyze it,” Beachy says. “You bring all those pieces together, then you tweak it, and see that you can make money in the business, and then you go for it.”

Smart Business spoke with Beachy to learn the keys of building a more profitable construction business.

What’s a good rule of thumb to follow as your first step toward profitability?

You have to be able to estimate for profit. Construction companies are generally bidding against the competition. You have to know your company’s backlog, what work flow you have in place, how busy the company is at present and how busy it will be when construction actually begins.

What other considerations are there?

Is the job within a niche of yours where your labor is skilled and has done work before and can do it efficiently and effectively? Or is it something new that you’re going to have to get up to speed on? That is a risk factor you have to be concerned about.

If you are a general contractor, you have to consider the subcontractor, what is his or her schedule and if you can use him or her.

If you are a subcontractor, you have to consider if you have the labor in place and will be able to get the job done effectively and efficiently.

You also have to know your overhead — the fixed prices, utilities, rent, the telephone — to be able to estimate for profit.

What about benchmarks and key performance indicators?

Another process within a more profitable construction company is being able to measure the financial aspect of your company. That includes breaking it down by job using a construction accounting software that allows you to job-cost.

That way, you’ll know whether or not you’ll have potential change orders, work that is added to or deleted from the original scope of the job. You have to be able to manage a change order and still be profitable.

After you tally up the figures for these jobs, then you can do your analysis. For instance, if a company wants to measure profitability on a job, you would measure gross profit margin. If you want to measure profitability within the company, you would measure return on assets or return on equity. Liquidity ratios, such as the current ratio, is an important measurement and one the surety is interested in as it measures to what extent your current assets are available to satisfy your current liabilities. An efficiency ratio one may want to consider is backlog to working capital. While backlog represents jobs waiting to start, the relationship between committed work and working capital may determine if you need more working capital to be able to finish the work.

How can ratios help you analyze your company’s performance?

You could do comparisons to industry — in fact, that is how you benchmark. You can get ratios for the industry through the Construction Financial Management Association, which conducts surveys. You can benchmark against the industry and determine which ratios are key to the company’s performance and measure those.

You can put everything in a nice package and show the company executives where they’re at. But you want to be able to determine what ratios are important to the company, to its profitability. Just a few ratios will make sense to the owner, the controller or other executive so they can measure on a regular basis to spot signs that will let them know if something is wrong.

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