Although many businesses have found success in today’s positive economy, they are constantly changing and adjusting to new trends. These changes can be implemented to keep up with customers’ or clients’ needs, provide more efficient services, or simply to learn more about a trend and what it means for the industry. The accounting changes and trends that affect businesses are all rather complex and detailed, but that doesn’t mean that the average business owner can’t understand and implement the changes surrounding their work. Jack Barry, chairman and CEO at Enterprise Bank and Trust in Arizona, sat down to answer the big questions and explain the major changes taking place in the world of accounting in 2019.
TAX REFORM
AZ Business: What is one of the most important pieces of the tax reform?
Jack Barry: The big winner in tax reform, or corporate entities, is what we call C-Corps and some business, if they’re small enough, can file their taxes on a Subchapter-S status. All the income for the business flows through the owners and just gets taxed there, and that was one of the things that I think in 2019, if you could switch from a Subchapter-S to a C-Corps, there may be some immediate lower tax benefits to do that.
AB: How popular do you think it will be to switch to a C-Corps status?
JB: I would say you’re probably not going to see a lot of that. One of the reasons that some companies choose Subchapter-S is because the money is taxed once. Whereas if you’re a C-Corporation, and if you’re IBM and you make $100 million, you’re going to pay tax on $100 million of income. Then that profit goes to your bottom line, and when you’ve sold that asset, you have to pay a capital gains tax on the increase; there’s a concept of double taxation. That’s why they introduced Subchapter S tax treatments 25 years ago, so you only do that (pay tax) once. But if the tax is materially lower under a C-Corps than it is under an S-Corps, you may be better off switching to a C-corps.
AB: How does tax reform affect the individual employee?
JB: There have been tweaks to entertainment expenses and some employee benefit costs that could have an impact on what you used to be able to deduct for meals, entertainment and travel. It’s not as generous as it used to be.
AB: What other things are changing within businesses due to tax reform?
JB: If you create a loss in your business, you used to be able to carry back the loss to prior years and recapture some of that income from the past. They stopped the look back, and you can only carry it forward now because there are limits on how much of a loss you can recognize. You can’t immediately go back and reclaim old taxes. You have to just apply it on a carry forward basis.
REVENUE RECOGNITION
AB: How does a business know what to recognize as revenue?
JB: There are standards as to how you recognize revenue, when you recognize expenses, and when you capitalize expenses for when you recognize them during the year that they occur. All those rules are sort of set by the American Institute of CPAs, or the AICPA, and also the Financial Accounting Standards Board, or FASB, so for years they have had the U.S. Standards. The international community have had their own board too, so companies in London, Spain and a lot of European countries in particular have had different standards. They’re very similar in many ways, but there are some notable differences and distinctions. Since many businesses are worldwide in their outreach now whether they’re buying or selling outside the U.S., the FASB got together with the International Accounting Standards Board to match up some standards.
AB: What notable differences are/were there between the U.S. standards and the international standards?
JB: Generally, the proposed changes by the US accounting authority (FASB) regarding revenue recognition are designed to match the International standard. As such, long-term, contractual based agreements that exchange fee for service will change in terms of how and when the revenue is recognized.
AB: How did the FASB and the IASB resolve this difference in standards?
JB:They came up with methodologies in terms of when you recognize that revenue. So if you have a business where you’re entering into contracts with people to provide a service to them, then how you recognize that income might change from what you used to do. Back to my cell phone example, you’d recognize it costs $150 for 10 months and $100 for the other 14 months. Well let’s say the way you should really do that is you should recognize $125 for all 24 months. If you do that for every single client, get a loan from a bank and tell them you’re paying $125 per month for 24 months instead of $150 per client per month, the bank may say, “you don’t have as much revenue as you used to have.” If you’re being impacted as a business on this revenue recognition, you want to talk to your bank and see if they’re providing you credit to explain to them under the new rules you’re going to see lower revenue per month but for a longer period of time.
AB: How do the new trends in revenue recognition affect how businesses recognize revenue?
JB: From a bank’s point of view, this could impact the level of revenue in any given year based on the timing aspects of the contracts. In general, the most impacted industries may be building contractors, technology companies and other service companies entering into contractual relationships.
LEASE ACCOUNTING
AB: What were the original rules under Lease Expense Recognition?
JB: The old rules were if you leased something that was really going to benefit your business for a long period of time, depending on the criteria, you could capitalize that lease. The way that would work is you would recognize the value of the equipment… let’s say it’s a $1 million piece of equipment, and you’re going to pay $1 million for it over a period of time. So you would have an asset on your balance of $1 million dollars and you would have a liability of $1 million dollars just as if you were to borrow the money and own it.
AB: How did these rules change?
JB: With small things you could just enter into an operating lease. Going back my cell phone example: you’re not sure you want to buy the cell phone because the cell phone technology is going to change in 2 years, so I just want to rent the cell phone from you. Your balance sheet didn’t used to get impacted. You just entered into an agreement that you’re going to pay somebody $20 a month to use their cell phone. It wasn’t yours it’s theirs, you’re just leasing it. On your income statement you would just have a $20 expense every month, but the way you have to do it now under the new rules, you can’t just do that every month and just have a $20 expense. You have to show on your balance sheet your full obligation so your obligation is $20 times 24 months, or $480, so your phone would be an asset on your balance sheet worth $480. Then you’d have a liability for $480. So you have to capitalize leases now and what that means as a bank is before I never saw that liability now I know “Oh you’re obligated to pay $480 over a period of time.” So we have ratios that we say to our customers, “we’re happy to lend you this money, but the ratio of how much debt you have to your net worth can’t exceed some ratio.” Well now all of a sudden, all those leases that you have now have to go on your balance sheet, and all of a sudden your liabilities are going to grow. You may bust through that ratio, and you may not look as good as you previously did.
AB: What will this change do to the relationship between companies and their lenders?
JB: For privately held businesses this doesn’t go into effect until 2020, but all these companies are having to go to their lenders and say, “Look, just so you know, all these operating leases we have now are going to be in our balance sheets so our ratios are going to be out of whack.” We understand it. We’re not going to over react to it, and we’re going to probably have to make some adjustments on our loan documents and so forth. But that is going to be the change in lease accounting.
