The Southbourne Tax Group: BBB Offers Tips on Filing Taxes, Avoiding Fraud

While all working citizens should have had their W-2 form delivered by now, it’s important for taxpayers to take time and use caution when selecting a tax preparer you can trust.

It’s important to avoid mistakes that could result in additional fees or even tax identity theft.

Unfortunately, identity theft is not the only thing to watch out for when enlisting the help of a tax preparer or tax software to file your taxes. BBB receives thousands of complaints from consumers against tax preparers every year.

In 2016, BBB received nearly 3,000 complaints against tax preparation businesses nationwide.

Common complaints state that the tax preparer made errors in their return which resulted in fines and fees. Other complaints allege customer service, billing and contract issues.

BBB offers the following advice when searching for a tax preparer:

* Look for credentials. Ideally, your tax preparer should either be a certified public accountant, a tax attorney or an enrolled agent. All three can represent you before the IRS in all matters, including an audit.

* Don’t fall for the promise of a big refund. Be wary of any tax preparation service promising larger refunds than the competition. Avoid any tax preparer who bases their fee on a percentage of the refund.

* Think about accessibility. Many tax preparation services only set up shop for the months leading up to the April 15 deadline. In case the IRS finds errors, or in case of an audit, make sure you are able to contact you tax preparer at any time of the year.

* Read the contract carefully. Read tax preparation service contracts closely to ensure you understand issues such as how much it is going to cost for the service, how the cost will be affected if preparation is more complicated and time consuming than expected and whether the tax preparer will represent you in the case of an audit.

* Ask around. Ask family, friends or co-workers for recommendations on filing your taxes, whether it’s through a CPA, tax preparation business or online tax service that allows you to file your own taxes. To find a BBB Accredited tax preparation business near you, go to bbb.org.

Tax season is also a busy time for identity thieves. Tax identity theft occurs when someone uses your Social Security number to get a tax refund, or a job.

According to the Federal Trade Commission (FTC), tax identity thieves get your personal information in a number of ways, including: going through your trash or mailbox; through emails asking for information, which appear to come from the IRS; employees at hospitals, nursing homes, banks and other businesses stealing data; and phony or dishonest tax preparers misusing confidential information or passing it along to identity thieves.

To lessen the chances of becoming a victim of tax identity theft, the FTC has the following advice, whether you choose to file your return yourself or use a tax preparer:

* File your tax return early. And do it before identity thieves have a chance to steal your information. Also, make sure your address is up-to-date so your W-2 doesn’t get lost in the mail or end up in the wrong hands.

* Use a secure Internet connection. If you file your return electronically, don’t use unsecure, publicly available Wi-Fi hotspots.

* Shred documents. This includes copies of your tax return, drafts or calculation sheets you no longer need. The IRS recommends that most people keep three years’ worth of tax returns in case of an audit. Keep hard copies and electronic files in a secure location.

* Check your credit report. To ensure your identity hasn’t been stolen or compromised, go to annualcreditreport.com to get your free credit report.


The Southbourne Tax Group: Accounting For Half-Truths


A report by a brokerage on Satyam Computers gives an 'accumulate' rating, which means it expects the stock to go up. The rating is based on the company's high cash/market cap ratio. The information technology company had reported a cash balance of Rs 4,500 crore at the end of the 2007-08 financial year. The report gives a one-year price target of Rs 373 for the stock. The stock closes at Rs 273 the day the report is written.

January 2009: The same brokerage releases a hurriedly-compiled report suspending the previous rating. "Low market cap, high cash status no longer holds," it says. On 7 January 2009, the founder of Satyam Computers admits to inflating cash and bank balances by Rs 5,040 crore, overstating debtors' position (money lent) of Rs 2,650 crore as against the actual figure of Rs 490 crore and non-disclosure or understatement of liabilities worth Rs 1,230 crore.

The Satyam accounting scam, one of the biggest in India, left millions of investors in the lurch, as the stock fell from Rs 179 to Rs 23 in one trading session.

The inability of stock analysts to identify the 'gaps' in Satyam's books and ring warning bells proved costly for investors. Had investors known the basics of reading financial statements and techniques used by companies to report false numbers, they would have asked their advisors a few valid questions about Satyam's finances.

Some would argue how lay investors could see red flags when experts failed to do so. It's a valid argument, though we believe that with a little bit of learning you can see what professionals cannot.

We discuss a few common forms of accounting frauds companies indulge in and signs that may alert you to wrongdoing -

FINANCIAL REPORTS

A company's financial health can be gauged through three statements - balance sheet, profit and loss account and cash flow accounts.

A balance sheet records a company's assets (land, machinery, inventory, cash balance, investments, loans given), liabilities (loans taken, income tax payable, tax liabilities) and owner's equity. It is generally prepared annually.

A profit and loss statement (or income statement) records a company's earnings and expenses. Any company whose shares are traded on exchanges is required to release its income statement every quarter.

A cash flow statement tells us where cash is coming from (inflow) and how it is being used (outflow). There are three types of cash flow-operating cash flow (sale of goods, revenue from services, interest/dividend received, payment for purchases, payment for operating expenses), investing cash flow (sale and purchase of assets, sale and purchase of debt/equity, loans advanced to others) and financial cash flow (issue of equity shares, borrowing, repayment of debt).

Notes to accounts are important as they detail the accounting policies followed, pension and other post-employment benefits and potential liabilities/losses.

MANIPULATION OF STATEMENTS

There are many items in financial statements for which companies use different policies. These are inventory valuation, investments and fixed assets, conversion of foreign currency and asset depreciation.

Companies often manipulate these to inflate revenue, assets, cash inflow and understate expense, liabilities and cash outflow in financial statements.

INFLATING EARNINGS

1) Lending to customers: Sometimes companies lend money to customers to buy their goods. This way they can report high revenue in the income statement and high receivables (treated as an asset) in the balance sheet.

2) Trade stuffing: Companies use this usually just before the end of a reporting period. They ship goods to customers even though the latter may not need them immediately. This increases sales ahead of the reporting period.

3) Understating provisions: Companies often allow credit sales on generous terms, sometimes even to customers with a poor credit history. Ideally, in such sales, the company should set aside a higher amount for bad debt provisioning. This amount is recorded as a liability. Understating such liabilities is another way of 'enhancing' the financial statement.

4) Round-tripping: This means getting into fictitious transactions with related parties to inflate revenue. In round-tripping, a company sells unused assets to a party with the promise of buying back at a later date at the same price.

UNDERSTATING EXPENSES

1) Spreading out expenses:According to accounting norms, if an expense has been made for acquiring an asset whose benefits the company will avail of over a long term, the expense is to be reported in the books in a spread-out manner over that period. The process is called capitalising. Companies often use this to delay recognition of short-term expenses.

2) Cookie jar accounting: Companies put aside money for possible loan defaults. Some companies, during periods of high revenue growth, increase the amount and release the same during periods of poor revenue, offsetting the impact of low sales growth. Among other common forms of financial statement manipulation are revaluation of assets, showing unrealised gains as profits and assigning higher values to fixed assets.

3) Off-balance sheet items: Some assets/liabilities or financing activities are not fully recognised in the balance sheet due to the complexity of transactions involved. These include pension assets and liabilities, assets and liabilities of joint ventures and unconsolidated subsidiaries and lease arrangements. These are recorded in footnotes of financial statements.

Many companies resort to off-balance sheet financing by way of entering into joint ventures, research and development partnerships and lease contracts. Floating special purpose entities or subsidiaries to expand business is another off-balance sheet arrangement.

As the liabilities/risk involved in such transactions are not reflected in the balance sheet, one may draw wrong conclusions about a company's financial health. It is, therefore, necessary to check the footnotes of financial statements.

RED FLAGS

Some manipulations we mentioned earlier are difficult to detect even for finance professionals. Here are some indicators of rot in a company's financial books.

Continuous high level of cash, cash equivalents and current assets: Satyam Computers showed high cash balance over the years. Later it turned out it had inflated cash and bank balances by as much as Rs 5,040 crore.

Reported earnings consistently higher than cash flow: If cash flow from operating activities of a company is consistently less than the reported net income, it is a warning sign. The investor must ask why operating earnings are not turning into cash.

Sudden increase in inventory/sales ratio: This indicates the company may be inflating assets such as inventories.

Spurt in other income: Revenue sources recorded under other income are non-recurring and may include earnings from asset sales and closure of debt or debt restructuring. However, sources of earnings are seldom disclosed under this head. A sudden spurt should raise eyebrows.

Frequent changes in policies: Earnings and assets can be inflated by alternative accounting policies. If one sees frequent changes in these policies, there may be something fishy about the company's books.

Financial ratios not in line with industry peers: This could be due to inflated earnings, asset valuation or understating of expenses and liabilities.

Too many off-balance sheet transactions: If a company has been expanding by creating special purpose entities and has entered into many lease contracts, it is possible a lot of liabilities are not reflected in its balance sheet.

We have seen in the past that many respected and renowned companies have been charged with manipulation of account books. Therefore, investors must stop treating financial statements issued by companies as gospel truth and scan them carefully to detect possible foul plays.