This memo has been prepared in response to Mr. Butterworth’s inquiry on behalf of the independent audit team reviewing XYZ Corporation, a wholly owned subsidiary of ABC Company. Specifically this memo addressed the methodology used to determine deferred taxes, the procedure for reporting accounting changes and error corrections, and the rationale behind establishing XYZ Corporation as a subsidiary. Also included in this memo, as requested, is a discussion of the responsibilities of a CPA, and the differences between a financial review report and a financial audit report.
Methodology used to Determine Deferred Taxes
Deferred taxes can be one of two different types of ...view middle of the document...
If a discrepancy between the book and taxable depreciation for a capital asset results in additional tax deductions for a future period, but there is a reasonable expectation that there will not be a profit during that period, the taxable liability should not be reported as it would create a false interpretation of the financial reports.
Procedures for Reporting Accounting Changes and Error Corrections
In the United States the governing regulations for accounting and audit procedures is known at the Generally Accepted Accounting Principles (GAAP). GAAP offers various methods for compiling financial statements for corporations to allow the financial statements to be tailored to present accurately the financial situation of the company issuing the report. As the GAAP are frequently reviewed and updated, and the nature of business is influx, it is sometimes necessary to change the methods for generating financial reports. The principle requirement for changing methods for preparing financial reports is that the new method offers an improvement in financial reporting, not just that the new method is preferred by the organization (Kieso, Weygandt, & Warfield, 2007).
When the method for generating financial reports is altered, the annual report should contain a notice of the change in method, the rationale behind the change, and where possible, a restatement of prior periods financial information using the updated method to ensure comparability with older financial reports. Reporting errors of a material significance will be adjusted in either a restatement of prior period earnings for the annual report or in the cases of highly significant errors, the previous annual report will be corrected.
Rationale behind Establishing the Subsidiary as a Corporation
As ABC Company’s investment into the sub-prime mortgage market began to expand, ABC Company saw that the nature of investments in the market resulted in an unacceptably high risk for the company, and the requirement for managing sub-prime mortgage businesses, was a specialized subset of management skills at ABC Company. The decision to split the business segment off into a wholly owned subsidiary was made, thus XYZ Corporation was formed. As a wholly owned subsidiary, ABC Company’s liability is limited to the capital invested in the company removing the additional risk to the business should another significant failure occur in the sub-prime mortgage market.
Professional Responsibilities of a CPA
In a strict interpretation, a CPA is an individual who has completed the Certified Public Accountants examination and achieved the necessary experience to be licensed as a Certified Public Accountant (CPA). The principle role of a CPA is to attest to the...