Weak Economy, IRS Make Accounting Especially Difficult

By Jim Jordan

In uncertain times, contractors need to strengthen their accounting functions.

For the nation’s contractors, managing taxes and accounting is getting more difficult: While Legislatures around the nation continue to fiddle with definitions of taxable income, the IRS keeps rewriting tax laws. In fact, the IRS hovers over our industry so much it has designated a section of the U.S. Tax Code (Section 460) entirely to the construction sector. That makes our industry the only one with its own IRS tax section.

The IRS is growing impatient as federal revenues decline. Beginning around 2000, the number of criminal prosecutions initiated by the IRS against contractors began to climb, according to the agency’s records. In 2004 the agency launched 212 criminal investigations and recommended 159 prosecutions. From those came 122 convictions, with defendants serving an average of 23 months in prison.

Clearly, the stakes are getting higher for contractors, particularly when it comes to financial and tax issues.

Contractors often ask me exactly what they should look for when seeking accounting assistance. The process should begin with the contractor defining its most pressing needs. Depending on the company’s size and market niche, it may need more than just income tax consulting and preparation. It may also need small-business financial management consulting, payroll records and reports, QuickBooks installation and training, construction cost and overhead audit and reviews, business plans and budget preparation, as well as personal retirement counseling.

Once primary needs have been identified, a contractor might select three or four accounting firms and interview them. Critical questions prospective to be asked include: How many clients do you have in the construction industry? What were the results of your last peer review? Has there been any litigation? How many people would you assign to work with my company? What is your staff turnover rate? Can you provide an estimate of the first two year’s fees? What is the billing procedure?

Then hone in on what has suddenly become a necessity auditing expertise.

For large, public construction companies, audit services have always been critical, especially since passage of the Sarbanes-Oxley Act. Because Section 460 of the tax code is not limited to public companies, private firms should also hire CPAs specializing in construction.

In Texas most contracting firms are mid-size operations. In the past, many needed only rudimentary tax and accounting assistance. That’s rarely the case today. Struggling against poor economic conditions and mounting write-offs, banks and sureties are tightening access to loans and lines of credit. To protect themselves, banks and sureties are requiring that a contractor’s financial statements be examined by an outside accounting firm.

To better understand financial reports that are now being required, here are descriptions of the three most common forms:

Compilation For this type of professional service, financial information is simply gathered from company officials and presented in a financial statement format. The accounting firm, however, does not express an opinion or any assurance about its accuracy.

Limited Review More involved than a compilation, limited assurance reviews apply certain analytical procedures to financial statements, and various inquiries are made of the contractor’s management team. The auditors then express limited assurance by making the statement: “We are not aware of any material modifications” for the financial statements to be in conformity with the Generally Accepted Accounting Principles.
 
Full Audit This is the highest level of assurance. It involves a methodical review and objective examination of financial statements in accordance with generally accepted auditing standards. A full audit includes testing of selected transactions and internal controls, and communication with third parties. This type of audit satisfies banks, sureties, suppliers and investors because it’s the most thorough financial examination that can be performed.

Not all accounting firms perform compilations, reviews and audits. It is important to select a firm that can provide whatever professional services are required now and in the future. Contractors who are accustomed to receiving loans, guarantees or bonds merely by asking are going to have a rude awakening in the future.