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Accounting studetns understand that the accrual method ofaccounting is superior to the cash method for measuring the incomeand expenses from an ongoing business for financial reportingpurposes. Thus, CPAs advise thier clients to use the accural methodof accounting. Yet, CPA firms generally use the cash method toprepare their own tax returns. Are the CPAs being hypocritical?Explain.

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Sixta Kovacek
Sixta KovacekLv2
5 Sep 2018

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The following is a transcript of a video

This video explores the vital role of accounting in one of the world's largest firms. Aon is a reinsurance broker, insurance broker, and employee benefits consultant operating in more than 120 countries. Its goal of being the world's most responsive and client-focused insurance company means it must integrate thousands of professionals in hundreds of disciplines in many countries.

Many view accounting as a primary business language. It is of little use, however, unless you know how to "speak" it. Fortunately, the fundamentals—the accounting equation and the double-entry bookkeeping system—are not difficult to learn.

0:01Clearly, in the financial world,

0:03if you want to be an effective accountant,

0:05you just can't be a numbers person.

0:07You also have to understand people.

0:09You need to know how to debate and hold your

0:11position on the arguments that you take.

0:14♪♪

0:34-Narr: You might not have heard of Aon.

0:36They've brokered deals between clients

0:38and more famous insurance companies.

0:40They often even insure

0:42those insurance companies.

0:45In fact, the only building taller than the

0:47Aon building in Chicago is the Sears Tower.

0:50With over 550 offices in 130 countries,

0:55there's a lot of money involved

0:56and a lot of numbers to keep straight.

0:58So who does all that math?

1:00Well, that's easy.

1:01The pencil pushers, the number crunchers,

1:03bean counters, right?

1:05Accountants are traditionally thought of as

1:07humorless people who type into

1:09pocket calculators all day.

1:11Nothing could be farther from the truth.

1:13Accountants are actually some of the most

1:15important and influential people in business,

1:18and Joe Prochaska is probably

1:20the most important accountant at Aon.

1:23Accounting is the process of recording,

1:25categorizing and interpreting financial

1:28transactions, but there are more creative

1:30aspects to accounting than mere bookkeeping.

1:32That's why Joe is usually smiling.

1:35-Oh, yeah, and my staff is learning to smile.

1:37It's very rarely that they see

1:39me frown, okay, but there are

1:40different kinds of smiles.

1:42-At Aon, managerial accountants interpret

1:46financial data for a company's internal use.

1:49Financial accountants such as CPAs summarize

1:52that information for outside parties

1:54like potential investors.

1:56At the end of the year, Joe uses

1:58a tax accountant to assure that

2:00Aon is in full compliance with

2:02changing tax laws, and to assure that Aon is

2:05taking advantage of the best tax strategies.

2:08But Joe gets the lion's share of the duties

2:10when it comes to Aon's financial information.

2:13-The role I play in the process of handling

2:16all these inputs is reviewing all the reports

2:20that come in so that when our management

2:22takes a look at those financial statements,

2:24they can have some assurance that they're

2:26looking at this as our shareholders will be

2:30looking at it when we

2:31present the information.

2:34-Did you know that every book

2:35you've ever read,

2:36every comic strip, poem and Web page,

2:39has its roots in accounting?

2:40That's because the earliest

2:42written languages were created

2:44to keep track of financial transactions.

2:46Every world culture engages

2:48in some form of trade,

2:49and Aon operates in most of those places.

2:53-The information we get

2:54on a monthly and a quarterly basis

2:56from our different operations around the globe

2:59is stated in a variety of currencies,

3:01yet Aon is a U.S.-based company that publishes

3:05its financials in U.S. dollars.

3:07There's a requirement for some assurance from

3:11a party outside the management

3:12of the company that you've done

3:15a fair job in presenting your financials,

3:17that they've been presented reasonably

3:20and in a consistent manner.

3:23-That's why the

3:24Financial Accounting Standards Board created

3:26the Generally Accepted Accounting Principles,

3:29to help everyone get on the same page

3:31with their accountant.

3:32The Generally Accepted Accounting Principles

3:34and the interpretation are one

3:36of my key functions at Aon.

3:38The Securities and Exchange Commission makes

3:41sure that companies stay on that page.

3:44-In its most adverse reaction,

3:46the SEC also is capable of doing

3:49what they would call an enforcement action.

3:52Many of you have heard of Enron,

3:53okay, and WorldCom.

3:56-The core of those principles is

3:58the six-step accountant cycle.

4:00Pretend you're on Joe's staff for a moment.

4:02First, a hundred different people

4:04send you transaction records

4:06from a dozen different departments.

4:08You collect and organize that pile of

4:10receipts, invoices, bank statements and

4:12purchase orders, account by account,

4:15into a book called a journal.

4:17Now divide all those

4:18transactions into purchases, sales,

4:21investments and so on, in a ledger.

4:24When that's done, do a trial balance

4:26to check your work.

4:28If it's off, go back and find the error.

4:31If it's okay, you can now begin

4:33the real task of accounting,

4:35reporting and analysis.

4:36-The mechanics of doing the accounting,

4:39that doesn't excite me too much.

4:41But going through the philosophy

4:42of what you're trying to accomplish

4:44and how you match revenue and expenses,

4:47which is really the underlying philosophy behind

4:50Generally Accepted Accounting Principles,

4:52to make sure when you recognize the revenue,

4:54you recognize the proportion of the expense.

4:57There's a lot of judgment and

4:58interpretation of what goes into

4:59an individual company in doing that.

5:05The two most basic reports you'll do are the

5:07balance sheet and income statement.

5:10The balance sheet contains the

5:12fundamental accounting equation.

5:14Assets are all the things Aon owns,

5:16like furniture and investments.

5:18Liabilities are how much the company owes

5:21others in the form of loans,

5:22bonds or unpaid bills.

5:24Equity is a little trickier to understand.

5:27Say that Aon owns $100,000, although we can

5:30pretty much guarantee they made a lot more.

5:33If they owe $70,000 in bills and loans to

5:36run the business, the $30,000 difference

5:39is called owners' equity.

5:42That's the amount of actual value

5:43that Aon's stockholders divide up

5:45between them to see how much their

5:47investment is worth at the moment.

5:49The income statement covers a specific period

5:52such as a quarter or year.

5:53It starts with revenue, which is all

5:56of Aon's earnings for the period,

5:58including sales, licensing fees

6:00and gains on investments.

6:02By subtracting the cost of goods sold,

6:04which is the amount of money applied

6:06to producing and distributing a product,

6:09you come up with a gross margin,

6:11or the profit and loss for the period.

6:18Okay, we've been throwing a lot of terms

6:20around, so let's take a break and learn a

6:22little bit more about what Aon does.

6:25One particularly interesting service

6:27has to do with extreme weather.

6:28-For instance, we do catastrophe modeling

6:32for hurricanes so that some of our insurance

6:35clients that may insure a whole lot

6:36of homes along the Gulf Coast to Florida

6:39what happens if a certain hurricane comes?

6:41What type of insurance or reinsurance

6:43protections do they need to make sure

6:46that they're still financially solvent

6:47if a big wind blows and takes out a

6:49lot of their clients' homes?

6:53In addition to that,

6:54one of the things that we innovated,

6:55we were one of the first people

6:56to provide a terrorism model.

7:00And you may be aware that Aon lost

7:02its major operations in New York,

7:04and we lost 175 of our associates

7:06in the World Trade Center disaster.

7:08That certainly spurred us into taking a look

7:11at what can we do to help companies manage

7:14and monitor their exposure to terrorism acts,

7:18and we've done a - have a strategic

7:20partnership with Rudy Giuliani and his group

7:23to try and help companies

7:25prevent and prepare for

7:27if a disaster like that would ever occur again.

7:34Okay, back to the income statement.

7:37Subtract the operating expenses of the company

7:39- that's salaries, electricity and stuff -

7:42from the gross margin to reveal

7:44net income before taxes.

7:46Then, obviously, subtract the taxes,

7:48and you get Aon's net income or net loss.

7:52That figure is what's known as

7:53the bottom line.

7:54If these two reports seem similar,

7:58just remember that the balance sheet is

8:00like a snapshot of the business at any

8:02particular moment, while the income statement

8:05is more like a movie of the company's

8:07performance over a certain period of time.

8:09Now you're at the final and most important

8:12step of the accounting cycle, analysis.

8:15A good example of analysis is budgeting,

8:18which looks at Aon's history to

8:19find ideas for the future.

8:22The budgeting and the planning process

8:23help us analyze and understand that

8:25and create a consensus among management

8:28of what are reasonable expectations

8:30for the coming years,

8:32and it also helps us to give some guidance to

8:34our shareholders on what they should expect

8:36for earnings from our company, which then

8:39I think also helps give people guidance

8:41on what reasonable valuations of our

8:43companies are for our shares.

8:45There are a host of other analyses

8:47you can do, financial ratios

8:49and activity ratios and liquidity tests.

8:52Of course, you don't have to do

8:53all of this math in your head; these days,

8:56most of it can be done by computer software.

8:58I can't think of anybody in our

9:01financial shop that doesn't have a computer

9:03on their desk, and I'm probably one of the

9:04biggest dinosaurs in that I can read all these

9:07financial reports and I can manipulate them,

9:09but I'm too far away from them

9:11to actually create them anymore.

9:13But clearly, the analysis and

9:15the financial reporting is definitely enhanced

9:18by the reporting tools that exist in computers.

9:22Well, your first day as an

9:23accountant went pretty well.

9:25You made a few decisions and learned a little

9:27about how Aon functions financially.

9:29If you're interested in learning more about

9:31accounting as a career,

9:32talk to your instructor.

9:34On the other hand, if accounting isn't for you,

9:36don't worry; your day hasn't been wasted.

9:39Understanding and applying the

9:41basic fundamentals of accounting is a skill that

9:43will help you in almost any

9:45business endeavor you pursue.

9:47Clearly, if you want to do

9:48anything in business - and I am biased,

9:51but there is no better foundation than

9:53having an accounting background,

9:55because that's how businesses are

9:57measured at the end of the day, and the

10:00intrepretation of those numbers are critical.

Question:

The value of the owners' interests is the same as

short-term liabilities.

equity.

revenue minus costs.

liabilities minus assets.

profits plus revenue.

TAX ACCOUNTING COMPREHENSIVE PROBLEM:

Carrie A Morgan, age 45, is single and lives with her dependentmother at 426 Grouse Avenue, Allentown, PA 18105. Her SocialSecurity number is 111-11-1112.

1. Carrie is a licensed hairstylist and operates her ownbusiness. Located at 480 Laurel Street, Allentown PA 18105, thebusiness is conducted under the name of "Carries Coiffures."Carrie's business activity code is 812112. In addition to 10workstations (i.e., stylist chairs) and a small reception area, theshop has display and storage areas for the products she sells (seeitem 2 below). During the year, Carrie leased nune of the stationsto other hairstylists. As is common practice in similar businessesin the area, the other stylists are considered to be self-employed.In fact, the IRS sanctioned the self-employment classification forthe stylists in an audit of one of Carrie's prior tax returns. Eachstylist pays Carrie a fixed rent for the use of a workstation,resulting in $68,000 of rents received during 2015. From her ownstation, Carrie earned $44,000 (including tips of $12,000) for thestyling services she provided to her own clients.

2. Carrie's Coiffures is the local distributor for severalbeauty products (e.g., conditioners, shampoos) that cannot bepurchased anywhere else. Carrie buys these items from themanufacturers and sells them to regular patrons, walk-in customers,and other beauticians (including those who lease chairs from her).Carrie's Coiffures is also known for the selection and quality ofits hairpieces (i.e., wigs, toupees). Through the shop, Carrie madethe following sales during the year:

Hairpieces and wigs: $69,000

Beauty Products: $48,000

Although Carrie operates her business on a cash basis, shemaintains inventory accounts for the items she sells as required bylaw. So, she uses the hybrid method of accounting for tax reportingpurposes. Relevant information about the inventories (based onlower of cost or market) is summarized below.

Hairpieces and wigs: $10,700 (12/31/2014), $12,600(12/31/2015)

Beauty products: $11,400 (12/31/2014), $9,900 (12/31/2015)

Carrie's purchases for 2015 were $30,500 of hairpieces and wigsand $26,100 of beauty products.

Carrie's Coiffurs had the following operating expenses for2015:

Utilities (i.e., gas, electric, telephone): $12,900

Ad valorem property taxes:

On realty (e.g., shop building and land): $4,200

On personalty (e.g., equipment, inventory): $1,800 ->Totalling $6,000

Styling supplies (e.g., rinses, dyes, gels, hair spray):$5,700

Fire and casualty insurance: $4,100

Liability Insurance: $4,000

Accounting services: $3,800

Janitorial services: $2,400

Sewer service, garbage pickup: $2,300

Water: $2,200

Occupation licenses (city and state): $1,500

Waiting room supplies (e.g., magazines, coffee): $1,300

As Carrie prefers to avoid employer-employee arrangements andthe payroll tax complexities, she retains outside agencies tohandle her accounting and janitorial needs.

3. In early 2015, Carrie decided to renovate the waiting room.On May 10, she spent $10,400 for new chairs, a sofa, various lamps,coffee bar, etc. Carrie follows a policy of claiming as muchdepreciation as soon as possible. The old furnishings were thrownaway or given to customers. For tax purposes, the old furnishingshad a zero basis.

4. Carrie's Coiffurs is located in a building Carrie hadconstructed at 480 Laurel Street in March 2001. The shop was builtfor a cose of $300,000 on a lot she purchased earlier for $35,000.Except for a down payment from savings, the cost was financed by a20-year mortgage. For tax purposes, MACRS depreciation is claimedon the building. During 2015, the following expenses wereattributable to the property:

Repainting (both interior and exterior): $8,000

Repairs (plumbing and electrical): $1,900

In May (after her accident settlement discussed in item 10below), Carrie paid the balance due on the business mortgage. To doso, she incurred a prepayment penalty of $4,400. Prior to payingoff the mortgage, she paid regular interest on the mortgage in 2015of $6,000.

5. In February 2015, Carrie's Coiffures was cited by the cityfor improper disposal of certain waste chemicals. Carrie questionedthe propriety of the proposed fine of $2,000 and retained anattorney to represent her at the hearing. By pleading nolocontendere, the attorney was able to get the fine reduced to$500. Carrie paid both the fine of $500 and the attoney's fee of$600 in 2015.

6. In August 2015, Carrie saw an ad in a trade publication thatattracted her attention. The owner of a well-respected stylingsalon in Reading (PA) had died, and his estate was offering thebusiness for sale. Carrie traveled to Reading, spent several dayslooking over the business (including books and financial results),and met with the executor. Carrie treated the executor to dinnerand a music concert. Immediately after the concert, Carrie made onoffer for the business, but the executor rejected her offer. Herexpenses in connection with this trip were as follows:

Car rental: $140

Entertainment of executor (dinner and concert): $280

Motel ( August 6-7): $220

Personal meals: $110

7. In March 2014, Joan Myers, one of Carrie's best slylists,left town to get away from a troublesome ex-husband. In order tohelp Joan establish a business elsewhere, Carrie loaned her $7,000.Joan signed a note dated March 3, 2014, that was payable in oneyear with 6% interest. On December 30, 2015, Carrie learned thatJoan had been declared bankrupt and was awaiting trial on felonytheft charges. Carrie never received payment from Joan, nor did shereceive any interest on the loan.

8. At Christmas, Carrie gave each of her 35 best customers alarge bottle of body lotion. Each bottle had a wholesale cost toCarrie of $12 but a retail price of $24. Carrie also spent $3 tohave each bottle gift wrapped. (Note: The lostion was special ordermerchanidse and was not part of the business's inventory orpurchases for the year - see item 2 above.) She also gave each ofthe nine stylists who leased chairs from her a friet basket thatcost$30 (not including a $5 delivery cost).

9. In March 2015, the Pennsylvania Department of Revenue auditedCarrie's state income tax returns for 2012 and 2013. She wasassessed additional state income tax of $340 for these years.Surprisingly, no interest was included in the assessment. Carriepaid the back taxes promptly.

10. On a morning walk in November 2014, Carrie was injured whenshe was side-swiped by a delivery truck. Carrie was hospitalizedfor several days, and the driver of the truck was ticketed andcharged with DUI. The owner of the truck, a national parceldelivery service, was concerned that further adverse publicitymight result if the matter went to court. Consequently, the owneroffered Carrie a settlement if she would sign a release. Under thesettlement, her medical expenses were paid and she would receive acash award of $200,000. The award specified that the entire amountwas for physical pain and suffering. Since she suffered nopermanent injury as a result of the mishap, she signed the releasein April 2015 and received the $200,000 settlement.

11. In January 2015, Carrie was contacted by the state ofPennsylvania regarding a tract of land she owned in York County.The state intended to convert the property into a districtheadquarters, barracks, and training center for its highway patrol.Carrie had inherited the property from her father when he died onAugust 11, 2014. The property had a value of $140,000 on that dateand had been purchased by her father on March 3, 1980, for $30,000.On July 25, 2015, after considerable negotiation and after thestate threatened to initiate condemnation proceedings, she sold thetract to the state for $158,000. Since Carrie is not comfortablewith real estate investments, she does not plan to reinvest any ofthe proceeds received in another piece of realty.

12. When her father died in 2014, Carrie did not know that hehad an insurance policy on his life (maturity value of $50,000) inwhich she was named the beneficiary. When her mother told her aboutthe policy in July 2015, Carrie filed a claim with the carrier,Falcon Life Insurance Company. In August 2015, she received a checkfrom Falcon for $51,500 (including $1,500 interest).

13. Upon the advice of a client, who is a respected broker,Carrie purchased 1,000 shares of common stock in GrosbeackExploration for $40,000 on March 4, 2015. In the months followingher purchase, the share value of Grosbeak plummeted. Disgusted withthe unexpected erosion in the value of her investment, Carrie soldthe stock for $28,000 on December 23, 2015.

14. While on her way to work in 2014, Carrie was rear-ended by ahit-and-run driver. Thankfully, she was not injured in theaccident. The damage to her Lexus was covered by her insurancecompany, General Casualty, except for the $1,000 deductible she wasrequired to pay. In 2015, the insurance company located the driverwho caused the accident and was reimbursed by his insurer.Consequently, Carrie received a $1,000 refund check from GeneralCasualty in May 2015 to reimburse her for the $1,000deductible.

15. After her father's death, Carrie's mother (Mildred Morgan,Social Security number 123-45-6789) moved in with her. Mildred'spersistent back trouble made it difficult for her to climb thestairs to the second-floor bedrooms in Carrie's house. So, Carriehad an elevator installed in her personal residence at a cost of$12,000 in January 2015. A qualified appraiser determined that theelevator increased the value of the personal residence by $5,000.The appraisal cost $400. The operation of the elevator during 2015increased Carrie's electric bill by $300.

16. As a favor to a long-time client who is a drama professor ata local state university, Carrie spent a weekend as a stylist forthe key actresses in the annual Theater Department fund-raisingevent. The drama professor provided all of the resources thatCarrie needed to provide her services. Carrie estimates that shewould have charged $800 for the services she donated to thischaritable event.

17. In addition to the items already mentioned, Carrie had thefollowing receipts during 2015:

Interest income:

CD at Scranton First National Bank: $900

City of Lancaster general purpose bonds: $490

Money market account at Allentown State Bank: $340 -> $1,730total.

Qualified dividends on stock investments:

General Motors: $470

AT&T common: $380 -> $850 total.

Federal income tax refund (for tax year 2014): $791

Pennsylvania state income tax refund (for tax year 2014):$205

18. Expenditures for 2015, not previously noted, are summarizedbelow.

Contribution to pension plan: $10,000

Medical:

Premiums on medical insurance: $4,800

Dental bills: $1,400 -> $6,200 total.

Property taxes on personal residence: $3,800

Interest on home mortgage: $3,200

Professional expenses:

Subscriptions to trade journals: $180

Dues to beautician groups: $140 -> $320 total.

The $10,000 contribution to the pension plan is to a 401(k) typeof plan she established in 2015. Previously, she had contributed toan H.R. 10 (Keogh) plan but found that the 401(k) retirementarrangement provides more flexibility and is less complex. Themedical insurance policy covers Carrie and her dependents and wasissued in the name of the business (i.e., "Carrie's Coiffures"). Itdoes not cover dental work or capital modifications to a residence(see item 15 above).

19. During 2015, Carrie made total estimated tax payments withrespect to her 2015 tax returns of:

Federal estimated income tax payments: $20,800

Pennsylvania estimated income tax payments: $2,400

Allentown estimated income tax payments: $800

Requirements:

Prepare an income tax return (with appropriate schedules) forCarrie for 2015. In doing this, use the following guidelines:

Make necessary assumptions for information not given in theproblem

Carrie has itemized deductions ever since she became a homeownermany years ago.

The sales tax option was not chosen in 2014, and Carrie had nomajor purchases that qualify for the sales tax deduction in2015.

Carrie has substantiation (e.g., record, receipts) to supportthe transactions involved.

If a refund results, Carrie wants it sent to her.

Carrie is preparing her own return (i.e., no preparer isinvolved).

Carrie does not wish to contribute to the Presidential ElectionCampaign Fund.

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