Respond 8

Question 1

You have decided to prepare tax returns for individuals and businesses. Discussing your decision with a friend, who is also a tax preparer, she asks if you have prepared an engagement letter to be distributed to your clients.

Perform an Internet search on "tax preparer engagement letters" or "engagement letters" (then focus on those for tax preparers).

What protections do these engagement letters offer tax preparers and/or their clients? How would you, the tax preparer, be impacted if your client informs you that they had $4,800 of deductible contributions but could not produce supporting documentation and then they are audited by the IRS and told that the $2,300 has been disallowed?

Will you use an engagement letter when preparing tax returns for a fee? Why or why not?

Respond to this… This seems to be a very good idea to use in any situation, whether filing taxes for friends, strangers, business or personal taxes.  It seems to me that it clarifies exactly what each party is responsible for doing.  When drafting this letter I would use terminology that everyone understands and then have it reviewed by a risk management professional to ensure that I have drafted the engagement letter appropriately.  These engagement letters can protect the preparer from having to submit anything that goes against their professional standards, puts in writing that the client is responsible for maintaining accurate record keeping and documentation, states exactly what tax year you are providing services for, and what tax forms and states you will be filing for as well.  I like the detail that it provides.  Leaves no ambiguity in terms of who is responsible for what, and in the case where a client can not provide proper documentation for the contributions, you could refer to the engagement letter and cite professional standards being compromised to opt out of filing that clients taxes, OR if you did file it the engagement letter again could be used in an audit situation to get out of any fines that the client might get for not keeping accurate records of their contributions, as the engagement letter clearly states, I am just filing the taxes based off the information given, the client is responsible for accurate record keeping.  Seems to me like a no brainer to have a proper engagement letter in place for each and every client that you prepare tax filings for.

Question 2

You are the head accountant at Wazzu Company. One of your main duties is verifying the existence of the fixed asset accounts. There has been increased employee turnover in several departments which are the custodians of these fixed assets. Due to this, you are especially concerned about the acquisitions and dispositions of all fixed asset transactions.

Based on these factors, how would you go about ensuring the existence of all fixed assets, and that they are accounted for properly on the books of the company? Explain your reasoning using at least one example.

Respond to this… One of the nice things about fixed assets is that they are tangible asset you can go see and touch.  I would go to each of the department with a list of the fixed assets, I would verify that each asset is still in our possession.  If I could not find it I would do more research to see what happened to it and if it was sold or disposed of I would make sure it is removed from the books.

  If sold I should have some record of the money received.  Then calculate any gain or loss on any sold or disposed of asset.

I would also be surprised to find any assets that weren't on my list, if I did, I would see if we traded for it(and then see if a like kind exchange treatment was required) or how it was acquired.

Question 3

Why does lowering a company's cost of capital increase overall firm value? If a company is financed with all equity, how might substituting some debt for equity impact the cost of capital?

Respond to this… Cost of capital is “the weighted average of the costs of the different components of financing-including debt, equity, and hybrid securities-used by a firm to fund its investments” (Damodaran, 2015, p. 343).  The value of the firm is a function of its cash flows and its cost of capital. When “the cash flows to the firm remain constant as the debt/equity is changed, the value of the firm will increase as the cost of capital decreases” (Damodaran, 2015, p. 343).

“As the debt ratio increases, each of the components in the cost of capital will change. Equity investors are entitled to the residual earnings and cash flows in a firm, after interest and principal payments have been made. As that firm borrows more money to fund a given level of assets, debt payments will increase, and equity earnings will become more volatile. This higher earnings volatility, in turn, will translate into a higher cost of equity. In the CAPM and multifactor models, the beta or betas we use for equity should increase as the debt ratio goes up. The debt holders will also see their risk increase as the firm borrows more. Holding operating income constant, a firm that contracts to pay more to debt holders has a greater chance of defaulting, which will result in a higher cost of debt” (Damodaran, 2015, p. 344).

 

Damodaran, A. (2015). Applied Corporate Finance (4th ed.). (J. Hollenbeck, Ed.) Hoboken, NJ: John Wiley & Sons, Inc. Retrieved from https://ambassadored.vitalsource.com/#/books/9781119081876/cfi/6/2[;vnd.vst.idref=Acover]