Why is the Balance sheet so important?

How many tax professionals out there use their clients QuickBooks, or for that matter any other accounting software program file, to create the tax return? I would guess quite a few, but are you really getting the financial information correct on the tax return? The client stops by with the printed profit and loss and their other information and you create the tax return probably using inaccurate information, close to being correct, but close only counts in tiddlywinks, hand grenades and horseshoes.

I have been a CPA for a long time and was always taught that when the Balance sheet is correct, the profit and loss statement will also be correct. Yet today, many tax professionals have never paid any attention to the balance sheet or even seen it and the clients have no idea what it is and the impact it can have on a tax return.

Why is the Balance sheet so important? There are lots of good reasons, is cash reconciled; are other current assets balances correct, i.e. inventory and receivables; and are there any changes to the fixed assets?

Then there are the liabilities balances like accounts payable, payroll and sales taxes, short and long term notes, do they reflect the correct ending balances. Then of course the equity section. Does retained earnings tie out to prior year, and were the draw or distribution accounts closed out and probably one other important item, are you looking at a “cash” or “accrual” financial information? Do you understand how this simple change from “cash” to “accrual” or vice versa can impact the bottom line?

Half of a journal entry made to adjust the assets and liabilities typically stays on the balance sheet and the other half of the journal entry goes down to the profit and loss.

So is it the responsibility of the tax professional to correct any issues or just make sure they ask enough questions? Does being a tax professional also mean you understand accounting? I would probably guess not. I have seen too many returns after they were done by someone else that had errors because the professional did not look at the Balance sheet, yes, the return matched the profit and loss, but incorrect items were on the Balance sheet and if adjusted would have changed the profit and loss.

If the client is ever audited by the IRS, and accounting software is used, they are going to require a copy of that data file and they for sure will look at all the financial information. With the next couple of months typically being slow, here is how you can increase your billings or just look better to your client and help to reduce you work load next spring, make an appointment to visit your client and review where they are.

Go over the Balance sheet with the client making sure it is up to date. Will an inventory be taken at year end; are the receivables collectable, have the note payables been adjusted to actual? Are credit cards listed in accounts payable, because they are considered cash, not accrual and should not be in accounts payable, if they are “cash” basis. Did they buy/sell or retire any fixed assets? Did you ask them to review the depreciation detail? Encourage the client to make a list of all physical items in their business with model and serial numbers; then put it away for safe keeping. This could be very useful after a theft or catastrophe.

If an accounting software package like QuickBooks is used, print it to screen and scan through the year to date general ledger. I do this for my clients looking for large dollar amounts in the expenses, other non deductible expenses like parking tickets, fines and penalties, life insurance, political contributions and club dues.

When it is time to do the tax return next season and the client uses QuickBooks, the best way to get the financial information is an “accountants copy”. The client does this from his computer using the Internet to transmit the file. The tax professional can make adjustments in the file, while the client continues using the data file each day. When the tax professional is done, he then exports the changes back to the client, who imports them into their data file, so it will agree to the tax return. If the client just shows up with a backup copy created in QuickBooks 2012 or 2013, the tax professional can still export any journal entries back to the client to update their file.

So by now you are saying I have not taken the time to do all of this, or I might not know how, the return is just prepared from the profit and loss that I get. Well this is what Circular 230 10.34(d) says: “Relying on information furnished by clients. A practitioner advising a client to take a position on a tax return, document, affidavit or other paper submitted to the Internal Revenue Service, or preparing or signing a tax return as a preparer, generally may rely in good faith without verification upon information furnished by the client. The practitioner may not, however, ignore the implications of information furnished to, or actually known by, the practitioner, and must make reasonable inquiries if the information as furnished appears to be incorrect, inconsistent with an important fact or another factual assumption, or incomplete.”

So I would encourage the tax professionals to start looking at the Balance Sheet as an important piece of information in preparing a tax return. If you need help with accounting principles many educational institutions offer short term classes in accounting or bookkeeping that might even earn you continuing education credits.

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