Raise your hand if your client or boss has given you a set of financial statements where the balance sheet does not balance. If anyone has their hand down it must be that they only do individual tax returns (heh).
Everyone that prepares and reviews tax returns will run into situations when a client’s corporate financial statements simply do not balance. The client does not have an answer for it and you are stuck trying to make it work.
Assuming you have used all of the options noted in my free guide (see at the top of the website), the client or your boss (or both) want you to simply “Plug it” (i.e. add whatever adjustment is necessary) to the Loans to/from Shareholder account or as a Schedule M-2 prior period adjustment to make the balance sheet balance.
Here is the logic the client and/or your boss are using. The missing amount is likely due to money that the owner previously put into the company or an expense that he forgot to record on the books. Therefore, the client is being conservative by not taking an expense and it is not worth the client’s or the firm’s time to go looking for the difference.
During the pressure of tax season, this logic seems very persuasive. All you have to do is enter one little number and everything balances. The computer software you are using is not your parents or the IRS. It is not going to stop you from plugging the difference. It is going to take whatever number you enter into the system and move forward. Since you do not have a time machine to go back and find the answer, you or your boss gets the fun of making a judgment call.
GULP = Danger Ahead
This is where the “Gulp” part of the equation comes into play. The balance sheet is out of balance for a reason. Double entry bookkeeping works unless someone makes an error in recording the transactions.
You don’t know if the amount relates to a missing:
- loan payment,
- expense or
Guess which one the IRS is going to choose if the client gets audited? (*Hint* It’s the one that gets them additional tax revenue)
As a long time tax manager, I do appreciate the materiality concept of making an adjustment and moving forward. Assuming the client agrees, there are times that the amount of the adjustment is not worth the time and effort to try to discover. Determining the risk/reward of making that call is the “fun” of being a manager.
However, as a tax preparer, you need to do two things to keep yourself out of trouble.
- Document manager approval. You need to document in the workpapers that the plug adjustment was made based on your manager’s approval. As time moves forward, people forget why they plugged a tax return. A year from now you might not even remember you worked on the tax return (Trust me. It will happen).
- Document client approval. You need to ask your boss if it is appropriate to get the client to confirm in an e-mail that he believes the adjustment is correct. If your boss says no (for whatever reason) then you need to put a personal note in your files about the adjustment and why it was made.
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