University of Phoenix
July 31, 2012
Individual CPA Report
Date: July 31st, 2012
To: Ms. Liza Stephens, CEO
From: Kendall Nicholson, CPA
Subject: CPA responsibilities regarding subsidiary.
Dear Ms. Stephens. Per your request, I am providing you with information regarding explanations about the subsidiary that has been set up as a corporation. This explanation includes the methodology used to determine deferred taxes, procedures for reporting accounting changes and error corrections, and the rationale for establishing the subsidiary as a corporation. I am providing you with information about the professional responsibilities of a CPA. I am also providing an explanation of the difference between a review and an audit. Deferred Taxes
Accounting for taxes and tax expense is extremely important to the company. Fundamental differences exist between accounting for taxes and the financial reporting of pretax income. Pretax financial income is calculated according to generally accepted accounting principles (GAAP). Taxable income is calculated using Internal Revenue Service (IRS) rules (Kieso, Weygandt, & Warfield, 2007). This difference in accounting principles creates a difference between taxable income and income tax payable. This difference results in a deferred tax amount. If the income tax expense is greater than the income tax payable, this results in a deferred tax liability. If the income tax payable is greater than the income tax expense, this results in a deferred tax asset. Deferred tax liabilities and assets cause temporary differences. Temporary differences are carried over into future years and adjustments are made accordingly (Kieso, Weygandt, & Warfield, 2007). Reporting Accounting Changes and Error Reporting
Accounting changes result from a change from one GAAP to another. Adoption of a new principle affects the current period’s financial statements. Three possible approaches are used to account for this change. If the company chooses to report the change currently, the cumulative effect of the change on prior years’ income is adjusted for the current period. Previous financial statements are not changed using this approach. By not changing prior financial statements, the company avoids any contractual difficulties that may arise and complicated calculations that may be wrong. Another approach is to report the changes retrospectively. This involves going back and changing prior financial statements as if the principle were always in place. Those in favor of this method argue that comparability between periods is ensured. However, this approach requires a significant amount of recalculation for the prior years’ statements. A third approach is to report the change prospectively. This means that the company generates future financial statements based on the new principle without any adjustment to the prior or current year. The Financial Accounting Standards Board (FASB) requires that companies use the retrospective approach. This is because the retrospective approach provides users of the financial information with more useful information than the other approaches. Because this approach results in greater consistency between reporting periods, user can make better comparisons (Kieso, Weygandt, & Warfield, 2007).
The retrospective approach considers the accounting principle change over the prior years and results in differences in net income. The changes in net income are reflected in the retained earnings balances for the years affected and carried forward until the current period. These changes are direct effects of the new principle. Indirect effects may also be experienced because of a change in accounting principle. Although these effects are not seen in prior years’ statements, the indirect effect may result in changes in the current cash flow and income statements (Kieso,...