Pension brouhaha south of the border

FASB is coming out with some tough new standards relating to defined benefit pensions that is expected to result in significant new liabilities (or increases to existing ones) for companies that had been accounting for their pensions under the more lax requirements of the old standard.

Defined benefit pension plans are definitely the more complicated type, compared to defined contribution. I’ve only worked on one pension audit thus far, and it was – luckily for me – a defined contribution. Auditing a defined contribution plan is easier to do because future estimates aren’t necessary. Defined benefit plans require an actuary to perform the highly specialized work.

Anyway, back to the change in the standard. Under the old standard:

Employers reported an asset or liability that almost always differed from the plan’s funded status because previous accounting standards allowed employers to delay recognition of certain changes in plan assets and obligations that affected the costs of providing such benefits.

Pension accounting is one of those things you learn in a 2nd or 3rd year course at university and then pray you don’t have to see frequently in practice, unless you’re a masochist. It’s just so very complicated! I feel lucky that so far the only pension audit I’ve been on has been defined contribution.

Specifically, the new standard requires an employer to:

(a) Recognize in its statement of financial position an asset for a plan’s overfunded status or a liability for a plan’s underfunded status

(b) Measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year (with limited exceptions)

(c) Recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes will be reported in comprehensive income of a business entity and in changes in net assets of a not-for-profit organization.

Sounds like they’ve improved things from both the investor viewpoint as well as the employee’s. This new standard brings up the issue of comprehensive income, which is a below-the-line adjustment to net income on the income statement. I believe the Canadian standards body has guidance out relating to it but it may or may not be in effect for year ends just yet.

Now that’s a niche

There’s a particular blog that only discusses the idea that accounting firms, and indeed all professional services firms, should “trash the timesheet” and implement “value pricing.”

The basic concept is sound: Timesheets treat the chargeable hour as the measure of the firm’s services’ value, which distorts its true value to the client and further commoditizes the work we do. Value pricing looks at our services from the client’s point of view and tries to determine what the work is worth to them, and pricing to that.

But it just occurred to me that this blog has such a small niche. It’s a firm’s blog, and they’re definitely leading the charge for value pricing for professional services, but I can’t help but wonder if they’re eventually going to run out of stuff to blog about!

Attending inventory counts

Part of any audit is attendance at the client’s inventory count. If the company being audited has material inventory in multiple locations, you’ll have to observe each count.

I’ve been busy lately with inventory counts. Yesterday I went to one and counted washing machines and dryers. This morning I was counting packages of cottage cheese, sour cream, and other dairy products. I’ll be doing the same thing tomorrow morning, at 7am! On a Sunday!

From the auditor’s point of view, the inventory count is all about making sure the client conducted the count accurately. So we test some of the counts, selecting items from the inventory listing and finding them on the floor, and selecting random items from the floor and tying them back to the listing.

Sometimes the client will estimate inventory, if counting is not feasible. For example, a gravel pit operator will have piles of gravel and sand and whatnot, and it’s not reasonable to count or weigh it. Obsolete or slow-moving inventory will need to be segregated as its value is much lower.

After attending the count, the auditor will summarize his/her findings in a “count memo”, as well as reporting directly the results of the individual sheet to floor and floor to sheet tests. The count memo provides a narrative of the experience, the arrival time and details regarding the count procedures and general conditions at the location.

For me, the best part about inventory counts (that aren’t on weekends) is that we’re allowed to wear jeans/casual clothes back at the office for the rest of the day. Anyone questioning your attire gets the standard reply: “I had an inventory count this morning.” It’s foolproof.

Incorporate or not: It’s the investment

A small business usually starts out as a sole proprietorship, owned and operated by the founder personally and reporting business income on their annual personal tax return.

But as the business grows, the question of incorporation will always arise, and there are several factors to consider when this happens.

The most important single factor, in my opinion, is the tax savings that can be achieved through the corporate structure. Income earned in the corporation is taxed at a relatively low rate (20%ish) for small businesses (in Canada at least) and is then taxed when it is paid to shareholders as dividends.

Unincorporated business income is taxed at the earner’s highest marginal rate, which, in Canada, is 46%(ish).

The conclusion is that income that will be reinvested in the business (and thus, not paid out as dividends) will be taxed at a lower rate and allow the business to grow much faster than if it remained unincorporated.

If losses are expected, the owner is better off unincorporated, because those losses will flow through to his/her personal return and can be used to offset other sources of income. Losses in a corporation can only be used against income earned in that corporation.

Other advantages:

  • Separating business and personal income
  • Controlling the timing of business (dividend) income
  • Limited liability of the corporation