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CPA, CFE | Principal

Matt is one of several Clark Nuber professionals who are musically inclined. But he’s not just a musician, he’s a music fanatic. When he’s not making music, he’s making spreadsheets that rank his favorite albums and songs. Spreadsheets – it must be an accountant thing.

As an executive, if you don’t receive accurate and timely end-of-month financial reports, your business could suffer in a multitude of ways:

  • You’ll be unable to identify errors in a timely manner, allowing the inaccuracies to balloon.
  • Year-end reporting will take longer than necessary.
  • Fraud is more difficult to detect.
  • And, you’ll lose the ability to capitalize on key performance indicators.

The ABCs of the Monthly Close Process

At the end of each month, the accounting department must reconcile the books with supporting documentation. Management then uses these statements to make decisions. These statements allow for quick looks at budgets v. actual revenue and spending. If these financial statements aren’t completed accurately and on time, managers can lose a valuable tool needed to smartly run their business.

Unfortunately, it’s not uncommon for executive managers to fail to receive the information and transparency needed from their controllers to make informed decisions. Perhaps your process is inefficient or is not systematized. It’s the controller’s responsibility to manage the financial reporting process.

It’s important that companies – large and small – have standard monthly close procedures, which should include a checklist and a strict timeline for completion.

Timing for the Close Process

We recommend that a close happens as close to month-end as possible. If accounting systems are integrated and everything is running smoothly, and the reports are computer generated, few manual entries or adjustments should be needed.

For some businesses – especially hotels and others in the hospitality industry – the close can be done quickly, say three to five days after month end. This process for other businesses with more complex revenue streams or accounting issues can take longer. But, all monthly closes should occur within the first 10 days of the month.

When Problems Arise in the Close Process

As expected, problems do arise. I recently spoke with an individual who expressed frustration he wasn’t getting enough information from his accounting team.  The financial statements were delayed several months, he didn’t know where their line of credit balance stood and whether accounts receivables were being collected timely. He asked whether he might need more accounting staff. And, he asked for best practices to make his monthly close more effective and efficient, so he had the necessary information needed to make good management decisions. One suggestion is to create a Cash Management report scorecard/dashboard for management to see every Monday. This would include key performance indicators including cash balances, accounts payable and accounts receivable aging reports and line of credit balances.  Another suggestion is to review the current financial reporting system and determine if it is being utilized to its full potential.  Is a significant amount of transactions being processed manually?  Any accounting procedure that can be integrated with the accounting system will facilitate an efficient monthly close process.

Tying It All Together

An accounting team should be a high-performing part of any business, providing data to help managers make intelligent business decisions. A lax system creates risk for internal control problems, and poor monthly close processes mean data may not be available until the end of the year, leaving managers in the dark. Critical areas such as financial analysis, budgetary control, and cash flow can all be negatively impacted.  Managers are unable to quickly identify errors and then make decisions based on inaccurate financial information. Year-end audits or other outside compliance reports take longer because managers must go back several months to identify what happened. Any past errors must be identified – and when they are – fixes come later than they should.

A good monthly close process is an important internal control step. It’s not just busy work. Without it, managers can’t make well-informed decisions. Make sure your monthly closes happen regularly and on time. Let us know if we can help.

© Clark Nuber PS and Developing News, 2019. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Clark Nuber PS and Developing News with appropriate and specific direction to the original content.

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Franchisors Seeing a Big Change in Revenue Recognition

The guidance under ASC 606 is effective for public entities with annual reporting periods beginning after December 15, 2017. For non-public entities, it is effective one year later, for years beginning after December 15, 2018.

Background of Franchise Agreements

Franchise agreements include a laundry list of deliverables that are provided to franchisees.  Those deliverables can include functions at the start of the contract, such as lease negotiations, assistance with location selection, hiring, training staff, and tenant improvements. The agreement typically includes the ability to use the brand name, ongoing advertising, menu support, as well as purchasing of goods. The franchisee normally pays an upfront fee as well as royalties over the franchise agreement based on a percentage of sales. Historically, the recognition of revenues was simple – upon completing the deliverables to start the contract (which usually coincides with the restaurant/hotel opening), the initial franchise fee was recognized as revenue. The royalty was recognized when sales took place.

What Will Change Under ASC 606?

Under ASC 606, franchisors can only recognize the initial franchise fee if any of the upfront activities performed are distinct services within the context of the franchise agreement.  Essentially, the franchisor needs to determine if any of the goods or services have stand-alone value. Certain delivered items are part of the brand and cannot be separated, while other items could be considered distinct.  For example, if the franchisee purchases furniture from the franchisor and the furniture is a key part of the brand (i.e., the same at every location) it is likely part of the overall franchise agreement. However, if the furniture is different at each location and could easily be purchased from a third party, it may be considered distinct. The franchisor should consider each promised good and service to determine whether any portion of the initial franchise fee may be allocated to it, allowing recognition of that portion of revenue at the time that the good or service is delivered. As the public company implementation has already occurred, there are numerous example disclosures related to the implementation. Following are two case studies.

Case Study 1: Hotel Franchisor

For our franchised hotels, we have a performance obligation to provide franchisees and operators a license to our hotel system intellectual property for use of certain of our brand names. As compensation for such services, we are typically entitled to initial application fees and ongoing royalty fees.

Our ongoing royalty fees represent variable consideration, as the transaction price is based on a percentage of certain revenues of the hotels, as defined in each contract. We recognize royalty fees on a monthly basis over the term of the agreement as those amounts become payable.

Initial application and relicensing fees are fixed consideration payable upon submission of a franchise application or renewal and are recognized on a straight-line basis over the initial or renewal term of the franchise agreements.

Case Study 2: Restaurant Franchisor

On January 1, 2018, the Company adopted ASU No. 2014-09 “Revenue Recognition (Topic 606), Revenue from Contracts with Customers” using the full retrospective transition method.

Under ASU No. 2014-09, revenue is recognized in an amount that reflects the consideration an entity expects to receive for the transfer of goods and services. The standard also requires additional disclosures about the nature, timing and uncertainty of revenue and cash flows arising from contracts with customers.

Under the new standard, the Company recognizes gift card breakage proportional to redemptions, which are highest in the Company’s first fiscal quarter. Previously, under the remote method, the majority of breakage revenue was recorded in the Company’s fourth fiscal quarter, corresponding with the timing of the original gift card sale.

Advertising fees charged to franchisees, which were previously recorded as a reduction to other restaurant operating expenses, are recognized as franchise revenue. In addition, initial franchise and renewal fees are recognized over the term of the franchise agreements. As part of the adoption of ASU No. 2014-09, the Company applied the practical expedient to use the portfolio approach to assess contracts and performance obligations. In connection with adoption of ASU No. 2014-09, a cumulative effect adjustment of $33.1 million, net of tax, was recorded as a credit to the ending balance of accumulated deficit as of December 27, 2015.

Regarding franchise fees,  initial franchise and renewal fees are recognized over the term of the franchise agreement and renewal period, respectively. The weighted average remaining term of franchise agreements and renewal periods was approximately 15 years as of April 1, 2018.

Take Action Now

If you have not yet already done so, now is the time to begin assessing and evaluating the impact ASC 606 may have on your business. While the magnitude of changes to a franchisor’s current revenue recognition practices will vary, almost all franchisors will see changes upon adoption of the new guidance.  In addition to the topics covered here, franchisors need to consider the impact of ASC 606 on gift card revenue as well as advertising or brand fee revenue. Contact your Clark Nuber professional or Christie Streit for more information about revenue recognition for franchisors. © Clark Nuber PS, 2019. All Rights Reserved
Originally published October 2018.

Peace, Love, and Family Harmony: Safeguarding the Long-Term Interest of Your Family Business

Various research has found that only 30% of family businesses transition successfully to the 2nd generation, 12% to the 3rd generation and 3% to the 4th generation. Further, 60% of transition failures were caused by a breakdown of communication and trust within the family unit. With these statistics in mind, how can you safeguard the long-term interest of your family business?

How Family Roles Affect Business

Why do communication and trust breakdowns often occur within a family that’s operating a business? The greatest challenge family businesses face is the multiple roles each individual plays: management, ownership, and family. Depending on which roles an individual plays, their viewpoint about the business may be different. For example, in the management role, an individual may be focused on achieving business growth. Those in an ownership role, however, may demand a certain level of return through dividends. Further, a family member who is not actively engaged in the business may value family harmony and fairness at all costs. These different—and sometimes overlapping—roles may contradict at times and add greater risk to the family business’s continued success—especially during leadership transition.

Governance Structure for Family Businesses

Governance is the system of rules, practices, and processes by which a company is directed and controlled. Your family business should implement a governance structure for three reasons:
  1. To effectively balance the interests of the many stakeholders—owners, management, and family members;
  2. To ensure the continuity of the business; and
  3. To promote family harmony.
Many business owners understand governance as the board of director’s fiduciary responsibility to represent the interests of shareholders. In a family business, however, the family is a key stakeholder and should not be ignored. Good governance provides clarity on roles, rights, and responsibilities for all stakeholders; encourages family members, business management, and owners to act responsibly; and regulates appropriate family-and-owner inclusion in business discussions.

Who Should Implement a Governance System?

Businesses that rely on any of the three following business structures should implement a governance system. The structures include:

1. Board of Directors

The board of directors is a group of individuals with the fiduciary responsibility to protect the interests of the shareholders. They do this by working with management to set the strategic direction of the company and oversee the operations of the business. In a family-owned business, the board also has the important responsibility of ensuring that management is directed by values and principles the family deems important. The board’s duties include monitoring performance of the business, approving major acquisitions, approving the strategic plan and operating budgets, guiding succession planning, and advising the CEO. The board of directors is governed by the bylaws of the company. The bylaws include policies describing the size and composition of the board, term limits, addition of independent directors, and family versus non-family board members.

2. Stockholders

Stockholders hold one or more shares in the company and have a right to vote on certain company matters. They are invested in protecting their ownership interest and focus on a return on investment, liquidity needs of the company, risk management, business acquisitions, and company growth plans. The stockholders are governed by the stockholder’s agreement, which is an agreement amongst the stockholders of a company. The agreement should document restrictions on transferring shares and rights of first refusal in relation to shares issued by the company—often called a buy-sell agreement. The agreement should also include specific rights for control and management of the company. For example, it should designate certain individuals to the board. The agreement should also include provisions for managing dispute resolutions.

3. Family Constitution

The family doesn’t just include those active in the business as managers or owners; it includes others who are impacted by the family business operations, but who don’t own stock. Who is considered family? Does family include spouses, step-children, second cousins, estranged siblings? This answer is different for every family and should be defined in the family constitution. The family constitution is a valuable governance document that addresses the human and emotional side of operating a family business. The process of developing a family constitution can strengthen the family by helping them see a vision for the future. It also helps each family member understand their role in assuring family and business continuity. A family constitution should address policies such as employment and interpersonal relationships. Some questions to consider include:
  • What qualifications, if any, does a family member need to meet before they can work in the business?
  • What is the decision-making process and how are conflicts resolved?
  • What are the family values and what is the vision for the future?
The constitution is a living document and should be reviewed and revised as needed to meet the needs of the changing family, ownership group, and business.

Bottom Line

All businesses have challenges that need to be addressed to ensure continued growth and sustainability. When you add the complexity of family dynamics to the mix, however, the risks are higher. Anticipating these challenges before they arise and proactively developing written guidance, or procedures to resolve them, sets a family business up for success. As you navigate those challenges, we are here to operate as an experienced, trusted advisor. Could your family business benefit from assistance in safeguarding its assets while maintaining family harmony? Please contact our professionals to get the process started. © Clark Nuber PS, 2019. All Rights Reserved

No Estimated Tax Penalty for Some Qualified Transportation Fringes

Since this new expense came into effect with the 2017 Tax Cuts and Jobs Act (TCJA), we’ve dedicated several articles in our newsletter to covering its impact. Under section 512(a)(7), added by the TCJA, tax-exempt organizations must increase unrelated business taxable income (UBTI) by amounts paid or incurred for any qualified transportation fringe benefits and any parking facility used in connection with qualified parking.

Steps to Take

Your accountant has filed or extended your organization’s Form 990-T and helped you compute and pay your first quarter 2019 estimated tax payment. But what about the estimated tax payments for 2018? You did not know about this in time to compute the payments and did not inform your accountant of it until it was time to prepare your organization’s return. Well, if you are a first-time filer of the Form 990-T, you are in luck. IRS Notice 2018-100, issued late last year, provides a waiver of the penalties for underpayment of estimated tax payments for this tax, due before December 17, 2018, to organizations not required to file a Form 990-T for 2017 (or for fiscal year organizations, the tax year before the tax year ending in 2018). This relief is limited to tax-exempt organizations that timely file Form 990-T and timely pay the amount reported for the taxable year. Taxpayers must pay federal income taxes as they earn income, usually by withholding or paying estimated tax on a quarterly basis. Generally, 25 percent of the required annual tax is due quarterly. Under section 6655(d)(1)(B) of the Code, the required annual payment is the lesser of (i) 100 percent of the tax on the return for the taxable year or (ii) 100 percent of the tax on the taxpayer’s return for the preceding taxable year, so long as the preceding taxable year was a full twelve months long and a tax return for that year showed tax liability. One can also compute the payments with an adjusted seasonal installment, a discussion of which is beyond the scope of this article. There are penalties and interest for failure to pay enough estimated tax timely. Due to the new law on qualified transportation benefits, many tax-exempt organizations owe unrelated business income tax and must pay estimated income tax for the first time. These taxpayers would not be eligible to use the safe harbor of paying estimated tax based on the tax in the preceding return. The IRS acknowledges in the Notice these organizations may need additional time to develop the knowledge and processes to comply with estimated income tax payment requirements. So, it has waived the penalties and interest for these first-time filers to the extent that the underpayment of estimated income tax results from this new law. To claim the waiver under this notice, the tax-exempt organization must write “Notice 2018-100” on the top of its Form 990-T. Contact your tax advisor if you have already filed a Form 990-T and did not take advantage of this waiver. If you have questions regarding estimated tax payments for qualified transportation benefits or need assistance with calculating them, please contact your tax advisor. © Clark Nuber PS, 2019. All Rights Reserved

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