James F Reeves

Well……It Depends

2012-01-16T11:18:00.000-06:00

I can only imagine some of the more interesting conversations that CPAs are having with their individual tax clients these days, in response to the inevitable question that comes up every year as the attention shifts from the prior year’s tax return to planning for the current year…….. “Ok, so what should I do?”

It seems like only yesterday that Congress and President Obama were at a virtual impasse over extending the Bush tax cuts for higher-income individuals as well as the pending reversion of the estate and gift tax regime to the pre-2001 rate structure. In an 11th hour compromise following the 2010 Congressional elections, Congress and the White House settled on a two-year extension of the current rate structure as well as a liberalized estate and gift tax regime, about two-weeks before an across-the-board tax increase for all taxpayers and a draconian transfer tax structure that no one supported would have become law.

Well, before too long it will be déjà vu all over again, with some additional wrinkles. Under current law, ordinary individual income tax rates are scheduled to rise virtually across the board on January 1, 2013, as are rates on long-term capital gains and qualified dividends. The standard deduction for married taxpayers will revert to a lower level than the combined amount for unmarried taxpayers, and the expanded 15% tax bracket for married taxpayers sunsets, bringing back the marriage penalty. Phase-outs of itemized deductions and personal exemptions for taxpayers exceeding certain income thresholds will be restored, and the child tax credit will be cut in half. And for estate and gift tax purposes, we are scheduled to see a drop in the exemption from $5 million to $1 million and an increase in the top rate from 35% to 55%. But that’s just the beginning. On top of these provisions, the health care legislation imposes an additional 0.9% Medicare tax on employees and self-employed individuals and a 3.8% tax on investment income of individuals with AGIs exceeding $200,000 (singles) and $250,000 (marrieds), beginning in 2013. And although it’s only in the proposal stage and unlikely to advance through the House before the elections, President Obama has endorsed a new minimum tax he calls the Buffett Rule for taxpayers earning more than $1 million.

So that’s the backdrop for responding to the “OK, what should I do?” question. While not dodging the issue, the prudent response may be to answer the question with another question….”What do you think is going to happen with the economy, unemployment, the budget, and the elections?” To a great extent these are the issues that will shape federal tax policy for 2013 and beyond.

Seasoned (or maybe cynical) Washington observers suggest that history will repeat itself in late 2012, with a lame-duck Congress enacting another short-term extension of the expiring tax breaks in the name of supporting the economic recovery, leaving it to the new Congress and administration to find a permanent solution in 2013 or 2014. While there is general agreement that lower income tax rates and marriage penalty relief are desirable for lower and middle income taxpayers, along with at least a $3.5 million estate tax exemption, there simply won’t be enough time after the November 6 election to resolve the more contentious issues. Perhaps something like the Buffett Rule or a compromise on the estate tax could sneak in as an 11th hour bargaining chip, but for the most part I believe we will enter 2013 with the 2012 tax structure largely intact for the near term. That said, I wouldn’t be shocked to see entrenched partisan positions in a lame duck Congress result in a gridlock scenario that causes the 2013 Congress to have to take up taxes as its first order of business.

Beyond considering the likelihood of a short-term extension of the current rate structure, it may be worthwhile to engage higher income clients in a multi-year, multi-scenario tax planning exercise. If President Obama and the Democrats come out of the elections with the wind at their backs, we may be looking at a scenario of higher income tax rates for upper income clients. Conversely, pressure to look at fundamental corporate and individual tax reform as part of a broader economic policy review could drive a scenario of lower tax rates with fewer tax ‘expenditures,’ or targeted benefits like the exclusion for employer-provided health insurance, lower rates on capital gains and dividends, and deductions for mortgage interest, charitable contributions, and state and local taxes. A number of credible tax reform proposals in recent years (Bowles-Simpson, Paul Ryan, Gang of Six, and Domenici-Rivlin) have recommended a top individual rate under 30% with various limitations on tax expenditures as a tradeoff for lowering the rates. It’s not a stretch to see a rate structure with lower tax rates and a less generous mortgage interest deduction, no state income or sales tax deduction, or even a cap on total itemized deductions as a percentage of AGI. Nor would I be surprised to see the tax on ‘Cadillac’ health care plans (scheduled to begin in 2018) be replaced by a tax on ‘Chevy’ health care plans where employee health care benefits above a moderate threshold are included in taxable compensation. It’s also not a stretch to imagine a scenario like we saw with the Tax Reform Act of 1986 where ordinary income, dividends, and capital gains were all taxed at the same rate. Democrats may find such proposals palatable as a means to reducing the deficit via the tax code and promoting progressivity, while Republicans can point to tax reform as cutting government subsidies and reducing the size of government while reducing the deficit and increasing overall economic efficiency. In any event, it would be wise to compartmentalize the various types of income for high income clients and look at the impact of the various proposals on each type – investment income, business (including pass-through) income, ordinary income, and retirement income, as well as their impact on itemized deductions.

Conclusion

There’s no question that the uncertainty surrounding the future of the federal tax code makes tax planning difficult. There’s no doubt there are a number of ways it can play out over the next few years. That said, upper income clients would be well served by a multi-year, multi-scenario planning exercise that contemplates a variety of legislative outcomes. At some level, failing to plan is planning to fail.

Let’s Make a Deal

2011-12-05T13:26:00.000-06:00

Maybe Rick Perry was right. These debates are more like a sideshow, more about personalities and taking the spotlight off the substantive issues facing the country. What if, instead of getting to know our candidates through a series of debates (that aren’t really debates), we followed the format of the 1980s hit game show, Let’s Make a Deal, whereby each of the candidates’ policies, platforms, and proposals are presented from behind a closed door without any visual clues as to which candidates are proposing which plans, so the voters get to decide on the policies rather than personalities. Sound like a deal? Monty Hall, come on down!
With regard to proposed tax policy, President Obama’s position is known – allow the expiration of the Bush tax cuts on ordinary income, dividends, and capital gains for higher income individuals to occur, beginning in 2013, along with imposition of the yet-to-be-defined Buffett Rule for the “fortunate few;” capping the benefit of itemized deductions at 28%; returning the estate tax to the 2009 structure of a 45% tax rate and a $3.5 million exemption; eliminating LIFO and tax preferences for the energy industry; and a host of international tax provisions to minimize the incentives to shift income and assets overseas.
Against that backdrop, let’s take a look at the most prominent Republican tax proposals, each from behind a different door:

Door # 1

This candidate has proposed a tax plan that while sweeping in scope, retains the basic framework of the existing Code. This “Time to Compete” plan would eliminate all itemized deductions and credits for individuals while reducing the rate structure to 8%, 14%, and 23% and eliminating the Alternative Minimum Tax and taxes on dividends and capital gains. The plan would reduce the top corporate rate to 25%, shift to a territorial tax system, taxing income only in the country where it is earned, and provide a tax holiday for the repatriation of corporate profits currently held overseas. And noteworthy for CPAs, this plan would repeal section 404 of Sarbanes Oxley.

Door # 2

The “Believe In America” plan would cut the corporate tax rate from 35% to 25%, while implementing a territorial tax system that would equalize tax rates on corporate profits earned overseas. The plan would also eliminate the estate tax, as well as tax on interest, dividends and capital gains for those earning less than $200,000 a year. This candidate would otherwise retain the current tax rate structure, making the Bush tax cuts permanent and retaining current deductions. The candidate has also alluded to a long-term plan to lower rates and reduce tax preferences, without providing specifics.

Door # 3

This is the plan Jimmy Buffet has been waiting for. The “Cut, Balance, and Grow” plan would offer individuals a choice between filing under the current system with a top rate of 35% or a flat rate of 20% and no AMT. The latter structure would eliminate tax on social security benefits, dividends and capital gains as well as the estate tax. Each individual in the flat tax scheme would be entitled to a standard deduction of $12,500, thus eliminating income tax altogether for a family of four making less than $50,000, countering the argument that a flat tax is inherently regressive. The standard deduction would begin to phase out when AGI reaches $500,000, countering the assertion that the plan favors the rich. The flat tax plan would retain itemized deductions for mortgage interest, charitable contributions, and state and local taxes, avoiding pressure from the real estate, nonprofit, and local government lobbies. The plan would lower the corporate tax rate to 20%, transition to a territorial system, and allow multinationals to repatriate foreign earnings at a 5.25% tax rate for a temporary period. This candidate’s plan would also repeal section 404 of Sarbanes Oxley.

Door # 4

This plan would impose a low, single-digit tax rate on individual income, corporate profits, and on consumption. The charitable contributions deduction for individuals would be retained, while payroll taxes and taxes on capital gains would be eliminated. Households below the poverty level would be exempt from the income tax, and deductions would be available for folks living or working in Federal Empowerment Zones, thus countering attacks the plan is regressive. The tax on corporate profits would be applied to gross income less purchases, investments, and dividends, and the plan would eliminate tax on repatriated earnings. Critics call the plan a flat tax on middle-class labor. The candidate has made some noise about eventually replacing the income tax with a national sales tax, but few specifics have been revealed at this time.

Door # 5

This candidate’s Jobs and Prosperity Plan includes an optional 15% flat tax for individual taxpayers, retaining the charitable contributions deduction. Taxpayers could file under the existing system if they so choose, ensuring no one is forced into a tax increase. The flat tax scheme would eliminate tax on interest, dividend, and capital gains, but retain the earned income and child tax credits, to deflect criticism that it is regressive. Charitable contributions and home mortgage interest could be deducted, but not state and local taxes, and a $12,000 personal exemption would be allowed for each individual. The estate tax would be eliminated. This plan would impose a 12.5% tax on corporate income, eliminate capital gains tax for corporations, allow immediate expensing of new equipment, eventually replace the payroll tax with personal accounts, and tax foreign profits at the same rate as domestic income.

Conclusion

So, a question for our Republican members…..without reflecting on the personalities, which plan do you choose? If it’s not apparent, behind Door #1 is Jon Huntsman; behind Door #2 is Mitt Romney; Rick Perry lies waiting behind Door #3; Herman Cain’s 9-9-9 Plan is behind Door #4; and Newt Gingrich is behind Door #5.
There is no doubt that taxes will take center stage during the 2012 election cycle. The differences between the two parties are extreme: President Obama believes the wealthy and higher income folks should shoulder more of the tax load, while Republicans generally believe lower rates will spur the economy and job creation. While the best plan may be somewhere in between, voters will ultimately choose the path forward.

What If CPAs Ran the Country?

2011-09-12T17:19:00.001-05:00

Background

Imagine that you are an audit partner asked to bid on a new engagement and a quick glance over the prior year’s unaudited financials shows a negative net worth of $44 million, an operating loss of $817 thousand, and a negative cash flow of $1.3 million. Would you bid on the job? Accept the engagement? Your first thought would probably be “Is this a going concern?”

Now imagine that instead of bidding on the audit, you are a consulting partner and asked by the board of directors to come in and review the company’s strategy and operations and make recommendations to turn the company around (and they agree to pay your fee up front).

You learn that the board is looking for a strategy to grow the business at 5% a year. You ask a few questions and find out that while board members are in agreement for the need to cut costs, they can’t agree on which costs to cut. Dig a little deeper and you find out that the annual budget is prepared on the cash basis, and there are about $31 million of off-balance sheet liabilities, mostly unfunded future pension and health care costs not reflected in the budget. Talk to a few board members and you learn that aside from these off-balance sheet liabilities and other one-time costs, the enterprise has reported a 4% net profit over the past 15 years, which is the picture senior management has been presenting to the board, keeping everyone content, until recently. And by the way, they tell you that while still the market leader, the company has been losing ground to competitors for the last decade, and that competitors hold 46% of the company’s debt. Finally, you review a credit report that expresses serious concerns about the organization’s ability to repay its debt. A quick back of the envelope calculation shows that in 15 years the organization’s obligations for health care and retirement expenses, plus interest on its debt will completely absorb all of its revenue. Accordingly, you clearly understand the board’s sense of urgency and the need for a restructuring specialist and accept the engagement.

The Engagement

The first thing you do is address the shareholders. You make it totally clear that long-term survival of the enterprise will be based on prudent cost management. You let them know that you will be focusing on the fundamental problems and underlying causes, not merely the symptoms.

Next comes a SWOT analysis, a candid look at the strengths, weaknesses, opportunities and threats facing the organization, including the competitive environment. As part of the SWOT analysis you bring in your due diligence team to evaluate the performance of the various lines of business, both core business lines and extensions, as well as the organization’s performance across its 50 geographic territories. You learn, not surprisingly, that some business lines and territories are out-performing others, and you note the ones that will require additional investment, ones that need to be scaled back, outsourced, or sold off. You also look at processes that can be automated and where technology can be applied, to ensure that each line of business is operating at maximum efficiency.

Your next area of focus is on the budgeting and financial reporting process. Clearly the board, shareholders, investors, and creditors are not consistently getting the full picture, as the budgeting process has historically focused only on current operations, ignoring the fundamental, or structural imbalance between receipts and disbursements resulting from the off balance sheet liabilities. You explain to the board that the budgeting process is where resource allocations and strategic priorities need to be addressed and the foundation for long-term success laid. While there are always tradeoffs, a good budgeting process will provide multiple parties the opportunity to present their recommendations, at the end of the day the chief executive and chief financial officer must sign off on the commitment of scarce resources in the pursuit of the organization’s aspirations as well as its most fundamental needs. Once the new budgeting process is in place you can identify the metrics and performance measures to help senior management make more informed decisions. Finally, once you have the completed the annual budget for the coming year, you can develop a financial forecast for the short term, medium term, and long term, which will be in your report to the board.

As part of the budget review you bring in your H.R. consulting team for a comprehensive review of the company’s organization structure and compensation practices. You learn that the company grew headcount 2% in 2008 and another 3% in 2009, while other organizations were cutting back, and it has been paying its employees at significant premiums relative to market rates. Further you learn that the majority of employees still participate in defined benefit pension plans, even though such plans are increasingly rare in other organizations. You conclude that what the organization needs is a performance-based culture focused on cost savings and operating efficiency with an incentive compensation program that ties bonus payouts to increasing the productivity of workers and meeting annual expense reduction targets. Further, it is evident that the enterprise must optimize its cost structure, including headcount, compensation, and benefits relative to industry norms.

Next Steps

Now that you’ve addressed the operational and H.R. issues, you understand that to complete the engagement you must drill down into the more strategic issues – restructuring the organization’s debt and revenue models in a way that will drive sustainable growth and lead to long-term solvency and a winning competitive position. To help with those formidable tasks, you appoint a super committee of board members to review all available options, with “everything on the table,” and make recommendations for at least $1.5 million in cash flow improvement over the next 10 years. The alternative, you tell them, is across-the-board spending cuts, which nobody seems to want.

Your final task will be an evaluation of senior management’s performance. Your recommendations will be considered at a shareholder’s meeting on November 6, 2012.

Stay tuned.

Note: This article is a CPA-centric adaptation of a report titled USA, Inc., by Mary Meeker, former analyst with Merrill Lynch and Morgan Stanley, and current partner with venture capital firm Kleiner, Perkins, Caufield, and Byers. You can access the complete report at www.kpcb.com. Note that you can multiply each of the above dollar amounts by one million to see the actual amounts for “the enterprise.”

The New Normal Revisited

2011-07-05T18:38:00.001-05:00

Two years ago, we explored in this column a concept that Ian Davis, worldwide managing director at McKinsey & Co., referred to as The New Normal. Davis suggested that the economic downturn was not merely another periodic dip in the business cycle, but a fundamental change in the business landscape, a restructuring of the economic order, and that we would emerge from the economic downturn in a new place. While this was a sobering and thought provoking view, Davis concluded that the new normal would not necessarily be a bad thing, and in fact, would open up a world rich in possibilities for those who are prepared.

Two years later, with 20-20 hindsight, do we believe Ian Davis was clairvoyant? Are we in a new place, a new economic order? Or could we be in a period of transition? Let’s take a quick tour of the CPA practice and regulatory environment to find out.

CPA Practice Environment

No doubt, many CPA firms across the country have experienced challenging times of late. According to an Accounting Today survey, Top 100 firms collectively reported a 2% aggregate revenue decline in 2010, including declines by three of the Big Four and 19 of the Top 25 firms. They managed their bottom lines like most businesses do during challenging economic times, by cutting expenses. 54 of the Top 100 firms, including 19 of Top 25, laid off staff, and 37 eliminated partner positions. Considering that only a few years before, double-digit revenue growth was common for firms of all sizes, this does sound like a new normal. Looking forward, however, firms are a bit more optimistic. Various surveys point to improving prospects for growth in 2011 and beyond. 57% of firms are expecting revenue growth in 2011 (PCPS/TSCPA MAP Survey), with fees and net income growing in the 3%-4% range according to a survey of firms by consultant Marc Rosenberg.

Look across the practice landscape and you do see a changing environment, with an intensifying level of merger and acquisition activity among firms of all sizes. Firms are looking at M&A as a source of expanded service offerings, economies of scale, geographic diversification, acquisition of talent, and certainly, as an ownership succession strategy. While the trade journals are quick to report the mega-mergers of regional firms, there are plenty of $10 million firms acquiring $1million firms, as well as horizontal mergers of $ 1- 2 million firms. And as the world continue to globalize, international M&A activity will begin to accelerate as well.

As a result of firm consolidation and the economic developments over the past three years, firms are experiencing an increasingly competitive environment with downward pressure on fees one of their biggest challenges. As a result of this increasingly competitive environment, firms are increasing their marketing spend and elevating their focus on practice development. A recent Rosenberg survey found that marketing and practice development ranked #1 in its list of Top 10 strategic trends. Similarly, the 2011 AICPA PCPS Top Issues survey showed that bringing in new clients and retaining existing clients is top of mind for firms of all sizes, and that fee pressure and pricing of services are not far behind.

Rapidly Changing Regulatory Environment

Also among the top issues cited by practitioners are keeping up with changing accounting and attestation standards and the changes and complexity of the tax laws. Based on my personal interactions with practitioners, the evolution of accounting standards has become the top area of concern, if not fear. We are currently going down a path of convergence of selected FASB and IASB standards, although the convergence process is not hitting its milestones. On a parallel path the SEC is scheduled to announce its position on IFRS for U.S. public companies by the end of the year. It could range from an outright requirement to adopt IFRS by a date certain, to an option to convert, leaving it up to individual registrants, or a hybrid approach by which U.S. GAAP would continue to exist, convergence would continue, and FASB would utilize an ‘endorsement’ process to evaluate new standards issued by the IASB for incorporation into U.S. GAAP, with or without modification.

Regardless of the SEC’s ultimate position on its IFRS, U.S. subsidiaries of foreign-owned companies and U.S. companies with foreign subsidiaries are converting to IFRS in increasing numbers, creating many opportunities for CPAs. Clients have to be educated and new accounting policies drafted. Compensation and benefit plans may have to be restructured; loan covenants and contracts renegotiated, accounting systems overhauled, and owner / shareholder expectations managed. Tax planning will be significantly impacted as well, as the Internal Revenue Code contains hundreds of references to generally accepted accounting principles that will have to be re-evaluated.

On a parallel path the Financial Accounting Foundation (FAF) is evaluating a new standard-setting model for nonpublic companies that follow U.S. GAAP, with exceptions. One thing to keep in mind as this process unfolds is the demand for private company GAAP will likely become even more acute if SEC mandates IFRS for public companies, consistent with other countries that are keeping national GAAP for private companies. It’s also worth noting that FAF now is including nonprofit entities in the scope of its deliberations, whereas the Blue Ribbon Panel specifically excluded nonprofits.

The Changing Tax Landscape

It increasingly appears that federal tax reform will be front one of the front burner issues during the 2012 political season. Congress will be taking a critical look at the overall tax structure for corporations, individuals, and estates, as the “Bush tax cuts” are scheduled to expire once again at December 31, 2012. It will also be looking at the compliance function (e.g., penalty provisions) as part of its ongoing quest to reduce the tax gap. This debate will be set against a backdrop of bringing down the deficit, making the U.S. more competitive in the global economy and stimulating job formation in the U.S.

We can probably expect tax reform proposals to include noncontroversial simplification provisions like consolidating child benefits, retirement benefits, and education benefits, simplifying the kiddie tax, and eliminating the individual and corporate AMT. They will hopefully address persistently troublesome areas like worker classification, the earned income credit, the myriad of phase outs, and neutralizing debt and equity financing of businesses. They will likely include base broadening, tax expenditure eliminating proposals similar to the ones suggested by the Deficit Commission et al. This will be the contentious part, as sacred cows like mortgage interest, state and local tax and charitable contribution deductions will be on the table, along with the exclusions for employer-provided health insurance and municipal bond interest. On the corporate side, tax expenditures include accelerated depreciation, the U.S. manufacturing deduction, the R&D credit, LIFO, the low income housing credit, and the deferral of CFC (foreign) income. Other contentious issues that have been floated recently include taxing large pass-through entities as corporations, broadening the social security wage base, modifying rules on valuation discounts, and eliminating fossil fuel preferences.

The More Things Change….

CPAs generally thrive during times of disruption in the status quo. Successful CPAs look at the problems their clients are experiencing at any point in time and see opportunities.

For many clients, the volume of regulatory change is unsettling and the level of complexity overwhelming. For them, this is the new normal. For CPA firms, it should be marked by an increased demand for CPA services, a reversal of the downward pressure on fees, and hopefully a return to a period of double digit growth. As Ian Davis of McKinsey might say, this new normal will open up a world rich in possibilities for CPAs who are prepared.

The Best Album of All Time

2011-06-02T11:01:00.000-05:00

As I was recently participating in the AICPA’s CPA Horizons 2025 survey and asked to opine on the Top 5 issues facing the accounting profession over the next 12 months, five years, and by 2025, I was reminded of a recent conversation about the best album of all time. I thought that was an easy one……The Beatles White Album, right? As we discussed it, however, we thought of a few more great albums, then a few more, and then a few more that deserved our consideration. Before I knew it, we had compiled a Top 25 list. Similarly, when thinking about the top issues or trends facing the accounting profession, it seems like an almost endless list of changing dynamics that will shape the profession in the years ahead. The rapidly consolidating and increasingly competitive CPA firm marketplace, globalization, demographic trends and the multigenerational workforce, new platforms for communication, a burgeoning entrepreneurial environment, technology-enabled mobility and telecommuting, immigration and multiculturalism, ever-increasing complexity, the convergence of information and software, sustainability, and the evolution of key industries like energy and healthcare will each have a profound impact on the profession. That said, given that generally accepted accounting principles and / or the federal tax code constitutes the foundation of most CPAs’ body of work, two issues rise to the top of any conversation about the most impactful trends facing the profession in the years ahead.

Accounting Standards Evolution

Everyone by now has at least heard of International Financial Reporting Standards (IFRS) and that the U.S. is one of the only industrialized nations not in synch with the rest of the world. We are currently going down a path of convergence of selected FASB and IASB standards under a 2006 Memorandum of Understanding. That project is supposed to be completed this year, but so far the convergence process is not hitting its milestones. On a parallel path the SEC is pursuing a Work Plan whereby it is scheduled to announce its position on IFRS for U.S. public companies by the end of the year. It could range from an outright requirement to adopt IFRS by a date certain (say 2016), to an option to convert, leaving it up to individual registrants, or a hybrid condorsement approach. With condorsement, first mentioned (and I don’t think by accident) by SEC Chief Accountant James Kroeker, U.S. GAAP would continue to exist. FASB and IASB would finish their joint convergence projects, then FASB would work to converge remaining U.S. GAAP with IFRS over a period of time. FASB would also utilize an ‘endorsement’ process, similar to that used in the E.U., to consider new standards issued by the IASB for incorporation into U.S. GAAP, with or without modification. This condorsement approach would move the U.S. gradually toward IFRS but allow FASB to retain control over U.S. GAAP and reduce the effort and risks associated with a full scale, mandated switch to IFRS.
What happens in the nonpublic company arena is another story altogether. In February, the Blue Ribbon Panel recommended a separate board under the oversight of the Financial Accounting Foundation (FAF) be established to develop a new standard-setting model that follows U.S. GAAP, with exceptions for private companies. The FAF has formed a working group to obtain input and issue an action plan later this year to address whether or how to devise rules that differ from those of public companies. One thing to keep in mind as this process unfolds is the demand for private company GAAP will likely become even more acute if SEC mandates IFRS for public companies, a framework consistent with other countries, as Canada, UK, others are keeping national GAAP for private companies. It’s also worth noting that FAF now is including nonprofit entities in the scope of their deliberations, whereas the Blue Ribbon Panel specifically excluded nonprofits.

U.S. Deficits and Federal Tax Reform

As the current imbroglio over raising the debt ceiling has illustrated, the debate over solutions to the U.S. fiscal crisis will likely become the center of the 2012 presidential campaigns. While no one expects serious action before 2013, the likelihood that federal tax reform will be one of the key elements of the debate is increasing as each new proposal is floated. From the National Commission on Fiscal Responsibility and Reform (aka Deficit Commission), to the Domenici-Rivlin Plan, to Congressman Paul Ryan’s Path to Prosperity (adopted by the House of Representatives), to the Gang of Six to President Obama himself, each proposal favors lowering the corporate tax rate and broadening the base by reducing or eliminating tax expenditures. The problem is that most US businesses are pass through entities, which brings individual taxation into the tax reform discussion. Ernst and Young recently published a study showing that small business owners’ tax liability would increase by approximately 8% if corporate rate lowering and base broadening were enacted. This leads directly into individual tax reform, which is much more politically dicey, especially at this point in the political cycle. A similar political challenge is the fallout from creating winners (via rate reduction) and losers (from the loss of targeted tax incentives that would be eliminated) that would certainly occur with such an approach to tax reform.
In any serious tax reform efforts, I believe we’ll see an evolution of the current system as opposed to a more radical approach like a value added tax (VAT). It will probably begin with noncontroversial simplification proposals like those recommended by the Volker Commission – consolidating child benefits, retirement benefits, and education benefits, simplifying the kiddie tax, and eliminating the individual and corporate AMT. It should also address persistently troublesome areas like worker classification, the earned income credit, the myriad of phase outs, and neutralizing debt and equity financing of businesses. It will probably include increased funding for technology initiatives at the IRS, like XBRL for tax reporting and Commissioner Schulman’s vision for a 21st Century return filing process whereby the taxpayer or preparer downloads a 1040 pre-populated with 1099 and W-2 data from irs.gov, adds whatever additional information is necessary to complete the return, and electronically submits. The reform efforts will also include base broadening, tax expenditure eliminating proposals similar to the ones suggested by the Deficit Commission et al. This will be the contentious part, as sacred cows like mortgage interest, state and local tax and charitable contribution deductions will be on the table, along with the exclusions for employer-provided health insurance and municipal bond interest. On the corporate side, tax expenditures include accelerated depreciation, the U.S. manufacturing deduction, the R&D credit, LIFO, the low income housing credit, and the deferral of CFC (foreign) income. In one recent proposal, conservative economist and former Reagan advisor Martin Feldstein provided what may be a model to overcome the political hurdles tax reform will face. Feldstein suggested in a recent New York Times op-ed that a cap on the tax reduction from tax expenditures, calculated as a percentage of adjusted gross income, would be a way to eliminate the revenue drain from tax expenditures without eliminating individual deductions. The cap would not determine the amount of an individual deduction or exclusion, so individuals would continue to benefit from their chosen tax benefits, up to the amount of the cap. Given political realities, it will take some creative policy making and effective legislation drafting to make tax reform happen, but Feldman’s proposal may provide a blueprint for a bipartisan solution. Finally, reform will likely address certain global realities, including a territorial tax system that has been proposed for multinationals, enabling income to be taxed in the territory where it is earned.

Conclusion

In a sense, we’ve just scratched the surface when thinking about issues and trends that will shape the accounting profession in years ahead. In any scenario, however, it’s hard to imagine that accounting standards evolution and federal tax reform would not be part of the conversation. But like trying to pick the top album or top song of all time, the list just keeps on growing.....stay tuned.

Fundamental Tax Reform: Political and Policy Issues

2011-03-27T11:39:00.000-05:00

In his State of the Union address, President Obama lobbed an opening salvo on the subject of tax reform. Without providing any details, the President told the nation and Congress he supports lowering the corporate tax rate without adding to the deficit, within the context of making US businesses more competitive, stimulating the domestic economy, and creating American jobs. It sounds good, like mom and apple pie, until you start peeling back the covers. When Mr. Obama made the reference to not adding to the deficit, did he necessarily mean ‘deficit-neutral’? Or did he mean that lowering the rate should be part of a broader package of deficit reduction, which could imply raising overall revenue while lowering the corporate tax rate? Many observers were hoping the answers to these questions would be unveiled in the President’s 2012 budget, which unfortunately did not happen, as the budget was disappointingly void of any mention of tax reform.

In either situation however, lowering the rate without adding to the deficit by definition implies offsetting the rate cut with elimination of tax expenditures, those special exclusions, exemptions, and deductions from gross income, preferential tax rates, credits, and tax liability deferrals that provide tax benefits to particular taxpayers. On the corporate side, tax expenditures include accelerated depreciation, the U.S. manufacturing deduction, the R&D credit, LIFO, the low income housing credit, and the deferral of CFC (foreign) income. The Wall Street Journal provided a great view into the world of corporate tax expenditures when, in a recent editorial supporting corporate tax reform, told how Whirlpool has amassed more than $500 million in green energy credits that brought its current effective tax rate to zero, and due to carryover provisions, “it may not have to pay a dime of corporate income tax for years.” And Whirlpool is not an isolated case. Google saved over $3 billion in the last three years using a technique that moved most of its foreign profits through Ireland and the Netherlands to Bermuda, reducing its effective overseas tax rate to 2.4%, according to Bloomberg.

While President Obama has focused mostly on business tax reform, a much cleaner political debate than comprehensive tax reform that covers all taxpayers, it’s important to remember that these corporate tax breaks, which the President keeps referring to as loopholes, are not limited to C corporations; they pass through to S corporation shareholders and LLC members as well. And if we expand the discussion to include individual tax rate reduction, which at some level will be necessary because of the high percentage of businesses organized as pass-through entities, tax expenditures will include lower tax rate on dividends and long-term capital gains, the exclusion of municipal bond interest income, the exclusion of employer-provided health insurance, the exclusion of gain on home sales, retirement and education savings incentives, the home mortgage interest deduction, state and local tax deductions, the charitable contributions deduction, and the earned income credit. Thus it’s easy to see that tax expenditures affect the majority of all taxpayers in some way, which makes the politics really tricky. As National Taxpayer Advocate Nina Olson testified before the Ways and Means Committee recently, “In short, we are all special interests.”

Companies that don’t take advantage of tax expenditures welcome the President’s proposal to lower the rates and eliminate the ‘loopholes.’ On the other hand, multinationals and others that enjoy a relatively low effective tax rate today could feel a negative impact from a revenue-neutral policy that would certainly create winners and losers. For this reason, and despite the fact that corporate tax reform (i.e., rate reduction and base broadening) seems to have momentum, don’t look for any type of tax reform to occur in the immediate future. Some level of broad-based support among the business community will be necessary for tax reform to move forward. As we saw with the 1986 tax reform, it takes years of behind-the-scenes maneuvering to build a consensus among widely divergent interests.

Just to frame the debate, legislators and administration officials will have to reach agreement, at least directionally, on whether to focus on revenue neutrality and tax reform in a vacuum or tax reform as part of a larger package of deficit reduction; whether to include individual tax reform along with corporate tax reform; whether to continue the present system of taxing worldwide business income versus a more territorial approach and whether to have a repatriation holiday; the preferable tax treatment of debt versus equity financing for businesses; the level of services the government is to provide; and the distribution of the tax burden across the universe of taxpayers.

Beyond framing the debate, Congressional leaders realize that sound change management principles require the voting public to be educated and share a sense of urgency about the federal debt for tax reform to be politically safe. To that end, several public education campaigns focusing on the deficit have emerged recently, and I expect we’ll be hearing more and more about the consequences of inaction to rein in the federal debt, especially as we move into the next election cycle. Further, when Congress needs to buy more time, it typically commissions a study. That’s where we are today. In mid-March, the chairmen of the congressional tax writing committees, Rep. David Camp, Ways and Means, and Sen. Max Baucus, Senate Finance, instructed the Joint Committee on Taxation to undertake “specific research” that will help Congress enact comprehensive tax reform. Mr. Camp will chair the Joint Committee in 2011 and Mr. Baucus will chair the Committee in 2012. The research will provide Congress data showing the impact of potential changes to the Internal Revenue Code.

As the debate over tax reform plays out, CPAs can play an important role in this process, educating both themselves and their clients and employers about the issues and alternatives. Future installments in this series will explore alternative proposals for tax reform that will be considered as the debate unfolds, the cast of characters involved, and criteria for evaluating the various proposals.

Fundamental Tax Reform: Here We Go Again

2011-01-29T13:30:00.000-06:00

Every few years, federal tax reform seems to resurface as a front-burner issue. The Reagan years brought us the Internal Revenue Code of 1986, which broadened the tax base, flattened the rates, took on the tax shelters with concepts such as passive activity losses, and expanded the alternative minimum tax. In 1996 we saw the emergence of a number of simplification proposals and Congressional hearings on alternative tax systems, including the Flat Tax promoted by Texas Congressman and House Majority Leader Dick Armey, a national sales tax favored by Ways and Means Committee Chairman Bill Archer, another Texan, a value-added tax, and the Nunn-Domenici USA (Unlimited Savings Account) Tax, a hybrid model. While these proposals were front page news for awhile, enthusiasm for fundamental tax reform eventually died down, partially because there were no clear-cut transition plans and partially because the Internet took off and the nation’s focus turned in a different direction. In 2005, President George W. Bush’s Advisory Panel on Federal Tax Reform released two alternative plans that promptly went nowhere, as the nation became preoccupied first by Iraq and then the recession.

President Obama’s Turn

In 2009, President Obama appointed Former Fed Chairman Paul Volcker to chair an advisory board to look at ways to reform the current system. The Board produced some common-sense recommendations most tax practitioners would have intuitively embraced such as consolidating child benefits, retirement benefits, and education benefits, simplifying the kiddie tax, and eliminating the AMT. Interestingly, it was not the Volcker Commission but President Obama’s bipartisan National Commission on Fiscal Responsibility and Reform that seemed to garner the most attention with its recommendations for putting the nation on a more sustainable fiscal course over the long haul. Among the Commission’s recommendations were lower rates for both individuals and corporations and reducing the size and number of “tax expenditures.” The President’s reaction, while tempered, was supportive, and ironically the report may have laid the groundwork for his taking the deficit reduction issue and all that implies (e.g., tax reform) as one of his signature issues for the 2012 campaign. As a proactive first step, the Administration initiated a dialog with business leaders on ways to stimulate economic growth and employment opportunities in the U.S., and it seems the President and his corporate advisors have coalesced around corporate tax reform as a catalyst for investment in the U.S. that would drive economic growth and reduce unemployment.

The Taxpayer’s Advocate

On a parallel path, the 2011 annual report to Congress by National Taxpayer Advocate Nina Olsen identified tax reform as the number one priority in federal tax administration. In releasing her report, Olsen echoed the near universal sentiment that “the tax code is broken and needs to be fixed.” Some of the more interesting data points from the report include:
• Taxpayers and businesses spend 6.1 billion hours a year complying with tax-filing requirements, requiring the equivalent of more than three million full-time workers;
• Tax expenditures, including income exclusions, exemptions, and deductions from gross income, plus credits, preferential tax rates, and tax deferrals total about $1.1 trillion annually, an average reduction in tax per individual return of about $8,000; and
• Among taxpayers who have a choice about reporting their income, compliance rates are well under 50%, with Schedule C taxpayers reporting only 43% of their actual business income and Schedule F taxpayers reporting only 28%. The predominant reasons cited for noncompliance are complexity of the tax code and a perceived lack of fairness.
Ms. Olsen advocates fundamental tax reform, not merely ad hoc simplification, beginning with a general premise that tax expenditures for both individuals and businesses should be avoided. Further, the report suggests public policy objectives such as increasing retirement savings and health insurance coverage and providing incentives for certain industries may be better accomplished through direct expenditures rather than through the tax code. Further, she recommends that Congress approach tax reform in a manner similar to zero-based budgeting, an approach also proposed by the National Commission on Fiscal Responsibility and Reform. What a novel idea – dealing with the nation’s public policy objectives in an open and transparent way, which ultimately empowers the voters, while improving the ability of individuals and businesses to make sound economic decisions.
In addition to complexity and fairness concerns, drivers of fundamental tax reform include the temporary nature of the recent agreement to extend all the Bush tax cuts and the 2009 estate tax structure, the ever-increasing reach of the AMT, dozens of expiring tax provisions (many that are now on year-to-year life support), the $350 billion tax gap, and competitive issues for our multinational corporations created by the Code’s approach to taxing worldwide income, which in turn drives these corporations to look for less taxing locations for investment in property, plant, equipment, and people.

Impact of Tax Reform on CPAs

Have no fear of fundamental tax reform. The Tax Reform Act of 1986 was the last time Washington actually enacted significant tax reform, and that ushered in a golden age for tax professionals. Businesses still have to measure income. The government’s need for revenue is increasing exponentially as boomers begin retiring, the new health care laws are phased in, and we look for a more sustainable fiscal path forward. Trust me, there is no easy way to raise $2.6 trillion a year through taxes ($3.8 trillion if you include federal expenditures financed by debt). CPAs will continue to play a vital role in the area of tax planning, compliance, and administration for many years to come.
Future installments in this series will explore political and policy considerations and the various tax reform alternatives that will be considered in the coming tax reform debate.

Welcome to 2011 – A Glass Half Full

2011-01-02T09:42:00.002-06:00

Apparently, gloom and doom sells. In the era of the 24-hour news cycle and media competition measured by eyeballs and page views, pessimism can become a self-fulfilling prophesy. If we let the daily newsfeeds determine our fate, individuals will not be opening their pocketbooks anytime soon, businesses will neither be investing nor hiring, and governments will forever be mired in a continuous state of gridlock. Maybe, however, that’s all just a glass-half-empty view of the world. If true, perhaps there’s a glass-half-full worldview as well.

Spurring Business Investment
To begin with, American corporations’ balance sheets are strong by historical standards, with approximately $2 trillion of cash sitting on the sidelines, the highest share of total assets since 1963, according to The Wall Street Journal. The conventional wisdom is once business leaders develop a greater sense of certainty about the tax and regulatory environment, all that cash will be deployed into capital projects, hiring more workers, and other investments. And once that happens, buckle your seat belt.
Proposals are on the table that could jumpstart the process. John Chambers, Chairman and CEO of Cisco Systems, and Safra Catz, President of Oracle Corporation, suggested in a recent WSJ op-ed a straightforward tax law change that would allow U.S. multinationals, which collectively account for approximately $1 trillion in retained earnings from their overseas operations, to repatriate these foreign earnings back into the U.S. at a relatively low tax rate of 5%. Today these companies are building plants, making acquisitions, hiring workers, and purchasing equipment abroad because they would have to incur a 35% federal tax hit (plus state taxes) if they repatriated the earnings back into the U.S. This stands in contrast to almost all developed countries that allow companies to repatriate earnings at 0%-2%. The effect would not only be the creation of a privately funded domestic stimulus of up to $1 trillion, but also another $50 billion of tax revenue the IRS wouldn’t otherwise receive. The private stimulus theoretically would be invested by these businesses in domestic hiring, capital expenditures, and research and development. And the additional tax revenue could be devoted exclusively to hiring and small business lending incentives, if Congress so desired.

Household Balance Sheets
In addition to strong corporate balance sheets, households, which account for 70% of GDP, have been rebuilding their balance sheets as well. Not only have the equity markets rebounded significantly from the depths of the recession, households have been deleveraging over the past few years, with debts and debt payments as a percentage of household income falling to more sustainable levels. Further, the nation’s savings rate is near six percent, up from almost zero just a few years ago. Collectively these trends indicate that American consumers are in a much stronger position to support a sustainable recovery than might have been the case after previous recessions, although no one expects a return to the spending spree of the bubble years.

The Three Waves
A third leading indicator of better times to come can be gleaned from connecting several recent datapoints. Hiring tends to follow a predictable cycle following an economic contraction. First, businesses and other organizations cut costs, including payroll, then try to wring as much increased productivity out of remaining workers as possible. When productivity increases wane, temporary hiring (contractors, freelancers) picks up, and finally, when business leaders see enough evidence of a sustained increase in demand for their products and services, they resume hiring. Of course everyone is aware of the layoffs and cost cutting that began in January 2008 in much of the U.S. and in September 2009 in Texas. What we’ve seen lately is a sharp decline in worker productivity increases, from a 6.3% annual clip in Q1, 2010 to 2.5% in Q3 according to the DOL, indicating that businesses have achieved about all the efficiencies they can expect from increasing productivity of existing workers. In addition, the Federal Reserve’s Beige Book, a qualitative survey of business conditions across the country, indicated a pickup in temporary hiring in the fall of 2010. And forward-looking firms in the accounting industry have begun looking beyond productivity and temporary hiring and are entering the third phase, actually increasing headcount. Deloitte indicated it plans to increase staff by 50,000 a year globally for the next five years, from a base of 170,000 employees; Ernst and Young expects to hire 38,000 new employees for its year ending June 30, 2011; a CPA Trendlines survey of local and regional firms in the U.S. indicated 37% of accounting firms planned to add headcount in 2011; and finally, the Bureau of Labor Statistics forecasts 280,000 new accounting jobs this decade, a 22% increase. Sounds like a reason to be bullish on the accounting profession.
The picture is especially encouraging with a Texas-centric view. According to the Comptroller’s website, job creation in Texas exceeded 28% of all U.S. job creation in the first seven months of 2010 more than three times the national average. And a report by the Real Estate Center at Texas A&M indicated that Texas produced over half the jobs in the U.S. for the year ended September 2010. A number of contributing factors - less unionization, a lower minimum wage, a lower tax structure, the smaller impact of the housing bubble, the industrial mix, and Texas’ geographic advantages – undoubtedly contributed to this very positive trend we need to ensure continues.

A Growth Agenda
As President Obama once said, “Elections have consequences.” Hopefully the consequences of the November 2010 elections will include a more pro-growth policy agenda at both the federal and state levels. There is no shortage of pro-growth proposals on the table. Surely most policy-makers realize by now that businesses and individuals have been stuck in a state of inertia for some time, unable to predict what their taxes will be, what their healthcare costs will be, and what their regulatory burdens will be, and that eliminating uncertainty will have a positive economic impact. And while a natural tension exists between one side that prefers a big infrastructure program, focused subsidies, and tax credits for key industries, and the other side that wants to end subsidies and tax credits and adopt a simplified tax system, each believes its policies will drive economic growth. Given that, it should be possible to put economic growth and job creation on the front burner and coalesce around that. (I know, but this is a glass-half full article!)

A Sustainable Texas Budget
According to the Texas Public Policy Foundation, a conservative Austin think tank, the state’s total appropriations were $92.7 billion in 2010, up from $23.3 billion in 1990, an increase of almost 300% over the 20-year period. During that time, the state’s population has grown 49%, and inflation has increased 66.4%, or a combined 115%. While the 2011 Legislature can’t reverse the growth in spending over the last 20 years, it can put Texas on a sustainable path going forward. If spending growth had been limited to the combined population plus inflation growth over the past 20 years, Texas would have spent only $50.2 billion in 2010, $42.5 billion less than the $92.7 billion, and we wouldn’t have to worry about $20+ billion shortfalls and sales tax on professional services. Of course, hindsight is 20-20, and most observers realize that to be sustainable to the point where we’re not in a fiscal crisis during every legislative session, the Legislature will have to structurally address the growth of state government spending. The Texas Public Policy Foundation favors a strong tax and expenditure limit tied to population plus inflation growth, or the growth in personal income if less, to prevent future budget short¬falls. It would require a supermajority vote of each chamber to ex¬ceed the limit rather than just a simple majority vote, and would expand the scope to include all levels of government within Texas. I personally don’t know if this is the best solution for Texas or even realistic, but I salute the Foundation for throwing a stake in the ground and initiating the debate. Hopefully the Legislature will take a cue and look beyond balancing the current budget and put Texas on a fiscally sustainable path going forward.

Conclusion
Is the glass half empty or half full? A case can be made for better times ahead and interesting suggestions are emerging. Many businesses are flush with cash and are looking to Congress to eliminate barriers that prevent investment and hiring in the U.S. Improving household balance sheets should result in a more confident consumer sector. Both companies and households are waiting for clarity in the tax and regulatory environment and hope the November 2010 election results will be the catalyst that moves Congress beyond its current state of gridlock. Certain trends suggest businesses are beginning to move into a robust hiring environment, especially in Texas and especially for CPAs. Finally, as we approach the 2011 Texas legislative session, we can hope that lawmakers can not only figure out how to balance the current budget but also agree on a more sustainable fiscal framework going forward.
That’s the half-full view. Happy New Year!

Effective Communication in the 21st Century

2010-09-12T20:41:00.002-05:00

Somebody once said that all business problems are communication problems. And of course, we all learned in junior high the three essential elements of communication are the sender, the receiver, and the message. Therefore doesn’t it follow that if you could master the three elements, you’d be a great communicator and hence, a great problem solver? That was probably the case for many years, but the era of constant change and evolution known as the 21st Century has introduced new elements into the equation. Effective communication in 21st Century will require an understanding of demographic and cultural differences among people as well as differences among the platforms through which they go to share information and connect with others.

Senders and Receivers

Many CPAs trained in the soft skills will recognize the Myers Briggs Personality Type Indicator as a foundational tool of effective communication. While the initial view of one’s personality type will certainly be interesting if not revealing, Myers Briggs’ best use is as a framework for understanding individual differences with others so that your communication can be tailored effectively. When you – the sender - understand your own personality type and how it differs from other firm members, clients, referral sources, revenue agents, and other members of your ecosystem, you can better understand the context in which others – the receivers – interpret your message, e.g., how clients best like to learn about services you provide and how they like to interact during the process of gathering information and making decisions.

Demographic Differences

With today’s workplace consisting of at least three generations, effective communicators will recognize the generational differences and their root causes and adapt their communication styles accordingly.
Baby Boomers came of age in the post-WWII era in a period of optimism, opportunity, and prosperity. They value loyalty and respect the organizational hierarchy. They recognize that people are living longer and understand the ugly mathematics of retirement; accordingly, we may not see Boomers retire in droves as they reach traditional retirement age, as many have suggested.
In contrast, Gen Xrs’ attitudes were shaped by recessions, Asian competition, downsizing, and the emergence of the personal computer. In the workplace, they are independent and like to take charge. Many are undoubtedly frustrated by the grey ceiling created by the Boomers’ delayed retirement.
Millennials’ opinions about business were shaped by the dot-com meltdown, 9-11, Enron, Andersen, Lehman Brothers, globalization, and layoffs. As a result they tend to put life before work, a foreign concept to many old-school CPAs. They are generally fast learners and highly motivated but change jobs more frequently than older generations. They want the ability to work from home and work flexible hours and are more likely to start their own businesses. They need continuous feedback, and an H.R. system based on an annual performance review is insufficient for their needs. They even view job security differently. A recent study at MIT showed that Millennials were less engaged during the recession than Baby Boomers, while Boomers didn’t seem to have disengaged at all, having seen the booms and busts of economic cycles before.

The difference in organizations today is that we often see 60-somethings working alongside 40-somethings and 20-somethings, each bringing different attitudes about authority, loyalty, formality, and the organizational structure. While this generational diversity can cause stress and conflict due to differing perspectives and values, it can also be the foundation for creative and innovative problem solving where the whole exceeds the sum of the parts.

Cultural Issues

In our global economy, it’s increasingly important to understand cultural differences among people. Whether scheduling appointments, entertaining clients, or closing the deal, the way you greet people, gesture, dress, and even receive gifts can influence the outcome. Some cultures are relationship based, so ample time is devoted to developing the right relationship as a precursor to doing business. Others place a higher value on rules and contracts rather than relationships. Some cultures value status, family background, the universities attended, and job title, while others are meritocracies and far less formal. Some cultures communicate in a very direct way, without ambiguity, while others more indirectly via body language, facial expression, and other non-verbal ways. A best-selling business book titled Kiss, Bow, or Shake Hands, cites the following examples:

Australia: The "thumbs-up" sign, which in the U.S. indicates "OK" is considered rude.

China: Avoid making exaggerated gestures or using dramatic facial expressions. The Chinese do not generally use their hands when speaking, and become distracted by a speaker who does.

Indonesia: Since it is impolite to disagree with someone, Indonesians rarely say "no"...a clear way to indicate "no" is to suck in air through the teeth.

Managing the Platform

…Which brings us to the platform --- the place where we go to share information and connect with others. In a relatively short period of time we’ve seen platform shifts from the traditional land line to cell phones to smart phones, from snail mail to overnight mail to faxing to email to instant messaging to texting, from desktops to laptops to tablets, from television to U-Tube, from bulletin boards to online forums, and from glossy brochures to websites to social media sites. And no doubt about it, there are platform preferences unique to the different generations and different cultures represented in the workplace. For example, a recent Pew Research Center survey showed that 90 percent of Millennials use text messaging, compared to just 11 percent of Boomers. People I know talk about how hard it is to communicate with young people. The real problem is they don’t understand the platforms the young people prefer. Effective communicators must be skilled at understanding the various platforms and how different people from different generations and different cultures prefer to be communicated with.

Conclusion

The key elements of effective communication will always be the sender, the receiver, and the message, as we learned long ago. What’s new in the 21st Century is that mastering the three elements has gotten much, much more challenging.

The Morphing Tax Ecosystem

2010-09-12T20:37:00.002-05:00

Ec-o-sys-tem: a system formed by the interaction of a community of organisms with their environment, functioning as a unit, all the parts working together to make a balanced system; every species has a niche in its ecosystem that helps keep the system healthy.

It’s interesting to think about the CPA’s role within the tax ecosystem, consisting of the President, Congress, Treasury, the Internal Revenue Service, taxpayers, and the tax advisors and preparers, information and software providers, other federal, state, and international agencies, each with their own roles to ensure the appropriate amount of tax is reported and collected. As with any ecosystem, the various elements of the tax ecosystem morph and change over time, and of particular interest is how this morphing of the tax ecosystem will cause changes in the roles and responsibilities of the various members of the system.

Follow the Money

To fully grasp the concept of the tax ecosystem, let’s begin with the federal budget. President Obama submitted a $12.63 billion budget for the IRS for FY 2011, up four percent from 2010. A four percent increase initially seems like a lot. However, in light of all the Service is being asked to do these days, is it enough? According to the IRS Oversight Board, created by Congress to review and approve the IRS-prepared annual budget request, yes and no. The Board, whose report is submitted to Congress along with the President’s request, believes the amount allocated by the President for enforcement is about right, while the amount needed for taxpayer service and operations (IT) support is insufficient. Consider the following trends:

• Spending for taxpayer service has been declining in recent years, with inflation adjusted funding down 6.8% since 2004. As a result, the Service answered only 53% of its calls in FY 2008, down from 87% in 2004. And while service levels are improving, the goal is only 71% for the current year.

• Regarding enforcement, examination coverage has been on the downswing for both individuals and corporations. A recent academic study from Syracuse University concluded that the IRS audited 22% fewer large companies in 2009 than in 2005 while increasing audit coverage of smaller companies, despite the fact that the ROI per hour worked is about nine times greater for audits of large companies than small-to-medium companies.

• With regard to collection practices, National Taxpayer Advocate Nina Olsen recently reported that since FY 1999, the IRS has increased lien filings by 475% and levies by about 600%, yet inflation-adjusted revenue raised by the IRS Collection function has actually declined by about 7% over that period.

The Core Mission

While 86% of taxes are collected voluntarily, i.e., without the IRS’s direct involvement, there exists a well-publicized tax gap, defined by Treasury as the aggregate amount of true tax liability that is not paid voluntarily and timely. For the past decade the tax gap has been thought to be in the $300 billion to $350 billion range. Key new initiatives to close the tax gap include:

Return Preparer Scrutiny.

According to Taxpayer Advocate Olsen, about 58% of individual taxpayers and 80% of small business taxpayers hire return preparers to complete their returns. The IRS recently completed a program called the Return Preparer Review, an assessment of the return preparer community, including both licensed preparers and unlicensed preparers, finding “extremely high rates of error and misconduct among preparers.” Characterized as an “educational” program, at times using undercover agents posing as taxpayers and in other situations using teams that included members of the Criminal Investigation Division, the initiative succeeded in highlighteding the level of unethical and unqualified return preparers in the overall tax ecosystem. As a result of the study, allpaid return preparers will also be subject to the Rules of Practice Before the IRS (Circular 230). This means that when the Service suspends or disbars someone, he or she will no longer be able to prepare federal tax returns, which previously wasn’t the case. The Service used a July 6 news release to remind return preparers of their due diligence responsibilities under Circular 230, describing the disbarment of a CPA for failing to determineinvestigate the correctness of entries on the tax returns of a corporation and its shareholders when the income reported was inconsistent with the taxpayers’ lifestyles. We can expect ongoing debate about what constitutes due diligence.

Globalization of Tax Administration

In a global business context the Service’s objective is to ensure that taxpayers don’t use the international capital markets and tax code complexities to push tax planning beyond acceptable limits. To that end, the IRS is working on developing a protocol for joint country audits of multinational corporations. For individual taxpayers, the focus is to ensure U.S. taxpayers with overseas assets pay what they owe, supported by provisions of the HIRE Act, which tightened the rules and increased the penalties on undisclosed foreign investment accounts. In addition, the IRS is opening Criminal Investigation offices in Beijing, Panama City, and Sydney, in addition to existing offices in Hong Kong and Barbados. On top of that, the Service has recently formed a new group called the Global High Wealth Industry Group that will focus on high-wealth individuals and their related entities, including trusts, real estate, foundations, corporations, partnerships, retirement plans, and other entities, wherever located. Other developed nations including Japan, Germany, the UK, Canada and Australia are setting up similar programs, and an increased level of cooperation and information sharing among tax agencies is in the plans.

Expanded Information Reporting

Most people think of Forms W-2 and 1099 when they think of information reporting. Commissioner Shulman takes a much broader view. Pointing to its current practice of issuing a large number of information document requests and spending a significant amount of time “rooting around for information,” Shulman believes taxpayers should be more transparent and forthcoming, so that the IRS and taxpayers spend their time more productively. Leveraging its recent Supreme Court victory in Textron and the FIN 48 requirement for disclosure of uncertain tax positions, the Service has issued a draft Form 1120 UTP that would require the reporting of a C corporation’s federal income tax positions for which the corporation or a related party has recorded a reserve in an audited financial statement. “It’s part of the broader theme of information reporting and having a transparent system,” said Shulman. Not surprisingly, the TSCPA, AICPA, ABA, and TEI all issued strong commentsobjections objecting to implementation of the new disclosure requirements as originally conceived. While the future of Form 1120 UTP has yet to play itself out, there are a number of enhanced informational reporting initiatives that, together with the new return preparer rules, could be transformational with respect to tax administration. These initiatives include reporting:

• Cost basis of securities;
• Debit/credit card payments to merchants;
• Payments to corporations by businesses;
• Information exchanges with foreign tax treaty partners;
• Foreign investment accounts; and
• Value of employer provided health-care benefits and whether they comply with coverage requirements.

For the IRS, it will mean a continuation of the trend toward more correspondence audits, which today comprise 77% of all federal tax audits. It will not be a panacea however. Information reporting won’t cover cash payments detect unreported cash payments or illegal activities; it probably will hit low and middle income taxpayers more severely than higher income taxpayers; and it won’t curtail fraud and abusive schemes resulting from refundable credits (e.g., EITC) because of the way these programs are designed by Congress.

Improving Information Technology

While the IRS Oversight Board concluded the Service’s IT infrastructure badly needs upgrading, there is one development on the horizon that, although a few years away, will enable the Service to take a quantum leap forward, once implemented – extensible business reporting language, or XBRL, which will involve the tagging of tax return data submitted by business taxpayers. While currently in the planning stages at the IRS, the SEC has begun requiring financial statements be submitted in XBRL format; other countries, most notably the UK, have already set the XBRL wheels in motion for tax reporting. Once the IRS requires businesses to file their returns tagged with XBRL, the IRS will have the ability to slice and dice taxpayer data in new and inventive ways, comparing companies’ data against benchmarks to identify anomalous entries and select cases for investigation much more efficiently. This may result in more cases being investigated, or in better identification of cases to investigate, but in any event it will allow the IRS to better enforce compliance with tax laws, as there will be less need for judgment and guesswork on the part of IRS examiners.

Expanding Roles and Responsibilities

Thanks to Congress, the IRS is being pulled in multiple directions as its responsibilities have grown exponentially over the last few years. While the agency has historically focused on taxpayer service and enforcement, Congress has directed it to administer a number of social-services programs, which means it now redistributes through credits and other mechanisms an increasing portion of the money it collects, for programs like the Earned Income Tax Credit, Economic Stimulus Payments, Making Work Pay Credit, First-Time Homebuyer Credit, the expanded COBRA provisions, and now the new health care system. As the new health care law is implemented, the IRS is charged with verifying whether taxpayers are carrying the required level of insurance, collecting fees if they are not, collecting taxes on high-value plans, and determining household income. The Congressional Budget Office estimated that it will cost the IRS $5 billion to $10 billion over 10 years to administer the new health care law.

Accordingly, some have expressed concern that the Service’s budget is not keeping up, and Congress has not provided sufficient funding. Commissioner Shulman proudly told the Journal of Accountancy that the IRS is now seen as the “go-to agency in government” because of its ability to execute quickly. Taxpayer Advocate Olsen, while suggesting the IRS is indeed capable of delivering the social programs, expressed concern that the Service is neither structured nor funded to absorb the additional responsibilities effectively. She suggests the IRS’ mission statement and strategic plan be revised to explicitly acknowledge its new hybrid role as part tax collector and part benefits administrator. This may be necessary to obtain sufficient funding for the Service to perform both roles effectively. Indeed, one has to wonder….is a 4% increase enough when service levels are down, audit coverage is down, collection practices are ineffective, systems upgrades are needed, and now the Service is being forced to expand its mission?

Conclusion

As we’ve seen, the IRS’ responsibilities are growing exponentially while its budget is increasing far more modestly. Certain parts of its operations appear to be underfunded while the agency is being called on to administer more and more social programs, most notably the new health care laws. The IRS is responding to its challenges with a global approach to tax administration, by promulgating new taxpayer self reporting requirements, by weeding out bad return preparers, and by automating as much as possible.

What will be the impact of this morphing tax ecosystem on CPAs? Is the IRS in effect deputizing the return preparer community? What will be the impact of return preparer registration on CPA tax practice? What will the CPA’s role be in administering nationalized health care and other social programs? How will the CPA’s role within the tax ecosystem change once XBRL, coordinated international audits, and disclosure of uncertain tax positions are all implemented? We can all speculate, but one thing is certain: the tax ecosystem is evolving, and new opportunities to serve our clients and employers will emerge as a result.

Changing Your Mind: Thin Slicing for CPAs

2010-05-22T19:12:00.001-05:00

While preparing for a recent presentation on current tax and accounting developments, I was almost overwhelmed by the sheer volume of regulatory change that has occurred in the past year. It’s easy to see why survey after survey shows one of the primary pain points for CPAs is keeping up with all the information one has to read, process, and retain, regardless of the area of practice. No matter whether your roots lay in generally accepted accounting principles or in the federal tax code, the volume of changing regulation and the velocity in which it’s coming these days can be overwhelming for seasoned professionals and staff accountants alike. Nevertheless, our clients and employers expect us to be on top of everything, have an answer for every question, and we naturally want to meet or exceed expectations.

Indeed, the quantity of information that’s readily available to us, whether via the free web or trusted subscription service, along with the technology that enables us to find and retrieve it, is changing the way we consume information, the way we learn, the way we make decisions, and indeed, the way we work.

I first noticed this trend at home, watching my kids and the way they studied. My son, who graduated from high school in 2001, approached his research papers in the traditional way, much as I had, spending hours in libraries, combing through volumes of encyclopedias, books, and journals. My daughter, on the other hand, graduated in 2007, became visibly frustrated if she didn’t locate a source directly on point within a few minutes on Google. Both were good students, made good grades, and did well in college. Nevertheless, I couldn’t help but wonder whether my daughter was developing the deep knowledge that comes from methodical and lengthy study. I have the same concern about today’s young CPAs. I feel like I developed a pretty good “accounting knack” and fairly deep understanding of tax law, but I’ve been at it for over 30 years. How do we make sure the younger generation develops that same deep knowledge of accounting standards and tax law? The sentiment was echoed recently by a senior tax partner at a firm in Chicago who told me this when asked about the biggest challenges and concerns in his practice:
One of my main frustrations with young staff is that they rely too much on technology. I often say Google is not the answer to everything. It might be that there is no Googlable answer, which is when analysis and critical thinking take over and provide value and thus justify higher billing rates or at least some value billing.

In 2008, a cover story in The Atlantic titled “Is Google Making Us Stupid?” suggested that technology has changed the way we think. Motivated by a desire not to miss anything, we seek efficiency, convenience, and immediacy, but with scattered attention and diffused concentration as a result. We’ve become power browsers, skimming one source after another, keeping tabs on numerous bits of unrelated information without completely concentrating on anything. It makes me wonder how much of what we read we really retain or learn. A former executive at Apple and Microsoft, Linda Stone, coined the phrase continuous partial attention to describe this state. Call it CPA for short. And it plays right into the Google business model, which calls for driving users from site to site, collecting information about them as they go that can be sold to advertisers. Thus it’s in their best interest to drive us to distraction; the last thing they want is for slow, concentrated reading and deep thought.

The desire to ensure we don’t miss anything can actually impair sound decision making. At first this may seem counter-intuitive, since we’ve been trained since childhood to carefully evaluate all available and relevant information (e.g., haste makes waste, look before you leap, stop, look, and listen). However, it has not only created a state of continuous partial attention, or a lack of focus, but it drives us to gather as much information as possible before reaching a conclusion or making a decision, often creating a sense of information overload, leading to analysis paralysis. This very phenomenon is the subject of Malcolm Gladwell’s best-selling book Blink. Gladwell points out that the additional volume of information may reinforce our judgment but doesn’t make it more accurate. Better judgments, according to Gladwell, can be drawn from simplicity and frugality of information, whereas too much data can distract decision makers and leave them in a state of continuous partial attention.

In Blink, Gladwell uses stories of physicians, policemen, gamblers, and military war games to illustrate the use of what he calls “thin slicing,” the art of using a relatively small number of key variables or bits of data to reach sound decisions. One story in particular provides some interesting parallels for CPAs.
A cardiologist named Lee Goldman developed an algorithm that formed the basis of a decision tree application that enabled physicians at the Cook County Hospital emergency room in Chicago to focus on a just a few critical pieces of information about patients suffering from chest pain--like blood pressure and the ECG, while ignoring other data such as the patient's age and weight and medical history. For two years, data were collected comparing patient outcomes using the decision tree with traditional methods of evaluation. In the end, Goldman's decision tree proved far superior to the traditional approaches. The success rate of the traditional approaches ranged between 75 and 89 percent, while the decision tool produced an accurate diagnosis more than 95 percent of the time. The decision tree application didn’t do the work alone. Rather, it provided the structure that enabled the physicians to focus their expertise on only the most important variables, avoiding extraneous information, input overload and analysis paralysis to reach an accurate diagnosis.

After reading Blink, I became intrigued with the concept of thin slicing for CPAs. (No doubt I felt the pain of information overload personally.) Wouldn’t it be awesome if we could easily separate the relevant from the irrelevant and instantly focus on the key elements that produce a decision or a conclusion on a tax or accounting issue? Avoid information overload and analysis paralysis?
Somewhat serendipitously, I began noticing a wide variety of decision support tools, document assembly applications, mind-mapping software, and business intelligence tools employed by a wide range of professionals, including attorneys, mediators, engineers, economists, physicians, and pharmaceutical companies. These tools generally provide a systematic methodology and framework for understanding a problem, identifying and evaluating options, and reaching a decision, forming a conclusion, creating a document, customizing a workflow, or making complex calculations. Like with Dr. Goldman, the tools don’t replace judgment and professional intuition, they force the user to focus on the relevant variables at the right moment and in the right order, supported by the underlying laws and standards.

In the not-too-distant future, the convergence of information and software will make thin slicing for CPAs a reality. We’ll see ‘intelligent’ applications that feel like software, perhaps with wizard-based user interfaces, driven by the underlying tax and accounting rules. We’ll be able to drill down into a tax topic or accounting standard within a framework that easily separates the relevant from the irrelevant and enables us to focus on the key elements, avoiding information overload and analysis paralysis. Thin slicing for CPAs. You heard it here first.

Looking Beyond the Numbers

2010-03-16T20:37:00.002-05:00

Conscious Capitalism

As the country crawls out of the recession, we find ourselves in a “new normal,” in which business leaders are beginning to embrace what author Patricia Aburdene of the Megatrends series calls “conscious capitalism,” where business and investment decisions are guided not completely by an absolute quest for profit at all cost, but profit-balanced to a degree by non-financial drivers including social consciousness, compassion, environmental responsibility, and contribution to the greater good. This paradigm shift in the way companies do business has been caused by a number of factors, including consumer demand for more sustainable products, increased influence of personal social missions on corporate governance, and a growing recognition that sustainable business practices can lead to lower costs and higher profits.

We’ve seen this trend take root with Bill Gates’ and Warren Buffet’s war on world hunger via the Gates Foundation, with the sustainability movement; with the One Laptop Per Child initiative; and the emergence of micro-financing techniques to fund business activities in developing countries that traditionally lack access to banking and related services, in hopes that such access will help people out of poverty. A key theme at this year’s World Economic Forum in Davos, Switzerland was the integration of sustainability issues with business decision making and the need for corporations to deliver wealth creation and economic returns in a more sustainable, responsible way.

A number of high-profile companies are moving beyond marginal social responsibility initiatives that are for the most part internally focused and adjunct to core business activities. A recent Wall Street Journal conference on business and the environment featured Robert Iger, CEO of Disney, which openly aspires to be the world’s most admired company. Iger requires each of his business units to report quarterly and publicly on their impact on the environment – how much waste they create, energy they use, water they consume, etc. In addition, every Disney capital request must include an environmental component, detailing the impact on the environment that the project is projected to have. And perhaps most interesting, the company levies a tax on each business unit based on their anticipated environmental impact over the next five years as a mechanism for funding conservation projects around the world.

We’ve also seen the emergence of new companies like Whole Foods and Seventh Generation, which build their organizations around a defined social mission. On the finance side, there have been socially responsible mutual funds around for a while now, the Calvert Funds being a large and well-known example, but the socially-responsible and mission-driven investing framework has started to expand to the private equity and venture capital worlds as well. The trend has become pervasive enough to support a host of research and advocacy organizations such as the Social Venture Network and the Sustainable Business Network that lead in development of best practices and entrepreneur connectivity. One of the best-known venture funds, Kleiner, Perkins, Caufield & Byers, has said that sustainability represents one of the biggest economic opportunities in history, and has jumped in feet-first. Kleiner Perkins’ John Doerr predicts that new and clean energy is the next great global industry, although he worries we are already far behind the Chinese in terms of investment. Vinod Khosla of Khosla Ventures believes energy storage is a rapidly evolving industry, and Paul Holland of Foundation Capital talks about a smart grid and energy web. In essence, what these venture capitalists are all saying is that they expect companies that practice conscious capitalism to outperform the market to a significant degree.

Why It Matters to CPAs

Skeptics may point to what has become known as “Climategate,” the deliberate attempt by certain scientists to distort research findings to support their dire global warming scenarios, and the failed attempt last year in Copenhagen to reach a global consensus on a path forward regarding climate change, as evidence the sustainability movement is a passing fad. CPAs, however, have been dealing with environmental issues professionally for many years, and it looks like things are just heating up (no pun intended). Existing accounting standards have come under fire, the SEC recently jumped into the picture with new climate change disclosure guidelines, and the convergence of U.S. GAAP and IFRS may bring the issue to the forefront in the next year or two. Further, the concept of sustainability reporting is being touted as a new practice area by the AICPA, and Big Four firms appear to be building robust new consulting practices helping companies assess and manage environmental risks (including those arising via M&A activities), develop sustainability benchmarking, apply performance metrics and reporting, and estimate remediation liabilities. And noteworthy to this discussion is a 2008 study listing climate change as the number one risk facing the insurance industry, according to a recent SEC release.

U.S. GAAP currently provides accounting guidance for environmental liabilities. Under FASB ASC 450-20 (formerly SFAS 5), when it’s probable that a loss has been incurred (e.g., via litigation or regulatory assessment) and the amount can be reasonably estimated, the liability should be accrued. FASB ASC 410-20 (formerly AICPA SOP 96-1) provides further instruction and clarification on determining probability and the reasonably estimated amount of environmental remediation costs. While GAAP was designed to prevent companies from managing earnings via recording contingent liabilities when the liabilities were not probable and estimable, there is a sense that current standards allow them to lowball their estimates by selecting the low end of the range of estimated cleanup costs. The issue is exacerbated by the attorney-client privilege, which to some extent shelters contingent environmental liabilities from disclosure. We can probably expect a refinement of our professional standards at some point, perhaps moving more along the lines of IFRS 37, which is a bit more stringent than U.S. GAAP, requiring companies to use the midpoint of the probable range of estimated cleanup costs. In any event, with the sustainability movement gaining traction, we will likely see an expanded focus on reporting environmental liabilities that will keep the issue on the front burner in the corner office, in legal and regulatory circles, and among auditing firms for the foreseeable future.

The focus on emissions reporting was recently elevated by an SEC release providing interpretive guidance to help registrants meet their disclosure obligations concerning the effects of climate change on their businesses. While the timing and scope of federal legislation is uncertain, the release points out that state and local governments have enacted legislation and regulation of greenhouse gas omissions, the EPA effective this year is requiring reporting of such emissions, and many U.S. businesses conduct operations internationally where they are subject to Kyoto Protocol standards. Accordingly, the SEC believes these accords can have a material impact on U.S. companies, their supply chains, distribution chains, personnel, and physical assets, prompting it to take a fresh look at disclosure requirements. In a nutshell, its Regulation S-K requires disclosure related to climate change in the Description of the Business, Legal Proceedings, Risk Factors, and in Management’s Discussion and Analysis. The Commission plans a public roundtable on disclosure related to climate change later this year.

Sustainability Reporting

The concept of environmental reporting has been around at least since the 1980s, with an emphasis on whether resources would be sufficient for future growth. By the late 1990s, the concept of the triple bottom line – reporting on environmental performance and social performance to supplement economic performance – had emerged and has since morphed into a concept called sustainability reporting, which includes a wide variety of metrics an organization can use to report on its economic, environmental, and social performance and its impact on the community. Environmental measures focus on reducing resource use, reducing waste and emissions, and recycling outputs. Social measures include growth and development opportunities for employees, contributing back to the community, and improving practices with external stakeholders. Companies are drawn to the concept for a variety of reasons, from risk management to brand and reputation building.

The European Union has embraced the concept of sustainability reporting and the UK Accounting Standards Board has issued a best practice guideline. A number of countries, including Japan, Australia, France, Spain, South Africa now require reporting of some sustainability elements, and by 2007, most large organizations in developed countries were producing some sort of report on social and environmental performance, although Europe seems to be ahead of the U.S. in terms of all three elements of the triple bottom line concept, according to an analysis published by Australian professor Graham Hubbard. Further, although 80% of the largest companies worldwide are issuing reports on sustainability, only 4% have integrated it into their annual reports, explaining how sustainability is connected to the overall operational strategy of the business, according to a 2008 KPMG study.

There are several issues that must be overcome before sustainability reporting becomes mainstream practice, as the current state of reporting is ambiguous and confusing due to the lack of a generally accepted global reporting framework, the lack of uniform definitions, inconsistent applications, and the lack of attestation standards in most countries. While multiple frameworks have been suggested, one will have to emerge as the standard for sustainability reporting, much like GAAP is for financial reporting and COSO is for internal control evaluation. Currently, the most widely used framework for providing guidance for disclosure about sustainability performance is called the Global Reporting Initiative (GRI), based on U.N. principles and used by three-quarters of the Global Fortune 250, according to the International Federation of Accountants (IFAC). The GRI, which itself is a stakeholder organization with participants from business, labor, and professional institutions worldwide, is pushing for development of XBRL taxonomies for non-financial information, which could drive further adoption of its sustainability framework in the U.S., given the SEC’s rule requiring all registrants to submit financial statements in XBRL. An alternative sustainability framework was proposed in 2009 by IFAC (http://web.ifac.org/sustainability-framework/splash), specifically to support professional accountants and their organizations integrate sustainable practices in their business processes.

Opportunities for CPAs

Today, sustainability reporting and assurance are not core competencies of CPAs in the U.S. However, proponents of sustainability reporting claim that governmental, regulatory, and audit oversight of sustainability issues will become the norm within the not-too-distant future, across all industries and around the world. Recognizing this trend, and potentially the risk of inaction, the AICPA has begun an awareness campaign, enlisting the help of none other than Prince Charles, the Prince of Wales, to deliver an inspiring presentation at its fall Council meeting, imploring “the U.S. CPA profession to take a leading role in helping develop the tools and information necessary for companies to embed sustainability issues effectively in their day-to-day operations and decision-making and to report sustainability performance in a more clear, concise and connected way.”

Some CPAs, by nature professional skeptics, may dismiss anything green-related as anti-business and may view the AICPA’s attempt to elevate awareness in sustainability reporting as another WebTrust initiative. Indeed, the AICPA may sense that the U.S. is behind in adoption of sustainability reporting and be concerned about IFAC, which sets global auditing standards outside the US, potentially emerging as the global standard-setter. The greater risk as I see it extends beyond who controls standard-setting to the entire global accounting profession, as various other types of organizations, including consulting, engineering, and credentialing organizations may sense the opportunity and take the lead. I’d like to think it’s ours to lose at this point.

As sustainability reporting becomes established, there are a number of ways CPAs can capitalize on the opportunity, which AICPA Chair Robert Harris describes as a new practice area. The following service opportunities for CPA firms have been identified by the AICPA (http://www.aicpa.org/innovation/baas/environ/faq.htm):

• Assurance services (examination, review, or agreed-upon procedures attest engagements) with respect to a sustainability report;
• Assurance services (examination, review, or agreed-upon procedures attest engagements) with respect to the effectiveness of internal control over sustainability reporting;
• Advisory services to develop systems to capture information related to sustainability reporting;
• Advisory services to promote improved dialogue and relationships with employees and communities in which operations are located;
• Certification for environmental management systems under ISO 14001;
• Due diligence services in connection with mergers and acquisitions, which could involve the assumption of environmental liabilities; and
• Benchmarking.

Conclusion

The conscious capitalism phenomenon is affecting CPAs in a number of ways, driving the evolution of professional standards, potentially creating a need for new core competencies, and creating new responsibilities and opportunities. Today, U.S. businesses and CPAs find themselves in an unfamiliar position, lagging the rest of the developed world in what may be a great opportunity to take a leadership role. We’re still on the ground floor but may not be for much longer, as sustainability reporting and attestation services are presently being driven outside the U.S. and not on our timetable. Nevertheless, progressive firms have an opportunity to establish themselves as leaders in this area, enhancing their professional reputation, their world view, and their future growth potential.

CPAs And The Regulatory Tsunami

2010-02-01T14:06:00.001-06:00

Fulfilling a major campaign promise to better protect investors and stabilize the capital markets, President Obama has proposed a far-reaching overhaul of the U.S. financial regulatory framework. These proposals, which have become a key domestic policy priority for the President, include restricting the size and scope of banks, creating a new consumer financial protection agency, allowing the government to dismantle failing financial institutions, consolidating the various bank regulating agencies, and regulating hedge funds and other private sources of capital. As one might expect, opinions surrounding the proposed financial regulatory reforms are all over the board, with critics pointing to the proposals as a political ploy designed to ignite populist anger against big business and Wall Street.

In the midst of this debate, accounting standards have moved on and off the front page, with differing opinions as to who should set the standards, the standards’ role in the financial crisis, the role of the Federal Reserve and the SEC, and the funding for and constitutionality of the PCAOB. CPAs are key stakeholders in this debate, with a vested interest in keeping the financial marketplace transparent, its players accountable, and the regulations relevant, consistent, and workable, all against a backdrop of a global, interconnected economy.

While the proposed financial regulatory overhaul has been one of the most visible regulatory initiatives coming out of Washington, a tsunami of additional regulatory “reforms” are on the way that to date have not been front page news. Scores of new labor laws to protect workers are in the works, as are proposals to align executive compensation with shareholder interests, along with new privacy initiatives. Businesses are also bracing for renewed enforcement of environmental regulations, a more aggressive OSHA, and a more powerful Federal Trade Commission. And of course, all of these initiatives would be eclipsed in magnitude by what Kipplinger calls the “mother of all regulation,” health care reform. Further, as businesses become more and more global, the regulatory compliance challenges can grow exponentially as companies are forced to comply with laws and regulations in remote and unfamiliar jurisdictions, in addition to federal and state regulations in the U.S.

Regulatory and Compliance Risk

While senior executives no doubt realize the cost of compliance with an ever increasing regulatory burden is hugely expensive and a drain on precious resources, the risk of noncompliance probably concerns them more. A recent Ernst and Young survey of the top 10 strategic business risks rated regulatory and compliance risk as the greatest strategic challenge facing global businesses. The study cites a concern that regulatory intervention in particular industries, including pharma, biotech, insurance, telecoms, and utilities could drastically impact the competitive landscape and drive a fundamental change in business models.

Despite the recognition of regulatory and compliance risk by senior executives, companies in general are doing a relatively poor job of institutionalizing effective risk management programs at the enterprise level, according to a study titled Report on the Current State of Enterprise Risk Oversight, co-sponsored by North Carolina State University and the AICPA. The study found that 60% of companies had no formal enterprise-wide approach to risk management, and three-quarters of the time, management is not informing the board of directors of the company’s risk exposures. The biggest barriers to implementation of an enterprise risk management system, not surprisingly, were competing priorities and insufficient resources, which basically means institutionally managing risk has not been a priority for many organizations, despite the fact that the volume and complexity of risks have grown steadily in recent years, and expectations for improving risk management are on the rise.

CPAs and the Risk Management Function

From an operational perspective, responsibility for compliance with regulations often falls on someone reporting up through the CFO’s chain of command. And the trend we can expect going forward is for a continuing reduction in materiality thresholds for ensuring compliance, meaning that companies will require greater precision in compliance in order to avoid public disclosure of noncompliance, including restatement of the financials (and the related impact on the stock price that’s sure to follow).

Against this backdrop, it’s not unrealistic to assume that enterprise risk management, including regulatory compliance, will become a new core competency of the corporate CPA, whose unofficial job description, simply stated, will be to make sure bad things don’t happen. Having had to comply with Sarbanes Oxley to formally document, monitor, and test internal control activities, their natural progression is to leverage the skills acquired from SOX compliance into a more strategic enterprise risk management role.

In some companies, the risk management responsibility been formalized in a function increasingly referred to as Governance, Risk Management, and Compliance (GRC). The objectives of the GRC function are to (a) align the corporate strategy with an enterprise view of risk management, including compliance with regulatory requirements; (b) turn risk management and regulatory compliance into a coordinated set of processes; (c) test, evaluate, and report on the risk management and compliance processes, and correct problems before they spin out of control. CPAs are particularly well-suited for prominent leadership roles within the GRC function, where they can leverage their skills and competencies to turn risk into reward.

Conclusion

The volume of new regulation affecting American business is growing exponentially, and while regulatory compliance can be both costly and painful, noncompliance is a significant risk, a fact not lost on senior executives. Nevertheless, most companies have not institutionalized an enterprise-wide risk management system. The maturation of enterprise risk management into a more strategic governance, risk management, and compliance function provides a great avenue for CPAs to expand their role and sphere of influence within their organizations.

We’re # 1…Aren’t We?

2009-11-25T17:59:00.004-06:00

We Texans are extremely prideful. Rightly so. We have the 11th largest economy in the world. Three presidents out of the last nine. Bob Wills, Buddy Holly, Willie Nelson, ZZ Top, and Stevie Ray Vaughan. Larry McMurtury, Cormac McCarthy, and John Graves. Tom Laundry, Nolan Ryan and Earl Campbell. Denton Cooley and Michael DeBakey. The best barbeque and Mexican food. The Alamo. The Dallas Cowboys. Heck, we were once a country, The Republic of Texas! We have a right to be proud.

And it hasn’t been lost on the rest of the nation. From mainstream media to special studies, publishers and think tanks alike have made state-by-state comparisons a cottage industry. The Economist (a British publication) recently ran a cover story titled “America’s Future, California v. Texas,” along with a 10-page special report on the Lone Star State. The cover story suggests that Texas is not only the best state in the Union in which to do business but also that its leaner, bipartisan approach to government and welcoming attitude toward Mexico and international trade make Texas a role model for the 21st Century.

Overall, the special report painted an impressive picture of Texas from an economic standpoint: a budget surplus, the leader in new job creation, the leader in Fortune 500 company headquarters (64), the #1 exporting state, an unemployment rate 2% below the national average, domestic migration of 150,000 net new residents a year, the lack of a housing bubble and a relatively low rate of foreclosures. Forbes recently listed the five largest Texas cities as the top five cities in the nation for job creation, as well as the top small city (Odessa). A 2008 Wall Street Journal editorial pointed out that since 2004 the Texas economy has produced nearly twice the rate of new job creation as the rest of the nation, and the State Comptroller’s website reports that Texas’ consumer confidence index in October 2009 was 71.7, compared to the U.S. index of 47.7.

These statistics don’t just happen. Various publications point to Texas’ lack of a personal income tax, its right to work laws, tort reform, diversified economy, relatively cheap land with room to expand, NAFTA, and effective banking regulations that enable a strong community banking system as the drivers behind the strong Texas economy. The $295 million Texas Enterprise Fund and the $235 million Texas Emerging Technology Fund are among the largest economic development engines in America and provide a competitive advantage. And we Texans like to point to our entrepreneurial spirit and laissez faire/small government mentality as the real growth drivers.

Compare and Contrast

California, on the other hand, has run into hard times of late, with a 2009 budget deficit of $26 billion, forcing it to pay its bills with IOUs. The Golden State has one of the highest personal income tax rates in the U.S., unemployment two percent above the national average, crippling environmental regulations, crumbling infrastructure, and an annual net exodus of 100,000 Americans, according to The Economist. And of course the tough times aren’t limited to California. New York, alsoalso with one of the highest combined state and local tax rates in the U.S., has experienced a net domestic outflow of more than 1.5 million people between 2000 and 2008. Overbuilding in Florida, Arizona, and Georgia has resulted in plummeting property values. Ohio, Indiana, and Michigan are losing manufacturing jobs, not necessarily to China, India, or Mexico, but to business-friendly states like Texas, where GM builds SUVs in Arlington and Toyota recently opened a state-of-the-art manufacturing facility in San Antonio. Observers point to these states’ high tax rates, protectionist attitudes toward the global economy and labor unions that impose heavy costs on employers as factors contributing to their tough times. The Journal, in an editorial titled “Texas v. Ohio,” cited Texas as a blueprint for the 21st Century when it concluded a 2008 editorial with “The challenge for our national economy in a world of competition is to become more like Texas and less like Ohio.” And a recent report by the Pew Center on the States warned that California, Arizona, Florida, Illinois, Michigan, Nevada, New Jersey, Oregon, Rhode Island, and Wisconsin all face serious fiscal challenges.

All That Glitters…..

No doubt we Texans are fortunate and have a lot to be thankful for. Most of our high standing relative to other states has resulted from hard work, sacrifice, and smart decisions over many decades. Peel back the covers, however, and we’ll see some things we may not be so proud of. We have the lowest percentage of high school graduates, highest percentage of residents without health care, lowest voter turnout, second highest rate of imprisonment, and third highest poverty rate in the nation, according to The Economist.
While our traditional low tax, low spend, hands off way of doing things has served us well, vaulting us into a leadership role by many economic measures, is it the right model going forward? The global economy is a knowledge-intensive place. While our rich history was built on oil, cattle, and cotton, and we’ve diversified exceptionally well since the mid-1980s, the booming fields and hot jobs going forward may well be in infotech, biotech, alternative energy, and advanced manufacturing. Are we setting ourselves up to extend our current leadership position into these areas? Will Texas be able to transform itself into a global, entrepreneurial, knowledge and information-based New Economy? Can we be globally competitive?

An influential group called the American Legislative Exchange Council (ALEC) ranked Texas first among all the states in its State Performance Index, 1996-2006, but 10th in its forward-looking Economic Outlook Rank, and 29th in its State Economic Competitiveness Index. Does this mean our past looked the brightest but our future is dimming? I don’t like that trajectory. The Kauffman Foundation and the Information Technology and Innovation Foundation, an innovation-focused think tank, partnered on a study that ranked Texas 18th in its New Economy Index. Among the factors pulling us down were workforce education, where we ranked 41st, and immigration of knowledge workers, where we were 46th. Similarly, the Milken Institute issues a State Technology and Science Index based on 77 indicators to identify technology and science assets that can be leveraged for economic development. Overall, Texas ranked #20, with human capital investment at a sad #44, clearly an area with room for improvement.

California Dreamin’

For all the maladies we see in California, they have produced Disney, Cisco, Apple, eBay, Google, Hewlett Packard, Sun Microsystems, and Intel. Time responded to The Economist’s issue with a cover story titled “Despite Its Woes, California’s Dream Still Lives.” The article highlights California’s tech-savvy private sector with its Silicon Valley venture capital machine and its early adopter mindset, enabling it to take leading positions in stem-cell research, high-speed rail, green jobs, clean energy, and agricultural production. California is Asia-oriented and has great research universities with institutions like Stanford, Cal-Berkley, and Cal Tech.
Thus the truth is that California and Texas can learn from each other. It’s part of what makes America great – that we have two (if not 50) drastically different models to observe and learn from, especially when the world is changing at warp speed.

The Path Forward

Texas clearly has a solid base on which to build its 21st Century economy, especially in relation to other states. It’s clear however that our education-to-employment system is not as effective as it needs to be, nor do we have the research universities necessary to generate the jobs, new businesses, and technological innovation that will sustain our leadership position in the 21st Century. These problems will be exacerbated as the demographics in Texas change over the next decade, and how Texas responds will significantly impact its future. If we make wise decisions over the next 10 years, there’s no reason to believe that Texas won’t remain globally competitive with high employment and a rising standard of living for years to come.

As CPAs know, the key to finding a solution is properly defining the problem. Sure, we have high unemployment and an unacceptable dropout rate, but let’s look at the ripple effect. What we really have is a growing skills gap in the U.S. Too many high skill jobs are migrating overseas, and simultaneously U.S. companies are being forced to import talent. While we may have 14 million people unemployed, we also have millions of jobs going unfilled. Go to the websites of practically any knowledge based business, including accounting firms, and you’ll see what I mean. Without the proper skills, our workers will end up competing with workers in other countries for jobs that can be performed anywhere. The problem will be compounded by immigration of low-skilled workers where the opposite is true: too many people and not enough jobs.

President Obama, noting recently that American students rank 21st in science and 25th in math compared with students around the world, recently launched the Educate to Innovate Campaign to promote math and science learning. The President is concerned that our skills gap in these areas is putting the U.S. at a disadvantage on vital issues such as medicine, energy and security.

While this is a national problem, I believe the ultimate solutions will be local, and that represents wonderful opportunities for Texas. Policies that increase the number of graduates with advanced degrees, especially in math, science, and engineering, have to be identified and fast tracked. This will likely include funding for more Tier One research universities, a process that has already begun with the approval of Proposition 4 last November, providing access of about $550 million to seven Texas universities for research that will hopefully be spun into innovative new products, new businesses, and high paying jobs. Similarly we’ll need to provide technical training for those who would otherwise have only marginal skills. Success will require active participation by and coordination of the state government, local governments, businesses, not-for-profits, organized labor, and educational organizations. The task will be to create and align talent with needs of local communities. Texas has an enviable and unparalleled base from which to build its 21st Century economy, with its high tech sector in Austin, the thriving medical and energy industries in Houston, trade with Mexico and Latin America based in San Antonio, and telecoms, aerospace, and distribution based in the DFW Metroplex.

I’m not suggesting that Texas’ low rankings in education, training and research are attributable solely to a lack of investment. Nor am I suggesting that we should ignore what made Texas the economic performance leader to begin with. What I’m suggesting is that the solution begins with both state and local commitment to education, research, and training, based on collaboration and active participation of all stakeholders. The alignment of schools, governments, NGO’s, organized labor, and businesses in the local communities to realistically support the knowledge economy and close the local skills gap is the key. Our elected officials must look at the policy variables that will support where we need to go, not necessarily where we’ve been. Businesses will need to invest in updated career information continuing educational programs that support the entire continuum of lifetime learning. Schools will have to realize that accountability and transparency produce a better product. The result for Texas will be a strong regional economy, continued job creation, global competitiveness, and a continuing leadership position for years to come.

Practice Development at the Speed of Trust

2009-09-13T15:59:00.000-05:00

2009 has been the year that many firms experienced the impact of the downturn in the business cycle that would be expected in any recessionary period. Clients go out of business; others look for ways to cut back or are slow to pay. Firms have seen a sharp drop-off in transactional work. As a result and despite tight cash flow, many firms have chosen to (or have been forced to) place a more focused emphasis on practice development – acquiring new clients and retaining if not growing revenue from existing clients. A recent AICPA CPA Insider reported the results of a survey that suggested that 70% of firms are expanding their practice development efforts, in some cases to maintain their revenue base, and in other cases to seize the opportunity to grow it.

But what exactly is practice development today? Unlike other professions that have chosen to pack the yellow pages, airwaves, and billboards with claims of what they can do for prospective clients, business development for CPAs remains largely relationship-based. That said, relationships are formed and maintained differently today than a decade ago. Glossy brochures and print newsletters sent through snail mail have given way to websites, e-newsletters, and social networking as client awareness and public relations tools to supplement relationship-based business development practices.

24/7 Practice Growth Drivers

There’s no question that in today’s business environment, news travels at warp speed. Today’s 24-hour news cycle is relentless…you snooze, you lose. And therein lies the opportunity. With the tools available today, firms can establish thought leadership and demonstrate expertise without regard to size of firm or geographic boundaries. Your best friend from a business development standpoint is the front page of the paper or the headlines of your favorite news site. One day the media is focused on Sarah Palin talking about death panels. The next day it’s President Obama’s plan to fund universal health care. The next it’s a New York Times headline screaming “Accountants Misled Us Into Crisis,” railing on fair value accounting, special purpose entities, and differences between U.S. and international standards.

Each of these headlines represents a business development opportunity. Use Sarah Palin’s diatribe as an opportunity to remind clients and prospective clients about the importance of living wills and health care powers of attorney; then segue into a discussion of estate planning in light of the uncertainties surrounding the estate tax. Use President Obama’s health care plan as a catalyst to review employee benefit plans with business clients and the impact of proposed tax increases, new taxes, and medical-related tax deductions and credits with individual clients. Use the New York Times article as an opportunity to visit pros and cons of alternative accounting policies and remind clients of the value of the attest function and the benefits of transparency and disclosure to their lenders and investors.

Essentially, all you have to do is connect the dots – recognize how current developments highlighted in daily headlines could impact your clients and prospective clients. Then quickly seize the day. How? Certainly not with printed newsletters you send out once a month or quarter. Today’s public relations and practice building tools like Twitter, which links to your blog, which in turn links to your website, which highlights articles you’ve published, press releases you’ve issued, speeches you’ve made and services you provide -- quickly establish you as a thought leader and expert, regardless of the size of your firm or the geographic proximity of your clients and prospects.

Shorter Decision Cycles and the Trusted Advisor

Clients have shorter decision cycles today than ever before. They have to access and analyze complex information on the fly, knowing their competitors are doing the same thing. The days of deliberate decision making are all but gone, at least in some industries. This can be a bit unsettling, yet it’s the new normal. Clients need someone they can trust to help make or validate decisions. If the CPA can synthesize developments as they occur and explain to clients what they mean to them, in as close to real time as possible, he or she will have earned the trust of the client, becoming a 21st Century rainmaker.

Trust at the Speed of Light

Trust is actually among the key business ingredients that’s in the shortest supply today. Trust is the lubricant of business that enables all the moving parts to work together…….yet 77% of respondents in a recent Harvard Business Review survey indicated a quantifiable erosion of trust in corporations and business leaders.

CPAs that can establish trust will win the game of practice development. That’s always been the key to practice development for CPA firms. The difference in the 21st Century is the increasing complexity coupled with shorter cycle times that drive more immediate client needs and create higher expectations. You simply have to establish trust as news breaks. You snooze, you lose, due to the compressed cycle times. Leverage the tools available to you, including social and business networking tools, to make it happen.

The CPA Value Proposition

The economy has forced firms to take a fresh look at their value proposition, or the underlying driver of demand for the products, services, and solutions sold by the firm. In a previous issue of Today’s CPA, I suggested that CPAs sell comfort more than anything else. The concept of selling comfort applies to practically everything the CPA does. To establish comfort, we must first establish trust. In this rapidly changing world, trust is the key ingredient to successful practice development.

Back to the Future - Revisiting the CPA Vision Project

2009-07-22T20:10:00.001-05:00

Flash back to the late nineties. It was a boom time for many - the Dot Com gold rush. CEOs became the new rock stars. A new breed of billionaires emerged and vast amounts of new wealth were created by the “new economy.” Not everyone bought into it though. Warren Buffet claimed he didn’t get it and stayed on the sidelines. Alan Greenspan called it irrational exuberance. We now know they were right. The internet bubble burst and by 2001 a recession had ensued. We saw the complete economic cycle in about five years.

Those were interesting times for the CPA profession too. We were feeling threatened by forces of change – technology, globalization, nontraditional competitors, and a sense that our traditional service mix – accounting, auditing, and tax return preparation - was not as valued as it once had been. We were concerned about our image…and our relevance. The consolidators, led by American Express, began acquiring high profile firms. Some firms bifurcated their practices, spinning off the so-called growth services into new entities and leaving the attest practices with the CPA firm, as we thought the public wanted one-stop shopping and multidisciplinary practices.

Against that backdrop, in 1997 approximately 3,400 CPA thought leaders from across the country participated in a series of structured, day-long “Future Forums” in their local communities to envision the profession in 2011. Building on the profession’s enduring core values that would serve as its foundation, participants identified the core services CPAs would be providing in 2011 and the core competencies needed to ensure success. With the input received at the local level at these Future Forums, each state sent a delegate to a national level Future Forum in January 1998, where a consensus emerged for a vision of the future of the accounting profession. In a nutshell, this Vision Project, which was a collaborative effort between the AICPA and state societies, concluded that the most successful CPAs would be the ones who could transition or reposition themselves, to move up the value chain from provider of historical information-based services to higher value, market-driven services, including management consulting, technology consulting, financial planning, and international services. The competencies, or skill-sets required to deliver such services were also identified in the Vision Project.

So where are we today, more than a decade later, relative to the vision of the future forged in 1997-1998?

It’s not a straightforward answer, as one might expect. Let’s look at what has happened in the interim. First was the dot-com crash as noted above. Then came epic business scandals like Enron, WorldCom, Adelphia, and others. The Big 5 became the Big 4, as the federal government chose to indict the Andersen firm for the deeds of a few. Congress reacted in 2002 with the Sarbanes-Oxley Act, which required CEOs and CFOs to personally certify financial statements under a threat of jail time if the financials proved to be misleading. Also included were Section 404, requiring corporations and their auditors to opine on the effectiveness of internal controls, and the creation of the PCAOB. The SarbOx legislation became a huge growth driver for firms of all sizes, as the 404 requirements created new opportunities for larger firms, which were forced to transition their smaller clients to smaller firms, a trend that continued in domino-like fashion. Double-digit growth was the norm for firms of all sizes, based predominately on core, traditional services. Many CPAs claimed to have all the business they could handle. The number one issue confronting firms was a shortage of qualified staff to do the work.

On a parallel path, the country emerged from the 2001-2002 recession, the stock market recovered and reached new highs, the economy turned robust once again, and unemployment became practically nonexistent. Then the great recession hit around December 2007 and continues today, leading us into what Ian Davis, worldwide managing director of McKinsey & Co., calls the New Normal. Davis suggests we’ve experienced a fundamental change in the business landscape, a restructuring of the economic order. Davis believes we will emerge from this restructuring in a different place, one unlike the world we’ve known in recent years. While this may seem a bit unsettling, Davis concludes the new normal will be a world that is no less rich in possibilities for those who are prepared.

Has the accounting profession entered into a new normal?

The 2009 PCPS CPA Firm Top Issues Survey provides some interesting insights. For the first time in many years, the staffing shortage is no longer the number one issue facing public accounting firms. For firms of all sizes, client retention is now the number one issue, indicating the recession is having an impact on the profession. As a result, firms can expect downward fee pressure on conventional compliance services, which is unfortunate because nobody likes to compete on price. Competing effectively in the new normal may require CPAs to move beyond compliance and into a most trusted advisor role. Clients in the new normal have new and emerging needs, which provides CPAs with fresh opportunities to provide advisory services - management consulting, technology consulting, financial planning, and international services – just as the Vision Project suggested.

With the recession potentially lasting another year or two, the Vision Project’s view of the profession in 2011 may prove to be clairvoyant, except for one thing. In light of the Enrons and Worldcoms, and more recently the Madeoffs and Stanfords, core CPA services will be as relevant as ever. High-growth firms will find a way to leverage traditional services with high- value advisory services that clients in the new normal desperately need.

The New Normal: The CPA Value Proposition after the Great Recession

2009-05-18T21:18:00.001-05:00

A few months ago, Ian Davis, worldwide managing director at McKinsey & Co., published a very provocative white paper titled The New Normal. In the paper, Davis contends the current economic downturn is not merely another periodic dip in the business cycle, but a fundamental change in the business landscape, a restructuring of the economic order. Davis believes we will emerge from this restructuring in a different place, one unlike the world we’ve known in recent years. This new world, the new normal, will include an expanded role of government, with a significantly restructured regulatory environment requiring new levels of transparency and disclosure. There will be significantly less financial leverage in the system, and higher prices for risk. It will include falling consumption levels, especially in the U.S. but continued technological innovation. While this may seem a bit unsettling and indeed a break from the past, the new normal will be a world that is no less rich in possibilities for those who are prepared.

With regard to the new normal’s effect on CPA firms, I generally agree with Davis’ theories….up to a point. To assess the impact of the new normal on CPA firms, we need to first look at three relevant macro-economic trends, then examine their effect on CPA firms’ clients, on firms themselves, and then connect the dots.

The New Normal’s Growth Drivers for CPA Firms

In a macro-economic sense,

• It’s clear we are on an unsustainable path with regard to federal government spending. The massive federal debt is growing exponentially; interest will consume a rapidly increasing share of the federal budget; and the Social Security trust fund is in reality a big IOU from the US Treasury that will begin to come due around 2017. President Obama has quietly assembled a tax reform task force led by former Fed Chairman Paul Volcker with a report due in December. One inevitable result: higher taxes for clients of CPA firms. While we’ll hear the usual lip service paid to simplification, complexity in the administration of the federal tax law will reach….a new normal.

• Davis was spot on when he cited an expanded role of government, which is significant for CPAs. The G20 - the leaders of the free world along with their finance ministers – are now meeting on a regular basis to coordinate a global response to the financial crisis, with a unanimous nod to a single set of high quality worldwide accounting standards as a key element of global financial regulation. It’s obvious that the firestorm over the fair value rules under both GAAP and IFRS elevated the visibility of accounting standards, as lawmakers on both sides of the Atlantic threatened to legislate standard setting if the FASB and IASB failed to revise their guidance. But the expanded role of government does not begin and end with accounting standards. We’ve experienced financial scandals of epic proportions, along with an insatiable need for cash by the federal government to fund its sweeping domestic agenda. As a result we will soon see a new level of regulation, complexity, and enforcement that we’ve not before seen in the United States. The IRS is adding 3,500 new enforcement employees and is increasingly targeting small businesses. The PCAOB’s budget increased 9%, as it expects a noticeable rise in financial fraud. And President Obama’s proposed 2010 budget would increase funding for the SEC and Commodity Futures Trading Commission by 6.8% and 8.8% respectively.

• The credit crisis is the equal and opposite reaction to the easy money days of just a few years ago and to the emergence of a shadow banking system that influences credit markets in ways that many investors and regulators simply do not understand. While the credit crunch may cause businesses to recalibrate their capital structures and banks to rediscover due diligence, the inevitable result is a new era of discipline, transparency and accountability. As a number of prominent business leaders are finding out, executive compensation, conflicts of interest, short-term incentives, and business risks in general are magnified more than ever. And say hello to regulation of hedge funds, increased oversight of credit reporting agencies, and the creation of a systemic risk regulator in the U.S.

CPA Firm Clients in the New Normal

Business clients in the new normal are facing new difficulties obtaining financing, forcing them to focus more on managing cash, cutting costs, and cutting back on capital spending. In addition, President Obama has promised a new financial regulatory system, with new rules to protect investors, oversee banks, and create transparency in capital markets. Those businesses with international operations may soon be paying higher taxes on foreign source income. And tax incentives for specific industries (e.g., oil and gas) are under attack. As a result of these trends and developments, many businesses are facing new levels of complexity, gearing up to comply with a tougher regulatory environment, anticipating higher effective tax rates, and adopting an enterprise-wide view of risk management.

For CPA firms, this could mean expanded opportunities for attest services to convince bankers to lend, cash management services, debt and employee benefit restructuring, helping clients sell unprofitable divisions, risk management services, bankruptcy work, and expanded opportunities for litigation support services. And who better to take advantage of this new environment of risk identification and management than CPAs, already schooled in forensic accounting, risk-based auditing, evaluation of internal controls, and detecting fraud? And these needs aren’t limited to large or public companies. Smaller companies may be the most vulnerable, and existing client files may well hold the key to client needs, areas of vulnerability, and risk exposure.

The evolution toward a single set of global accounting standards has already begun. Regardless of the SEC’s ultimate position on its IFRS, U.S. subsidiaries of foreign-owned companies and U.S. companies with foreign subsidiaries are converting to IFRS in increasing numbers, creating many opportunities for CPAs. Clients have to be educated and new accounting policies drafted. Compensation and benefit plans may have to be restructured; loan covenants and contracts renegotiated, accounting systems overhauled, and shareholder expectations managed. Tax planning will be significantly impacted as well, as the Internal Revenue Code contains hundreds of references to generally accepted accounting principles that will have to be re-evaluated.

For individual clients, many retirement and college savings plans are under water, and the future of Social Security is uncertain. Accordingly, anxiety about interest rates, inflation, and market risks has soared. Yet a recent McKinsey survey shows that relatively few are considering postponing retirement or adjusting their standard of living. The proportion of individuals planning to finance their retirement via home equity has actually increased, despite the fall in home values. These statistics suggest a disconnect between the financial crisis and the response to it at an individual level. Accordingly, personal financial planning services, including investment, education, and retirement planning, asset protection, and insurance strategies are more important than ever. And estate planning that takes advantage of suppressed asset values and low interest rates represents a golden opportunity.

President Obama has proposed increasing income tax rates, the FICA and SE tax base, the tax rate on dividends and capital gains, and reinstating the pre-2001 personal exemption phase-out and limitation on itemized deductions for individuals and families with higher incomes. If all of President Obama’s tax proposals are enacted, high income clients could face a marginal income tax rate approaching 70 percent and tax planning services will be in demand.

Practice Management in the New Normal

Many firms are experiencing the impact of a downturn in the business cycle that would be expected in any recessionary period. Clients go out of business; others are slow to pay. Firms see a sharp drop-off in transactional work.

While the economy may force some businesses to bring tax and accounting work in house to save on professional fees, most are already operating in a lean mode without excess capacity in their finance and tax departments and with little bandwidth to absorb additional workload. Accordingly, many businesses are taking the opposite approach – eliminating back office positions and outsourcing even more tax and accounting work to CPA firms. Unfortunately, many firms are constrained by their ability to find experienced staff, although the supply of college graduates seems to be meeting the demand for entry-level positions.

The new normal presents generational differences that firm elders may not totally grasp. An older generation of practitioners may not be ready or able to retire on schedule, creating a grey ceiling for would-be successors. Then you have the gaming, high achieving, well educated, team oriented, electronic networking Millennials that bring a different set of values than my generation brought a generation (or two) ago. One young staffer of a CPA firm recently told me his network is more important to him than his employer. That’s the new normal. This network-centric world encompasses a wide spectrum of communication experiences and devices and signifies a shift to a more collaborative business model. Some firms will look at that as a threat, or at least annoying. Others will realize the business potential of that network.

The CPA Value Proposition in The New Normal

Ask a CPA what makes his or her firm unique. Ask them what they are selling. Often the response is not too clear. Most practitioners don’t spend too much time on their elevator speeches. Many speak about the quality of their services. Some say they will find more tax deductions than any other firm. Others will say their clients get to deal directly with a partner. Others say they will always respond to a client within 24 hours. Some compete on price. Whatever the response, this is the firm’s value proposition, at least in its own eyes. A value proposition is the underlying driver of demand for the products, services, and solutions sold by an enterprise. It articulates the reasons why a customer will pay for and utilize a product or service. Every business delivers some sort of value proposition, even if it is not consciously chosen by its leaders. For CPA firms, the value proposition is why clients engage them in the first place and why they keep coming back.

Successful CPAs look at the problems their clients are experiencing at any point in time and see opportunities. As the professional problem solver, the CPA knows the firm can redefine its value proposition for its clients (or target clients) in response to changing circumstances. In the new normal, I believe CPAs sell comfort more than anything else. The concept of selling comfort applies to practically everything the CPA does. For many clients in the new normal, the volume of change is unsettling and the level of complexity overwhelming. CPAs can provide comfort by helping them manage change and deal with complexity. For other clients in the new normal, increased governmental scrutiny and new regulatory and banking requirements create a new level of risk exposure, and CPAs can provide comfort by helping them assess these risks and advise them accordingly. Letting clients find out about these risks the hard way, e.g., when a banker calls a loan for breech of a loan covenant, can create a very un-comfortable situation for both the CPA and the client.

The More Things Change…

CPAs generally thrive during times of disruption in the status quo. Today, our clients are facing more frequent change, greater complexity, and bigger challenges than ever. That’s the new normal. For CPAs, this means expanded opportunities to meet customer needs and solidify our standing as the most trusted adviser. As Ian Davis of McKinsey might say, this is a time rich in opportunities for CPAs who are prepared.

That said, CPA firms are fortunate in that a significant portion of their annual revenue is recurring, and traditional services are for the most part not optional. This is where I must diverge with Mr. Davis. While we may emerge from the economic recalibration with expanded opportunities for client service, our traditional services are more relevant than ever.

With increased accountability and tougher lending standards, the importance of the CPA attestation function will be more apparent than ever. The value of the going concern opinion has never been greater, or more visible, as CPAs continue to provide comfort to investors, lenders, stakeholders and governments.

Tax returns are not optional either, and with higher tax rates, elimination of many incentives, and increased enforcement, the value of professional tax services has never been greater or more apparent. Clients engage CPAs to prepare and sign their tax returns, review proposed transactions, and represent them before tax authorities not only for the CPAs’ technical competence, but also because of the comfort factor.

When we look back at the new normal, we may in fact see that it was a perfect storm, providing enumerable new opportunities, as well as a new level of appreciation for our traditional services.

The Entrepreneurial CPA, Part 2

2009-03-30T18:26:00.003-05:00

Entrepreneurs are always alert for opportunities to profit from change and disruption in the status quo. Accordingly, they survey the current landscape with a heightened sense of awareness of the suboptimal aspects of the status quo, as well as the uncertainties and discontinuities they believe will be disruptive and cause the status quo to not perpetuate itself. Entrepreneurs are problem solvers, and have a knack for spotting disruptive forces ahead of their competitors. In Part One of this series we looked at the trends and events disrupting the status quo in public accounting. In this installment, we’ll look at how entrepreneurial-minded CPAs can take advantage of these uncertainties and discontinuities to stimulate the next big wave of growth in their practices.

Practice Development and Management Opportunities

While the news media certainly paints a bleak picture of the U.S. economy, CPA firms are fortunate in that a significant portion of their annual revenue is recurring and in a sense “locked in.” Accounting is not an optional event, nor are audits or tax returns. While the economy may force some businesses to bring tax and accounting work in house to save on professional fees, most were already operating in a lean mode without excess capacity in their finance and tax departments and with little bandwidth to absorb additional workload. Other companies are taking the opposite approach – eliminating back office positions and outsourcing even more tax and accounting work to CPA firms -- and entrepreneurial minded firms are ready to seize the opportunity.

Firms following their natural inclinations typically look inward to assess the economy’s impact (e.g., clients going out of business or slow to pay, less transactional work, partners suddenly without the means to retire, etc). At the same time, the entrepreneurial CPA looks outward at the problems his clients are experiencing. As the professional problem solver, he knows the firm can redefine its value proposition for its clients (or target clients) in need of a different service mix.

The recession will cause some companies to default on loan covenants and others to seek bankruptcy protection. There will be significantly less financial leverage available, upending traditional business models. There will certainly be an expanded role of government, both in the U.S., and around the world. Entrepreneurial CPAs will look at these developments as opportunities to turn lemons into lemonade. For business clients, this could mean attest services to convince bankers to lend, cash management services, debt, organizational, and employee benefit restructuring, helping clients sell off unprofitable divisions or product lines, risk management services, and bankruptcy work. According to the Dallas Fed, litigation and bankruptcy activity in Texas remains strong, and we may well be on the cusp of an unprecedented wave of litigation that will drive significantly expanded opportunities for litigation support services.

For individual clients and prospective clients, many retirement plans are in the tank, outspoken politicians consider 401(k) plans a failed policy, and Social Security overhaul is imminent. Consumers are spending less and saving more. Accordingly, personal financial planning, including investment and asset allocation, risk management, asset protection, and insurance strategies are more important than ever. And since it appears we will soon have clarity regarding the future of the estate tax, estate planning that effectively takes advantage of suppressed asset values and low interest rates represents a golden opportunity.

It may also be a good time to purge the more unprofitable (or unmanageable) clients. CPAs frequently tell me they’ve got all the business they can handle. However, entrepreneurial-minded CPAs simply don’t think that way. With so many opportunities, they refuse to allocate scarce resources to less profitable engagements. In addition, with all the layoffs being reported, this is a great time to locate and recruit talent that might otherwise not have been available. Just last week I received a notice from an online IFRS community I belong to of an ex-Big 4 CPA with 12 years of IFRS financial reporting experience looking for a job. Similarly, I recently received a resume of an international tax specialist who was laid off from the national office of a Big 4 firm. A year ago you simply couldn’t find people with these credentials.

Capitalizing on Regulatory Developments

In the last 18 months we’ve witnessed the fallout from an under-regulated financial regulatory system that allowed an array of risks to lenders, savers, investors, and to the system itself to perpetuate and flourish. From Madoff’s Ponzi scheme to excessive leverage to sophisticated financial products and freewheeling hedge funds, we now know that lax regulatory oversight contributed heavily to excessive risk taking and ultimately the financial meltdown. As a result we’re beginning to see what Sir Isaac Newton would call the equal and opposite reaction – an overhauled financial regulatory system designed to identify, assess, respond to and manage risk in a way we have never experienced or imagined. We will see new rules to protect investors, oversee banks, create transparency in capital markets, and manage conflicts of interest.

Who better to take advantage of this new environment of risk identification and management than CPAs, already schooled in risk-based auditing, evaluation of internal controls, and detecting fraud? Entrepreneurial CPAs will recognize the opportunities presented by the new world order. Not only have clients come to the realization they will be paying a higher price for risk, but public and non-public companies alike will proactively seek to institute sound risk management practices, and business owners and boards of directors will be judged by lenders, investors, regulators, and even the media on their ability to manage risk. Look for governance, risk management, and compliance services to flourish and entrepreneurial-minded CPAs to seize the day. And these needs aren’t limited to large or public companies. Indeed, smaller companies may be the most vulnerable, and existing client files may well hold the key to client needs, areas of vulnerability, and risk exposure.

The Opportunity of Global Accounting Standards

The evolution toward a single set of globally coordinated accounting standards is not only inevitable, it has already begun, as both U.S. subsidiaries of foreign-owned companies and U.S. companies with foreign subsidiaries are converting to International Financial Reporting Standards (IFRS) in increasing number. Further, the AICPA announced in 2008 that it will recognize the International Accounting Standards Board as a standard setter. While the SEC is grappling with its timetable for a mandated conversion to IFRS, the FASB and IASB continue to move toward convergence, and in a few years the U.S. and the rest of the developed world will be using very similar standards. Whether the evolution is driven by convergence or mandated conversion, the pace of change will accelerate, and entrepreneurial CPAs will take advantage of the myriad of opportunities associated with this harmonization of standards.

Obviously client accounting staff will have to be trained on any new standards, and auditors will have to bless new accounting policies. However the tentacles of IFRS, whether driven by convergence or wholesale conversion, reach far beyond the accounting function, opening up many non-attest opportunities for entrepreneurial-minded CPAs. Compensation and benefit plans will have to be restructured, loan covenants and contracts renegotiated, accounting and management reporting systems overhauled, and shareholder expectations managed. Tax planning will be significantly impacted as well, as the Internal Revenue Code contains hundreds of references to generally accepted accounting principles that will have to be re-evaluated. For these reasons, consulting opportunities created by an IFRS mandate could surpass those created by Sarbanes Oxley in both number and magnitude.

Obamanomics and Tax Planning Opportunities

President Obama’s 2010 budget calls for increasing marginal income tax rates in 2011 for couples with income over $250,000 and single people with income above $200,000. The top two tax rates would revert to their pre-2001 levels -- 36 and 39.6 percent. The budget also reinstates the personal exemption phase-out and the limitation on itemized deductions and imposes a 20 percent tax rate on long-term capital gains and qualified dividends. The Tax Policy Center estimates that taxpayers making between $500,000 and $1 million would pay, on average, $18,000 more in taxes and suffer a 3.4% reduction in after-tax net income. Taxpayers making more than $1 million would pay about $134,000 more a year, equating to a 6% net reduction in net income.

These proposals, particularly with a 2011 effective date, will undoubtedly create a wealth of tax planning opportunities for entrepreneurial CPAs. The higher rate on dividends and capital gains will encourage investors to accelerate gains into 2009 and 2010 and similarly encourage corporations to accelerate payment of dividends. Companies will be encouraged to accelerate bonus payments from 2011 into 2010 due to the increase in top marginal brackets. The proposed limits on itemized deductions to 28 percent will further increase marginal tax rates for clients in the top marginal brackets. Thus accelerating itemized deductions into 2009 and 2010 will be another smart move for affected clients.

And of particular interest to Texas CPAs are the oil and gas provisions. President Obama’s budget calls for eliminating the expensing of intangible drilling costs, the enhanced oil recovery credit, the Section 199 deduction for oil and gas producers, percentage depletion, and the deduction for tertiary injectants, beginning in 2011. There are no special allowances for small producers. If these tax preferences are eliminated, and as industry insiders are already predicting, domestic drilling significantly declines as a result, Texas would lose significant revenue streams -- the severance tax at the state level and ad valorem taxes at the local level. As these taxes fund education, infrastructure, and human services in the state, the lost tax revenue will have to be made up through other taxing mechanisms, which will create new tax planning opportunities.

Technology

In addition to being problem solvers, entrepreneurs have a knack for spotting opportunities to improve the status quo, even when no specific problems are apparent. They are especially good at leveraging technological innovations to improve business processes and business results. Entrepreneurial CPAs use new and emerging technologies to reinvent existing practices and take client service to a new level. They are recruiting and job hunting through online networks and communities rather than generic job boards. They are using internet portals and collaboration tools such as Microsoft’s Sharepoint and Groove to communicate with their clients, staff, and other professionals, share documents, and improve cycle time. They don’t look at geography as a barrier and are taking advantage of ubiquitous broadband to stay connected and access their applications and data remotely, anytime, anywhere, from mobile devices. They also leverage these technologies to address staffing issues and provide flexible work schedules and remote access for their staff. And while many firms see Web 2.0 technologies as a potential productivity drain, entrepreneurial CPAs recognize the business applications, improving their ability to connect with people and manage information. I’ve heard of CPA firms using Twitter to disseminate news to clients, texting and instant messaging for more efficient audit engagements, recruiting staff on LinkedIn, and screening candidates with Facebook.

Conclusion

CPA firms are facing uncertainties and discontinuities they’ve never faced before. Some are the result of the recession. Others are the result of globalization, technological innovation, or regulatory developments. While one’s natural inclination is to look inward, entrepreneurial-minded firms will look outward to anticipate how these discontinuities, uncertainties, and problems are impacting their clients and prospective clients. When we look back at this period, we may in fact see that it was a perfect storm, one rich in opportunities for entrepreneurial-minded CPAs.

The Entrepreneurial CPA, Part 1

2009-01-25T20:01:00.003-06:00

Visit any bookstore, from Barnes & Noble to Borders to Amazon, locate the business book section, and you’ll find scores of books claiming to provide the secrets to success in business. The authors range from high profile CEOs to Ivy League professors to $50,000-a-day consultants. Some speak from personal experience while others base their claims on analytical data that purports to identify the common characteristics of businesses that outperform their peers. While there is always something to learn from the voice of experience, I’ve observed one single, albeit rare trait that will drive above-average results and can be applied by just about any organization, including CPA firms --- an entrepreneurial mindset and approach to business. It sounds deceptively simple but actually requires more thought and discipline than might be apparent.

The Entrepreneurial Mindset

I started thinking about this several years ago when a friend who is a managing partner of a Texas CPA firm described his organization as a ‘collection of entrepreneurs who just happen to be CPAs.’ I’ve watched his firm and a few other like-minded firms grow rapidly over the years, and one of the common denominators is their entrepreneurial approach to growing and managing their practices.

Serial entrepreneurs are always alert for opportunities to profit from change and disruption in the status quo. Accordingly, the first thing they do is survey the current landscape with a heightened sense of awareness of the suboptimal aspects of the status quo, as well as the discontinuities, or forces of change they believe will be disruptive and cause the status quo to not perpetuate itself. The serial entrepreneur is also a serial problem solver, and those that have a knack for solving problems and are able to spot the discontinuities before their competitors are the ones that outperform. Accordingly, in Part One of this article we’ll take a look at the trends and events disrupting the status quo in public accounting. In Part Two we’ll look at how entrepreneurial-minded CPAs will be taking advantage of these discontinuities to stimulate the next big wave of growth in their practices.

The Economy

Looking across the public accounting landscape, the entrepreneurial CPA would certainly begin with a view of the overall economy and its impact on public accounting. He / she would see a country in a deep recession, with rising unemployment, and entire industries in jeopardy. We’ve witnessed a year of bank failures, credit crises, and market turbulence. Many clients’ retirement plans are in the tank, and many politicians and commentators consider 401(k)s a failed policy. Consumers are spending less but saving more. Business profits and capital spending are down and labor markets are weak. We’ve also seen the emergence of a financial scandal of epic proportions that has devastated investors and shaken the confidence in the regulatory system in which CPAs play a critical role.

While Texas is not immune to the national recession and its economy is clearly weakening, the Lone Star State is in far better shape than just about anywhere else, based on the Federal Reserve’s Beige Book for December. While the overall employment in the Texas district was flat to down, the Fed cited accounting firms as the “main exception, continuing to add staff although at a slower pace.” While the Texas service sector in general reported weaker sales across a wide range of industries, “sales at accounting firms continues to grow at a moderate pace and contacts say they are cautiously optimistic about demand over the next few months,” according to the Beige Book. The report goes on to point out that transactional demand for banks and real estate firms is weak, while litigation and bankruptcy activity remains strong.

Practice Management

Several MAP surveys published in 2008 indicated firms in general are still growing but not as fast as they were in the previous few years. Average net income per owner was approaching $250,000 in 2008, up 8% from 2006, and exceeded $350,000 for large firm partners, according to the 2008 PCPS/TSCPA National MAP Survey. Much of growth comes from specialized services, which may or may not be impacted by economic downswings. Nationally, we can expect transactional work to slow considerably in 2009 and cash flow to be tight, as many clients will be slower in paying their fees.

From a staffing standpoint, the supply of college graduates should be ample, turnover will be trending down, and experienced staff will still be hard to find. Unemployment for experienced CPAs is around 2.5%, although layoffs at Big 4 firms in Texas and across the country have been reported. A surge in M&A activity within the CPA marketplace has been driven partially by the need of larger firms to acquire talent, and also by the desire of small firm owners look for an exit strategy. The classified section of Today’s CPA consistently features a number of “For Sale” signs for CPA practices. It will be interesting to see if this tapers off as many practitioners’ retirement savings have taken a substantial hit from the bear market of the last 18 months.

Technology

Technology, of course, is always causing change, often impacting our workflow and processes….the way we work. Many of the technology-driven changes will involve ways we leverage the internet. Gartner Research observes that the Web seems to be morphing simultaneously into a social platform, a mobile platform, and a programmable platform. In that context, I believe we’ll see the impact of the evolving Web on public accountancy in all three areas.

Firms are beginning to use social and business networking platforms like Facebook and LinkedIn for recruiting, if not practice development. Certainly the crop of recent college graduates has significant experience using these sites. Gartner predicts that email will decline in use as individuals increase communications via these platforms. Similarly, the growing use of internet portals and collaboration tools such as Microsoft’s Sharepoint and Groove are changing the ways CPAs communicate with their clients, staff, and others, as well as the way they use applications and access, share, and exchange documents.

The Web as a mobile platform continues to make geography less relevant. With technologies like WiMax and 3G cellular service, people can connect, communicate, collaborate, and access their applications and data remotely, anytime, anywhere, from any internet-accessible device. It may be both a blessing and a curse, as clients will expect immediate response from their CPAs, and it will be increasingly difficult to separate work time from personal time.

The Web as a programmable platform can be seen in a variety of ways, from handy applications downloadable to mobile devices to online tax preparation software to the coming release of an online version of Microsoft Office that’s scheduled for a Fall 2009 release. This will enable multiple people to work on the same document at the same time and allow access to Office documents via smart phones as well as desktops and laptops. Adoption of this technology could spread faster than the typical new technology adoption cycle due to the ubiquity of Microsoft Office.

Globalization

Globalization simply can’t be ignored by local and regional accounting firms, although the ramifications are all over the board. Foreign corporations acquired over 2,000 US nonpublic businesses in 2006, the latest year on record. One Texas CPA told me that three of his clients were acquired by foreign corporations in December alone. IRS data shows that 14% of US corporate revenue and 16% of US corporate assets are owned by foreign corporations. Accordingly, international tax, accounting, transfer pricing, & business skills are in strong demand. Firm associations are increasingly critical to serving clients with international aspects of their businesses. And regardless of where new SEC Chair Mary Schapiro comes down on IFRS, a single set of worldwide accounting standards is inevitable at some point. Currently, U.S. businesses acquired by foreign corporations are the ones having to convert to IFRS in the near term, and if their existing accounting firms are unable to handle the transition, the companies are looking elsewhere for help.

Technical Issues

2009 looks to be a year of significant change for accounting and auditing practitioners, who will be dealing with:

· FASB Codification beginning July 1, 2009, which will change the way accounting standards are issued, researched, communicated, and referenced;
· A spotlight on accounting standards as a component of the financial regulatory system that will be substantially overhauled, with “better enforcement, better oversight, better disclosure, and increased transparency,” according to President Obama;
· The uncertaintly surrounding the SEC’s proposed roadmap for transitioning U.S. pubic companies to IFRS created by new SEC Chair Mary Schapiro;
· Audit considerations of XBRL-tagged data for SEC financial reporting that will initially impact the 850 firms that audit public companies and eventually impact all audit workflow when XBRL is embedded in enterprise accounting systems;
· Electronic confirmations – a good thing from an efficiency standpoint, but change nevertheless, as 3,500 firms that have already made the switch can attest;
· More clients with potential going concern issues, including banks, developers, and other businesses that may have trouble accessing credit or other funding;
· Increased demand for forensic accounting, assurance services other than auditing, and risk management and compliance related work;
· FIN 48 scheduled to become effective (once again) for nonpublic companies in 2009, along with a new disclosure requirement for their 2008 financials for those businesses that defer compliance;
· SFAS 141R on business combinations effective for nonpublic companies in 2009; and
· 403(b) plans that are subject to ERISA (primarily plans sponsored by nonprofit organizations) will be subject to audit requirements for their 2009 year-ends if the plan has more than 100 participants.

Meanwhile, tax practitioners will be dealing with:

· Revised Form 990;
· Estate tax legislation;
· Federal income tax legislation as a significant component of the economic stimulus package;
· AMT scheduled to affect 33 million taxpayers in 2010;
· Over 30 tax provisions scheduled to expire in 2009;
· President Obama’s campaign promises of tax increases on individuals with income exceeding $250,000, creating a potential marginal tax rate exceeding 60% when you consider:
· A marginal income tax rate of 39.6%,
· A 20% tax rate on long-term capital gains and dividends,
· A combined employee and employer Social Security tax raised by 2%-4% for families (not individuals) earning over $250,000,
· A return of the phase out levels for itemized deductions and personal exemptions back to their levels under President Clinton, and
· State income taxes for most Americans;
· Congressional attack on the current 401(k) system;
· Tax aspects of bankruptcy, liquidations, debt restructuring;
· Many state budgets facing shortfalls; and
· New preparer penalty rules that raised the stakes for tax return preparers and advisors

Conclusion

In light of these trends, developments, and issues, it would be hard to make a case that the pace of change in our profession is not accelerating. In Part 2 of this article we’ll look at how entrepreneurial-minded CPAs will be taking advantage of the changes and discontinuities the profession is experiencing to drive growth in their practices.

Obamanomics 101 for CPAs

2008-11-17T20:37:00.000-06:00

President Obama takes office January 20 facing three interrelated and daunting challenges – the mortgage / housing crisis, which led to the financial / credit crisis, which in turn led to massive deleveraging by individuals and businesses and a global recession. Not surprisingly, Mr. Obama has indicated that economic recovery, including middle class tax relief is his number one priority.

In recessionary times, consumer and business spending contracts, and the federal government traditionally uses some combination of lower interest rates and easier monetary policy, increased government spending (e.g., stimulus checks to individuals, investment in infrastructure projects), and lower taxes to boost consumption and make up for the contraction of spending by individuals and businesses. What makes the current financial crisis unique is an apparent breakdown of certain regulatory mechanisms that will require direct government intervention in certain industries and a comprehensive review of our financial regulatory structure. The Fed has already lowered interest rates about as low as they can go. That would leave government spending, intervention and regulation, and tax cuts as the primary tools available.

Government Spending

While President Obama certainly has lofty goals for our country, he will face a federal deficit that’s already projected to top $1 trillion for his first full fiscal year in office. Nevertheless, we can expect the President and the new Congress to enact a stimulus package that will add another $300-$500 billion of red ink to the deficit. It won’t help matters that the recession will have a dampening effect on federal and state tax revenue, but to the extent the stimulus can be directed to pro-growth measures, such as support for innovation and entrepreneurship, logistical infrastructure improvements, technology-enabled worker productivity and training assistance, the nation will work itself out of the recession and into a sustainable recovery sooner than if stimulus checks are issued directly to consumers.

Intervention and Regulation

Many around the world are blaming the supply side principles of lower taxes and smaller government for the current economic situation. The truth is we’ve seen failures by governments, regulators, financial institutions, speculators, and individual borrowers. What I’m afraid of most is that we may be about to see what I think of as the Sir Isaac Newton Principle at work…the equal and opposite reaction to the economic problems currently faced by the nation and the world. We’ve already seen the federal government take equity stakes in financial institutions and AIG, the world’s largest insurance company. We will surely see a sweeping new regulatory structure for the financial markets, perhaps in the form of higher capital requirements, curbs on subprime lending, and greater transparency requirements for hedge funds and complex derivative instruments. Further, the government will shape the future of the housing industry as it determines the fate of Fannie Mae and Freddie Mac. The ultimate fate of the Big 3 automakers may also rest with the Obama administration and Congress, as well as other companies and industries seeking assistance. Conversely, other industries may be targeted for other reasons, including the big oil companies, health care and pharmaceuticals, and defense contractors. It will be interesting to see what kind of strings come attached to the assistance and subsidies, and how Washington channels its considerable leverage.

Of particular interest to CPAs is the scrutiny placed on accounting standards as an element of a comprehensive review of financial regulation. Many observers, including outspoken politicians, blame the credit crisis at least in part on fair value accounting, which forced financial institutions to write down values of assets as their markets disappeared. Here in the U.S. the FASB and the SEC have largely resisted pressure to suspend fair value accounting, although the $700 billion bailout bill included a requirement for the SEC to study the impact of FAS 157 on the crisis and report back to Congress. Across the pond, the IASB was forced to cave in to the demands of the European Union to relax its position on fair value accounting. The subject of accounting regulation even came up at the recent meeting of President Bush and the G20 leaders in Washington, led by French President Nicholas Sarkozy and other EU leaders who favor “reforming” accounting standard setting practices by more closely aligning them with global banking regulations. Two questions come to mind regarding the intrusion of government into accounting standard setting….(1) could this happen in the U.S.? and (2) could it derail the coming migration of US GAAP to IFRS? If it provides any comfort, House Banking Committee Chairman Barney Frank was recently quoted as saying: “I’m determined, as long as I’m chairman, we won’t legislate accounting.” At the same time, Mr. Frank promoted a proposal to soften mark-to-market accounting by halting the adjustments when the value of bank investments has been reduced. Go figure. At a minimum, we’ll probably see new leadership at the SEC, chosen for its commitment to investor protection, including making public company financial information more accessible, transparent, and reliable, and will be expected to enact policies consistent with that direction.

The Mother of All Tax Legislation ?

As seasoned tax practitioners are well aware, much of the government’s social and economic policies are implemented through the Internal Revenue Code. It’s also worth pointing out that we’ve seen significant tax legislation during the early years of every new Presidential administration going back to at least President Carter. Couple these facts with expectations set during the campaign regarding the “Bush Tax Cuts,” and I think we will see some significant tax legislation early on in the Obama administration. Despite a $2.8 trillion price tag over 10 years, look for Congress to take up Obama’s middle class tax relief during the early part of 2009 as part of its deficit busting strategy. Such middle class tax relief will take a variety of forms, typically referred to as tax rebates or refundable tax credits for taxpayers earning below certain thresholds. In addition, seniors with income less than $50,000 would be taken off the tax rolls, and start ups and small businesses would pay no tax on capital gains and receive tax breaks for new job formation under President Obama’s proposals. We may also see energy legislation early on in 2009, with incentives for investment in what Thomas Friedman of the New York Times calls green technology.

Eventually we can kiss the 15% top rate on long-term capital gains and dividends, and the 35% top marginal rates on ordinary income goodbye. It’s just a matter of when. Raising taxes on anyone, particularly business owners who report as pass-through entities (i.e., two-thirds of all US businesses) during a recession seems counterintuitive. However, with the dire need for revenue, not to mention Mr. Obama’s campaign promise to raise taxes on the top 5% so that we can “spread it around a little,” some individuals will likely see a hefty tax increase during Mr. Obama’s first term. Once the economy and financial markets are stabilized, look for the big tax increases. As Rep. Barney Frank said in October 2008, perhaps echoing the sentiment of the Democratic majority, “Speaking personally, I think there are a lot of very rich people out there whom we can tax at a point down the road and recover some of the money.” In addition to raising the top marginal income tax rate to 39.6%, President Obama has also proposed to raise the maximum tax on long-term capital gains and dividends to 20%, raise the combined employee and employer Social Security tax by 2%-4% for families (not individuals) earning over $250,000, and return the phase out levels for itemized deductions and personal exemptions back to the levels they were under President Clinton. In aggregate, these proposed changes take the top marginal rates from 37% to 53%. Add on state taxes for most Americans and the top marginal rate would exceed 60%.

As draconian as that sounds, the tax increases won’t stop there. We’ll probably see the 2009 rate structure for the estate tax extended into 2010, and probably made permanent, along with curtailment of some popular estate planning techniques like valuation discounts and sales of property to grantor trusts. I would not be terribly surprised to see Congress attack the current 401(k) system, as the current framework for retirement saving is under heavy attack, partially for the tax subsidy that costs the government $80 billion a year and partially from a feeling by some politicians that a government run retirement account administered by the Social Security Administration would be a safer alternative for most Americans. Other revenue raisers could include ordinary income tax rates for services rendered by hedge fund managers attributed to carried interests, some kind of excise tax on executive compensation that exceeds certain thresholds, limitations on the deferral benefits of like-kind exchanges, limits on interest deductions from mortgages on second homes, and codification of the myriad of economic performance rules. And let’s not forget the proposals submitted by Ways and Means Committee Chairman Charlie Rangel in 2007 in what he described as the “mother of all tax bills:” (1) a surtax of 4% on individual AGI exceeding $200,000 and $4.6% of AGI exceeding $500,000, which would occur on top of the return of the top rate to 39.6%; (2) self-employment tax on S shareholders as a way to pay for AMT repeal; (3) increased phaseouts of itemized deductions and personal exemptions to pay for an expanded earned income tax credit; and (4) lowering of the top corporate tax rate to 30.5%, along with a broadening of the tax base. Given that all tax legislation must originate in Ways and Means, coupled with Mr. Rangel’s seniority and stature, his proposals may well resurface.

Of course, the major hurdle in passing any of these changes is the Senate rule that requires at least 60 votes to bring any bill up for consideration. The ability of the Democratic majority to enact legislation without compromise is somewhat limited, and President Obama has promised a pragmatic approach. Areas for compromise could include a delayed effective date for income tax rate increases, lower tax rates on estates and corporations, a higher standard deduction, and elimination of stealth tax increases caused by AGI phaseouts.

Conclusion

In the near term we can expect the government to focus on near term problems. While an economic stimulus and reforms of the financial sector are clearly needed, the only long term solution to today’s problems is sustainable economic growth, which will come about only via free market principles that encourage hard work, innovation, entrepreneurship, job creation, saving and investing. Hopefully President Obama will understand that we need a legal, regulatory, and taxation system that will encourage and reward these activities. This will be a huge challenge for President Obama, right from the beginning. Hopefully the stars are aligning behind an economic recovery in 2009 – 2010, followed by a period of fiscal responsibility and return to prosperity. Then it will be 2012, and the American voter will once again be the judge.

Inside The Firm of the Future….Connecting the Dots

2008-11-03T18:47:00.000-06:00

A number of significant trends – people trends, globalization, business trends, regulatory trends, and technological trends -- are transforming the accounting profession and influencing the nature and quality of practice. Looking at each trend individually can be insightful. However, to truly see inside the Firm of the Future, one must connect the dots and look at the collective impact of these trends, which are the catalysts for change the forces that will shape the Firm of the Future.

People Trends

For at least the last 10 years, CPAs have experienced an imbalance of supply and demand in a traditional sense. This trend is common to most knowledge-intensive industries and will not be reversing anytime soon. In fact, it will soon be exacerbated by demographics…the aging and pending retirement of the Baby Boomers to be followed by a younger generation that is far fewer in number. I recently read that 86% of partners in large accounting firms are between 55 and 60 years old, and also that 75% of the AICPA’s membership will reach retirement age within the next 15 years. This phenomenon is the single biggest factor shaping the Firm of the Future.

Concurrently, the so-called Digital Natives are entering the workforce with their own unique, free agent, entrepreneurial, multitasking, collaborative, gaming style, expecting instant communication and access to multimedia applications. They grew up with the Web and accordingly, process information differently than older generations, in more of a non-linear fashion. To them, work is a means to an end and must be fulfilling. They insist on balance in their lives and aren’t necessarily motivated by the traditional incentives. For these reasons, firm culture will be a key differentiator and competitive issue in the war for talent.

Today’s workplace is also being transformed by the abundance of and instant access to information. The result is higher expectations of knowledge workers of all types, as people implicitly assume that with such abundance, knowledge will naturally follow. A further manifestation of this trend is the increasing blur between work time and personal time. Blackberries and laptops are completely ubiquitous, the web is increasingly wireless, and webcasts and podcasts are archived for people to catch in their “free time.”

Globalization

Geography is simply not a constraint on many economic activities, particularly knowledge work. The equity and credit markets around the world are all connected, and we’re about to enter an era of multilateral regulation to some degree. Manufacturing, technology, and capital flow to wherever they can be most efficiently deployed. Trade agreements between nations continue to accelerate change. These developments have brought globalization to Main Street. Practically every city in the U.S. has created a Foreign Trade Zone to stimulate foreign investment. Merger and acquisition activity over the past few years has created an explosion of foreign investment in U.S. businesses. According to IRS statistics, total receipts of foreign controlled domestic corporations have reached $3.5 trillion, or 14% of all U.S. corporate receipts. These same corporations now own 16% of all U.S. corporate assets. . Worldwide, cross-border transactions accounted for more than $10 trillion of economic activity in 2007 and are expected to grow to more than $70 trillion a year by 2025, according to a recent McKinsey report. To put that into perspective, the GDP of the United States is approximately $14 trillion, and the global GDP is approaching $55 trillion today.

Economic Trends

Today, economic gloom and doom dominate the business press. Economists are forecasting higher unemployment, rising bankruptcies, declining commercial real estate values, growing defaults on credit card debt, and astronomical budget deficits. There’s no doubt we’re in for a tough time until the economy corrects itself following a period of deleveraging and reallocation of capital. In the meantime, we’re likely to see massive new government spending, waves of litigation, revamped financial oversight of banks, hedge funds, and credit rating agencies, a consolidation of financial institutions, and a renewed focus on risk management.

Once we reach a point where credit markets and real estate prices stabilize and investors get a sense of the cards they’ve been dealt by the new administration, we may well begin a new economic cycle led by U.S. businesses, particularly those with global operations that have maintained strong balance sheets. .
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Regulatory Trends

There is no doubt the pace of change in the regulatory arena has been relentless, and it’s only going to increase. For accounting firms, this means tax laws, accounting standards, auditing standards, and legislative mandates such as Sarbanes Oxley.

In the U.S. tax arena, consider the following:

We have a new President with ambitious plans for the nation elected on a platform of change;
Congress often drives its economic agenda through the tax code, particularly during recessionary times;
Significant tax law changes typically occur during the early years of a new Presidential administration;
The 15% rates on long-term capital gains and dividends, and the top marginal rates on ordinary income were highly visible during the Presidential campaign and even if they aren’t legislated away, will expire after 2010; and
The federal estate tax is currently scheduled to expire after 2009, then return in 2011 at pre-2001 rates, impacting estates with more than $1 million to estates (62k estates a year).

Throw in Social Security, Medicare, and general health care reform and we could be looking at tax legislation of epic proportions, eclipsing even when compared to the Reagan years. And that’s just on the domestic front. Let’s not forget that many corporate tax departments cite international tax issues, including transfer pricing, as their greatest challenges, and we know who they call for help. That’s why 72% of the Top 100 accounting firms list international tax as among their fastest growing client service niches. And also why 22% of the Top 100 also cite international trade issues – importing and exporting – structuring activities to minimize duties and tariffs, as high growth areas.

In the Accounting & Auditing world, we will soon see FASB Codification, which should simplify accounting research, as over 20 current sources of GAAP are codified into one authoritative source, except that the old numbering system and references will no longer apply, and the entire Codification will be updated several times a year, not unlike the Internal Revenue Code. This does not mean that the current barrage of new standards will slow down; it will just be delivered differently. Just in the past couple of years we’ve seen an entire new wave of standards overload --- FAS 157 & 159 on Fair Value Reporting, FIN 48 on Uncertain Tax Positions, FAS 123R on share-based payments, FIN 46 on special purpose entities—we don’t expect to see a slowdown of this trend anytime soon.

FASB Codification is just an interim step, however, to the more significant trend, the eminent convergence of U.S. GAAP with International Financial Reporting Standards (IFRS). Currently approximately half of the Global 500 companies and more than 7,000 E.U. public companies report financial results using IFRS, and over 100 countries require, permit, or are converging to IFRS. The U.S. is in the distinct minority, and some feel this puts the U.S. capital markets at a competitive disadvantage. The SEC recently proposed a roadmap for adoption of IFRS by U.S. public companies. The proposal calls for conversion to IFRS by 2014 by most public companies, with three years’ of comparable financial statements. And with roughly a two year lead time required for a conversion, the time to begin identifying and quantifying the differences, drafting new accounting policies, and obtaining the auditor’s blessing will soon be here. IFRS is not limited to public companies, however. With the increasing volume of foreign investment in American businesses, a number of privately held companies have been thrust into IFRS reporting by their foreign parents, and their U.S. accounting firms have been caught unprepared to handle the conversion, sometimes losing their clients to a more well-prepared firm.

On a parallel track, global adoption of a common set of auditing standards is a distinct possibility. More than 70 countries have already adopted international auditing standards, which are used for almost half of the world’s public company audits and will soon be required by the European Union.

One additional regulatory trend is worth noting…Sarbanes Oxley activity seems to be stabilizing, if not slowing down a bit. While some of the recent shifts in the A&A landscape may well be permanent – risk-based audits, focus on internal controls and independence issues, we’re beginning to hear about more fee pressure and national firms competing for mid-market clients than was the case a year or two ago. Whether this trend continues in the world of Obamanomics and the regulatory barrage that’s sure to follow remains to be seen.

Technological Trends

With the proliferation of bandwidth and with the cost of storage shrinking to immaterial levels, licensing software on the Internet (aka software as a service, cloud computing) will soon be faster and cheaper than on a desktop’s CPU. In addition, the auction of additional bandwidth (formerly used by TV channels 52-69) by the FCC will lead to widespread deployment of WiMax, which is like extending the wireless network in your home in an 18 mile radius. The first commercial WiMax network was recently launched in Baltimore to rave reviews. This may be the tipping point at which time the masses switch to a true mobile, browser-based computing environment, where all applications, including Microsoft Office, are accessed through any device with a web browser and data is stored on a commercial server, not on a local-area network or individual hard drive.

Accounting firms will also be impacted by Web 2.0 technologies entering the workplace. To most people, Web 2.0 refers to user-created content like blogs, podcasts, wikis, YouTube, and social networking sites where people upload and share video, photos, audio, and text. Big 4 firms and headhunters are using networking sites, including Facebook and Linked, for staff recruiting. It’s not a stretch to see how these applications can evolve into professional networking sites designed to increase productivity and extend the reach of local and regional accounting firms, for example, if a collaboration site were established for a CPA association that linked all the CPAs from all member firms to share expertise and referrals.

Of special interest to accountants is XBRL (Extensible Business Reporting Language), a data tagging system designed to make the analysis and exchange of business and financial information easier and more reliable, even when generated by disparate systems in varying formats. XBRL has been described as bar coding for financial information, whereby data can be electronically searched, extracted, exchanged, and analyzed more efficiently than ever before. The SEC recently completed a $54 million project to transform the financial statements in its Edgar database into XBRL-based interactive information and will soon require company filings to be submitted in XBRL. Investors, financial analysts, and other users of financial information will soon be able to search SEC filings and download data into spreadsheets to compare companies and mutual funds in any way they choose using the SEC’s new platform called IDEA (Interactive Data Electronic Applications). Demand for XBRL-tagged private company financial information will surely follow. Software developers are adding XBRL capabilities to their products, and it will soon be essential for CPAs to learn to manipulate and interpret XBRL data within their clients’ accounting systems and financial reports. The tipping point will come soon enough – when the IRS requires tax return data to be tagged in XBRL – probably in 3-5 years.

Impact of Trends on the Firm of the Future

So what will the Firm of the Future look like? By connecting the dots, some things are fairly obvious, while others require speculation and imagination.

While larger firms that can take advantage of leverage and scale have been enjoying double-digit growth rates for the last three years, the impact of the economic slowdown will likely have an impact on firms of all sizes. Creative firms, however, will find a way to capitalize on emerging client needs arising from the economic downturn, as well as capitalize on opportunities created by the expected barrage of new tax laws and regulations. Income and estate tax planning, retirement planning, entity and debt restructuring, cash flow planning, foreclosures and bankruptcies, compensation and benefits planning, and mergers and acquisitions are services that should thrive in the near term.

Firms of all sizes continue to tell us that managing the volume of work and workload compression is their top challenge. How they meet the challenge varies widely. When demand for services exceeds the supply of available providers, improving productivity and efficiency of the existing workforce typically becomes Job #1 for management. This can take the form of improving workflow within the firm by automating manual tasks and leveraging integrated product suites that minimize data entry, share common architecture, and deliver information and guidance at the point in the workflow in which it is needed. Improving productivity and efficiency can also take the form of increasing the emphasis on education and training of workers to enable them to perform at a higher level.

The Firm of the Future will learn to not think of geography as a limitation. Many tax and accounting services can be performed online and delivered through secure electronic networks. For that reason, firms of all sizes can outsource work and recruit talent from around the corner or around the world, can provide flexible work arrangements and telecommuting, and can just as easily serve clients in far away locations as clients next door. At some point in the not too distant future, I expect to see innovative Web 2.0 technology solutions emerge like we’re seeing in other industries and other professions to help firms find the talent they need and to meet the demand. We’ll also see the emergence of online professional networks for niche practice areas, where like minds will establish communities for sharing knowledge and solutions to problems. Convergence of U.S. and international GAAP and GAAS will require more and more practitioners to become “bilingual,” developing proficiency in multiple sets of standards. And international tax and transfer pricing skills will be in extremely high demand.

Firms of the Future will also have to learn to compete on a different level. With the volume of regulatory change and complexity in both tax and A&A, the demand for services will continue to grow faster than the available talent pool, despite the growing number of accounting graduates and no matter how creatively firms approach the market. The work will get done, perhaps by new players, both domestically and globally. An increasing number of firms are turning to international associations to expand their service offerings and extend their geographic reach. In many cases, associations have been treated as a social outlet for senior partners but will become increasingly critical to the firm’s ability to compete in a global environment.

The paperless trend will continue to proliferate, and will encompass tax, as well as accounting and auditing engagements as firms standardize with integrated product suites delivered on a common online platform. This new digital environment will enable them to electronically collaborate on engagements, share and store information, and communicate with clients and third parties and complete projects (e.g., audits) more efficiently than ever, regardless of physical location of the clients or team members. These platforms will become the ‘hub’ of operations within the firm and even associations.

Data extraction, analytical, benchmarking, forecasting, and business decision-making services will grow as the number of integrated information solutions available to support such activities, including XBRL-based applications proliferates. These tools will enable accountants to slice and dice historical information more effectively and enhance their value to their clients and employers.

To prosper in the Firm of the Future, it will no longer good enough to merely know the rules. Higher expectations, justified or not, will force practitioners to filter information, look beyond the rules, look beyond the numbers, and ultimately add value at a higher level in a global marketplace. Being absolutely right may be less important than being nimble and adaptive; CPAs will have to adapt to the speed of business, while continuing to uphold the core values and ethical obligations that established the profession. The biggest risk I see is believing that what worked yesterday and what works today will also work tomorrow.

The Entrepreneurial Surge – Opportunities For CPAs

2008-09-30T20:20:00.000-05:00

It’s no secret that the growth engine of the U.S. economy is the fertile environment for entrepreneurial activity that encourages and rewards risk taking and enables start up businesses to thrive in a capitalistic, free-market system. Approximately 460,000 new businesses are launched each month in the U.S., according to the Kauffman Foundation. Start ups and small businesses employ over half of America’s workers, generate over half of our nonfarm GDP, produce the vast majority of new jobs, and reward investment that can be redeployed into more new businesses. There are the success stories we are all familiar with -- the Microsofts, Googles, Dells, and Apples that began in a dorm room or a garage. Far more common are the millions of small businesses that never make headlines, don’t go public, but are core to the fabric of nearly every city and town in the U.S. The good news is that we are presently on the cusp of an explosion in entrepreneurial activity that will hopefully provide the spark that our economy needs to continue to grow and prosper.

Why Entrepreneurism is About to Explode – The Demographics

We are beginning to see a convergence of demographic trends which, when overlaid with certain enabling developments, could create a perfect storm for new business formation and consequently, opportunities for CPAs, especially here in Texas.

For the past 10 years, adults aged 55-64 were the most active age group for starting new businesses in the U.S. This data suggests that the Baby Boomers, the 78 million adults who constitute 25% of the U.S. population, are moving into the prime period of their lives for business creation. I think we intuitively realize that some Boomers will be financially set but looking for something new and challenging or to follow a passion, while others would like to retire but haven’t saved enough, including those who find themselves downsized, outsourced, or offered early retirement from corporate America. In any event, even if business formation rates for this age group remain flat, the number of new businesses will grow dramatically simply because of the size of the Boomer population.

While the 55-64 age group has been the most entrepreneurial in term of total new businesses formed, the fastest growing segment is the 20-34 age group. This group has watched their parents experience corporate downsizing and outsourcing and are less attracted to the corporate lifestyle and moving up the corporate ladder than previous generations. This group, who I refer to as “digital natives” because they came of age with the Internet and are so electronically networked, generally views both starting new businesses and contracting work as superior alternatives to the corporate lifestyle. And even if they begin their careers in large corporations, they will likely change jobs many times and develop an entrepreneurial, or free-agent mindset as a result. Many are hyper-competitive as a result of a background in electronic gaming and thus have the DNA that a serial entrepreneur has to have to relish the competition and not fear failure.

Another demographic group driving an explosion in entrepreneurship is the immigrant population, estimated to be almost one in eight people living in the U.S., according to the Center for Immigration Studies, an immigration advocacy group. Many immigrants came to the U.S. to take advantage of higher education opportunities and remain in the U.S. and start businesses. According to the Kauffman Foundation, immigrants have a substantially higher rate of starting new businesses than American-born individuals. Regardless of education level, it’s often difficult for immigrants to find jobs in the corporate world, but the same DNA that drove them to relocate to a foreign country in search of economic opportunity proves to be a critical success factor in the entrepreneurial world. They quickly learn to leverage their bilingual, bicultural makeup, as well as their international references and contacts to seize opportunities that their American-born counterparts simply don’t have.

Why Entrepreneurism is About to Explode – The Enablers

A number of technological developments are reducing or eliminating barriers to entry and enabling start-up businesses to scale up fast. The emergence of the software-as-a-service (SAAS) business model now provides start-up businesses with little capital access to world-class platforms previously available only to large corporations. In addition, small businesses can now access computing infrastructure and large-scale facilities such as data centers offered by IBM, Google, and Microsoft, as well as global warehousing and distribution networks provided by UPS and Amazon. Businesses of all sizes are embracing B2B equivalents of social networking sites to share information and collaborate on projects with colleagues from around the globe, without the time and expense of adding internal headcount. For these reasons, we could see a tidal wave of small and start-up businesses engaged in importing and exporting activities in the coming decade.

Another driver of the surge in entrepreneurial activity is the emergence of entrepreneurship programs in colleges and universities. Several of the major universities in Texas offer entrepreneurship programs, complete with business incubators to help aspiring entrepreneurs get their businesses off the ground. Student demand for these programs is strong, and it is not uncommon to see public companies with roots in academia, with professors in advisory roles providing links to alumni hungry for investment opportunities.

A third enabler of entrepreneurism is somewhat cultural in nature. Some call it the Free Agent Nation, referring to independent contractors who provide project work and services to larger businesses. A variation is the emergence of the personal business -- a single person with no employees who launches a web-based business, often from home. The tools and services available via virtual marketplaces to help these start-up entrepreneurs are phenomenal, from finance and management to sales and marketing to legal to manufacturing services. These businesses with their variable cost structure can scale up quickly, and geography is not a limitation. The successful ones often attract the interest of large corporations who are willing to partner with or acquire them in what has evolved into an outsourced innovation model for corporate America.

Texas as a Fertile Environment for Entrepreneurism

Texans have traditionally been independent and entrepreneurial by nature. It’s in our DNA, and drives our economic policies, which probably explains why Texas, relative to most other states, generally enjoys a higher level of economic prosperity.

A Washington D.C. organization called the American Legislative Exchange Council (ALEC) has identified 16 policy variables among the states that cause some to be prosperous while others struggle. ALEC analyzed the impact of these variables on each state’s financial well being and concluded that states that states that keep spending and taxes low exhibit the best economic results, while states that get trapped in the endless tax-and-spend cycle lag far behind. The analysis includes a ranking of states by economic performance, defined by personal income growth per-capita, domestic migration, and non-farm payroll growth, weighted equally, from 1996-2006. Texas ranked Number 1, and in light of the demographic and enabling trends discussed above, I believe this bodes well for Texas to become a hotbed for entrepreneurial activity in the years to come.

Opportunities for CPAs

Given the demographics, given the enablers, and given the fertile business environment in Texas, service opportunities for Texas CPAs will abound. Simply from supply and demand standpoint, we can expect to see a huge uptick in the number of new businesses seeking our help and advice. However, many CPAs’ view entrepreneurs as risky clients to take on, for a variety of reasons. Their experience has taught them that startups are often cash-strapped, frequently fail, and entrepreneurs don’t understand or appreciate any level of tax, payroll, accounting, or other regulatory compliance requirements. Stated differently, the initial reaction to taking on a new startup business client is a high risk of spending too much time without getting paid, weighed against the opportunity cost of spending that time on more established clients with a higher probability of full realization.

Those are legitimate concerns, and historically that may have been the prudent way to approach entrepreneurial services. That may be a short-sighted approach, however, in the 21st Century. First, we can expect to see a new wave of Boomer entrepreneurs that have sufficient capital, relationships, and skillsets to ensure a high probability of success. These will be desirable new clients. The digital natives and free agents who launch businesses on the Internet may be the most intriguing, with the low barriers of entry, variable cost structures, and ability to scale rapidly, needing more services as they grow. Immigrant entrepreneurs will bring a unique set of challenges and opportunities. With their global perspective, international relationships, superior work ethic, and advanced degrees from American universities, they may in fact ignite the next wave of globalization through the businesses they create.

With each of these demographic groups, CPAs will find ground floor opportunities to participate in the growth of their entrepreneurial clients with expanded service offerings. Here are a few that come to mind:

· Business plans
· Choice of entity
· State and local tax and regulatory requirements
· Financing and cash flow planning
· Budgeting and forecasting
· Income tax planning and compliance for the business and the owners
· Compensation and benefits planning and compliance
· Family wealth transfers and estate planning
· Asset protection strategies
· Facilities planning, including lease-buy decisions
· Risk management and insurance
· Business information systems—back office (accounting) and front office (sales)
· Management reporting

With this in mind, Texas CPA firms would be well served to evaluate investing in a formalized entrepreneurial services practice as a strategic growth area. It may require a different revenue model with a delayed gratification approach, but from an investment perspective, it could provide diversity and a competitive advantage. The firm’s strategic plan should address the skills needed to provide cradle-to-grave services for entrepreneurs as well as the practice development approach to attract the business and the revenue model to capitalize on the opportunities.

A Time for Tough Calls

2008-07-27T20:13:00.000-05:00

Let’s face it --- we’re in a pickle. Until a year ago, we had enjoyed about five years of uninterrupted economic prosperity in the U.S., financed in part by massive deficit spending by the federal government. Because of the global availability of capital, we were able to finance this deficit at relatively low interest rates, leading to a robust economy and a growing stock market. The Federal Reserve’s easy money policy enabled consumers to spend and businesses and investors to invest at a very low cost. Anybody could buy a house, home prices skyrocketed, and homeowners treated their houses like ATMs. Nobody seemed concerned about the deficit, short-term or long-term. When times are good, it’s like Robert Earl Keen says – “the road goes on forever and the party never ends.” Fast forward a year. As of this writing, the stock market is down over 20%, gasoline exceeds $4 a gallon, food and health care costs are outpacing inflation, unemployment is up, home prices are down, home equities are falling, consumer confidence is shaky, and the Fed will probably have to raise interest rates to head off inflation. The deficit has grown to $9.3 trillion. The prevailing sentiment seems more in line with Willie Nelson’s direction – “turn out the lights, the party’s over.” Could Willie be right? Is it really time to turn out the lights? The answer, of course, depends on who you ask, and as usual, there are multiple views.

There Will Be Blood

The problem with the deficit is the longer we put it off the worse it will get. Our country’s entitlement programs, particularly health care costs, exacerbated by the baby boomers’ reaching retirement (and Medicare-eligible) age, is a train wreck waiting to happen. CPA David Walker, former Comptroller General of the United States described the compounding federal debt as an actuarial nightmare and the most serious threat to our country. Alice Rivlin, former director of the Congressional Budget Office and head of the OMB under President Clinton described the federal government as a ship headed straight for an iceberg. Accordingly, I continue to feel that the long-term deficit situation is the number one domestic issue at stake during the presidential campaign. It’s not that education and infrastructure aren’t important. Indeed they are critical to our long-term prosperity. But if we don’t get a handle on entitlement programs, we’ll have to take away from those programs to fund the entitlements. The problem is that the entitlement programs are on autopilot and have been treated as sacred cows by both political parties.

To their credit, both candidates acknowledge the deficit spending issue on their websites. However, neither candidate has made reining in the deficit a top campaign priority, and both John McCain and Barack Obama have proposed tax plans that would cost in the trillions of dollars over the next 10 years according to the Tax Policy Institute. Accordingly, as we watch and evaluate the debates and move closer to November 4, it’s imperative that we pay particular attention to the budgetary impact of the candidates’ proposals, and also their plans to limit the growth of Medicare, Medicaid, Social Security, and other non-defense spending. Further, as we move into 2009 and beyond and the economy rebounds, to the extent the federal tax receipts are greater than expected, whether from tax increases or economic growth, it’s extremely important that some mechanism be put into place to ensure Congress doesn’t simply spend the excess.

A Call for Leadership

As most seasoned CPAs understand, cutting costs and managing expenses are not the most difficult part of running a business. The reason CEOs get paid the big bucks is for their ability to develop strategies and align and motivate their organizations to drive top-line growth. That’s called leadership. The all-too-common view from the right, including McCain advisor Jack Kemp, is that we can simply grow our way out of the current deficit situation. They claim that setting the economy on a track to grow will generate sufficient tax receipts to eliminate the deficit. I’ve personally felt pretty closely aligned with that view over the years. But when the Comptroller General of the United States, with all he knows from 10 years on the job, tells us that growing our way out is impossible, and if we don’t act it could bankrupt America, I’m not going to doubt him. I think we all realize there is no silver bullet or single solution, and the positive impact from economic growth will be part of, but not the complete, solution.

If the next President can put a structure in place to make it easier for a business to raise capital and execute its business plan, more jobs will be created, driving demand for housing, education and training, and creating a larger income and FICA tax base without increasing tax rates. How can he do that? Generally by keeping taxes low, minimizing regulations and trade barriers, and keeping inflation in check so that capital flows freely, entrepreneurship and innovation can flourish, risk-taking is rewarded, and people can earn, save, invest, and grow to the point they’re not totally dependent on the government for retirement or health care. This will happen only if we have policies that allow people to keep most of the fruits of their labor within their own families. A 39.6% marginal income tax rate plus a 15.3% FICA tax plus a state tax in most states, coupled with a 45% tax for the privilege of passing wealth to one’s heirs is a counterproductive system that kills ambition and penalizes success. We can’t afford a high tax environment that disincentivizes upward mobility. Neither can we afford a 28% penalty for successful risk taking; a high capital gains tax does not drive the desired behavior by investors.

Suggested Solutions

While we’ve dug ourselves into a hole, I’m hopeful the next President can lead us out of it. First, let’s see how far we can go toward long-term financial solvency without drastic tax increases. A pro-growth agenda to eliminate the current deficits while encouraging capital formation and investment should theoretically lead to an economic growth across all income groups, along with increased tax revenues as a byproduct. Such a pro-growth agenda, coupled with a sincere, bi-partisan attempt at solving the long-term budget crises attributable to increased entitlement spending provides the clearest path to continued prosperity. Accordingly, here are my recommendations for President 44, given the inevitabilities of the Washington D.C. landscape in 2009:

1. Bring the best of the center-right and center-left proposals together when dealing with the future of the Bush tax cuts and the estate tax. It doesn’t have to be all or nothing for either party. For example:

· Don’t increase the payroll tax or the marriage penalty on anyone;
· Go with a $10 million estate tax exemption for married couples, and tie the marginal rate to the capital gains rate;
· Speaking of the capital gains rate, don’t raise it above 20% and index capital asset bases for inflation;
· Secure consensus that dividends are ordinary income in most situations, closely held businesses notwithstanding;
· If you must raise the top marginal rates, raise them for taxable income exceeding $1 million.

2. Establish programs that will increase payroll taxes without increasing the rates or tax base, or otherwise shore up the solvency of the entitlement programs, which can be accomplished via:

· Limit increases in social security to percentage increases in the consumer price index instead of the wage index;
· Through a combination of statute and incentives, push the retirement age back to encourage people to work longer, delaying both Medicare and social security eligibility, keeping them paying into the system longer;
· Design and implement a coherent framework of tax incentives based on simplicity and flexibility to encourage savings for retirement, in turn providing a financial cushion for social security;
· Implement policies designed to drive employee productivity improvements, so employees will earn more and thus pay more in payroll taxes;
· Drive immigration reform that allows an increase in the H-1B visa program so that foreign workers, particularly those educated in the U.S., can remain here longer and contribute their fair share of payroll taxes;
· Implement means-testing, requiring wealthier seniors to pay higher premiums and co-payments; and
· Promote wellness and market-based incentives in health care.

3. Take proactive steps to keep a lid on inflation in general and employer health care costs in particular to avoid increasing the cost of capital for business owners and their investors.

Conclusion

What we cannot afford is inaction. The longer we wait to address the issues, the more painful it will be to fix them. If President 44 and the next Congress can enact pro-growth legislation to stimulate the economy without adding to the current deficit, while taking a bi-partisan approach to curb the growth in entitlement spending, they will prove Willie wrong: the party’s not nearly over, and yes, Robert Earl, it never has to end.

President 44 and International Trade Policy

2008-05-26T22:59:00.000-05:00

One of the more intriguing policy issues to be debated in this year’s presidential campaign is the candidates’ positions on international economic issues. One reason it’s intriguing is that we’re part of a global economy with an almost unlimited number of moving parts, and I don’t believe modern economic models and theories have matured in a way that will let us confidently predict the outcome of certain presidential actions and inactions. What we do know is the infrastructure is in place for an integrated, web-enabled global marketplace for products and services, the volume of international trade is exploding, globalization has reached Main Street, and we cannot effectively view the Texas economy or the U.S. economy in isolation without regard to global economic issues. We also know that Presidents historically have taken the lead on trade agreements with other countries, but can’t act in isolation without Congress’ consent. Against that backdrop, let’s take a look at the candidates’ positions on global trade policies that are sure to affect our firms, our clients, and our employers during the next 4-8 years.

Traditional Economic Positions

Traditional conservative thinking suggests that the best thing a president can do is keep taxes low, keep the government out of the way, and let free markets operate as efficiently as possible. If markets are left open, businesses will naturally grow, productivity will increase, demand for workers will grow, as will wages, leading to an improved standard of living for all. The contrasting liberal view encourages presidents to be more proactive in introducing policies aimed at educating workers, building infrastructure to support business, investing in research and development, and driving the desired results through tax policy. With regard to international trade, conservatives believe that globalization is a good thing, opening new markets for American goods and services, creating more jobs in the process. The liberal view, now shared by the majority of Americans in recent polls, is that globalization has subjected American businesses and employees to unfair competition and cheap labor, and the federal government should take steps to ensure American jobs are not lost as a result of free trade agreements with other countries. They also look at trade agreements as a mechanism to enforce certain environmental standards around the world.

Free Trade or Fair Trade?

Global trade did not become a key campaign issue until the Ohio democratic primary (which incidentally occurred the same day as the Texas primaries), where NAFTA became the poster child for the anti-trade crusaders, from Lou Dobbs to Hillary Clinton to Barack Obama, each of whom blamed NAFTA for hundreds of thousands of job losses in Ohio. Neither candidate faulted automation for cutting the number of man-hours required to make a car, or the sky-high cost of health care, including retiree health care, as contributing factors. Both Clinton and Obama told Ohio voters they wanted to renegotiate NAFTA, although neither raised the issue in Texas, where NAFTA is widely viewed as an economic growth engine.

During the Ohio primary, Clinton proposed a “time-out” on trade agreements, to which Obama famously replied “The world will not pause. China and India will not pause.” To his credit, Obama acknowledges that not only is global trade not going away, it can create significant opportunities. His response is retraining U.S. workers to enable them to compete more effectively in the global economy. John McCain, while clearly favoring NAFTA and having a long voting record as a free trader, has made similar proposals. In that light, both Obama and McCain seem to be taking a pragmatic, glass half full approach.

Just the Facts, Please

Since CPAs like data to support their conclusions, let’s cut through the campaign rhetoric and speculation and look at some facts. U.S. Secretary of Commerce Carlos Guiterrez, in a recent op-ed in the Wall Street Journal, pointed out foreign companies invested $200 billion in the U.S. in 2006 alone, creating five million jobs, and U.S. exports reached $1.6 trillion in 2007, up 13% year-on-year and up another 18% in Q1, 2008. Business Week points out that trade now accounts for 27% of U.S. economic output. At a time when the economy might have been much more deeply devastated by the subprime mortgage fallout, credit crunch, and high gasoline and food prices, the positive impact on the U.S. economy from opening markets and eliminating barriers to trade is huge.

Conclusion

It’s essential that the next President maintain these positive economic trends in the years ahead. We cannot afford an overly protectionist trade policy that cuts off foreign investment or fails to recognize that trade agreements are by definition reciprocal, meaning we can’t afford to tax imports and expect exports to continue to flourish. I hope the next president will embrace the theories of British economist David Ricardo, who two hundred years ago introduced the theory of comparative advantage in his book Principles of Political Economy and Taxation. Comparative advantage basically says that if each country specializes in what it does best and then trades with other countries for what they do best, overall gain and a rise in income levels will result. This argument has merit if you believe the global pie will keep growing via investment, innovation, and invention. The contrarian view is that global competition is a zero-sum game with a loser for every winner and no prospects for overall economic growth. If that’s the case, we should erect walls and seal the U.S. off from the rest of the world. That view reminds me of Charles H. Duell, Commissioner of the U.S. Patent Office in 1899, who allegedly said “Everything that can be invented has been invented.”

A Democratic victory in November will probably mean the U.S. will go slower, greener, and insist on provisions protecting U.S. workers in future trade negotiations. John McCain would probably embrace free trade agreements like the ones currently on the table with Columbia, South Korea, and Panama, and initiate others. Also, if you close your eyes you can almost hear him talking about the importance of close economic ties with our allies and their effect on our national security, an important issue rarely mentioned in the trade debate.

Crisis on the Horizon

2008-04-06T13:48:00.000-05:00

While many important issues dominate the headlines during the current Presidential campaign, the one issue that could become the most critical of all over the next decade has practically escaped coverage altogether – the federal debt and ongoing deficit spending -- and the candidates’ plans for reigning it in before we reach crisis mode.

One CPA Trying to Make a Difference

Certainly the challenges facing our country are many – Iraq, 47 million Americans with no health insurance, the credit crunch, the falling dollar, immigration, globalization, foreclosures – but those aspiring to lead our country, as well as the news media that follows their every move, don’t seem to grasp the magnitude of the deficit situation. The $9.3 trillion federal debt is like Washington’s dirty little secret that it sweeps under the carpet and hope nobody notices. The problem is the longer we put it off the worse it gets. It’s all about what Albert Einstein called the most powerful force in the universe. He called it exponential notation. We call it the power of compounding. CPAs understand the concept, and one CPA in particular is trying to do something about it. David Walker, the former Andersen partner who until March was the Comptroller General of the United States, knows better than anyone what’s on the books (and under the carpet) of the USA.

David Walker became Comptroller General in 1998 and signed on for a 15-year term. The long tenure was specifically designed to allow the agency he oversees, the Government Accounting Office, to have continuity of leadership and independence from the political fray, so that the Comptroller General can take a long-term view and keep policymakers abreast of problems looming on the horizon before it’s too late.

For the last few years, Walker has been traveling the country with like-minded thought leaders from both political parties on a “Fiscal Wake Up Tour,” sharing what he’s learned as the government’s top accountant. Walker told 60 Minutes that he believes our country’s entitlement programs, particular health care costs, exacerbated by the demographic tsunami expected from the baby boomers’ reaching retirement (and Medicare-eligible) age, is a fiscal cancer that could have catastrophic consequences for our country. He believes our current standard of living is unsustainable unless drastic action is taken, and described the compounding federal debt is an actuarial nightmare and the most serious threat to our country. He’s even made a comparison of the United States to the Roman Empire, in that, among other things, fiscal irresponsibility by the central government led to its fall.

In his Comptroller General role, Walker ran simulations of possible outcomes if nothing is done about the problem. He has concluded that when you add in the impact of our Medicare, Medicaid, and Social Security obligations, the U.S. is looking down a $50 trillion hole, which is like adding a $450,000 mortgage to the balance sheet of every American family. Likely outcomes include some combination of dramatic tax increases, reduced government services, and massive dumping of U.S. debt by foreign governments. In that light, it will clearly impact our children and grandchildren, and that makes it a moral issue in my opinion. The data is there, and Walker has offered to brief the Presidential candidates and has urged them to include fiscal responsibility and inter-generational equity among their top priorities. So why aren’t the candidates responding? Why isn’t the media forcing the issue? Simply stated, it’s not a popular issue. There is no feel good outcome, other than the sooner we (Congress and the President) act, the softer the impact.

After all, the President submits the federal budget, which means he/she is the first to frame the level of the budget deficit. Presidents can pursue fiscal policies marked by large deficits, which over time drive up interest rates and slow growth, or smaller deficits or perhaps surpluses that eventually allow interest rates to fall and growth to accelerate. The President can also influence the dollar and trade policy, and initiate policies that influence worker productivity, taxes, education and worker training, research and development, immigration, and regulation. In that light let’s take a look at each candidate’s stance on the budget deficit and the federal debt.

The Candidates’ Views

To their credit, all of the candidates acknowledge the deficit spending issue on their websites. The problem is that they haven’t made it central to their campaigns, and the media has let them get away with it by not elevating the issue during the primary debates. No candidate has offered a pledge to not increase the deficit.

John McCain has a long track record of opposing tax hikes, abhorring earmarks, supporting proposed balanced budget legislation, supporting medical savings accounts, and generally opposing excesses in government. He counts former Texas Senator Phil Gramm, an economist and outspoken deficit hawk, as one of his closest economic advisors. And while he voted against the Bush tax cuts in 2001, he told Meet the Press that he did so because the bill did not include a corresponding cut in spending. He had actually supported the cuts in a budget resolution but withdrew his support when a cap on discretionary spending was omitted from the final legislation. He favors supplementing Social Security with private accounts, which he refers to as personal savings accounts, particularly for younger workers. These personal accounts would not be financed by diverting payroll taxes and would not be a substitute for guaranteed Social Security payments. He has advocated reducing the growth in benefits and is evaluating extending the retirement age to 68 and reducing cost of living adjustments. He told The Wall Street Journal that he would fix Social Security by sitting down with both parties, voicing opposition to tax increases, and then negotiating a fix. As for Medicare, his website indicates he has proposed a pro-market health care plan that among other things would control increases in Medicare premiums and spending.

Barack Obama has publicly recognized the need for Social Security reform, initially declaring that all options were on the table, but more recently proposing to address the looming shortfall with higher taxes, specifically imposing payroll taxes on salaries over $200,000 after exempting wages between $100,000 and $200,000. During the campaign, he has advocated streamlining government programs including Medicare Part D (prescription drug benefit) to make them easy to understand and use. In addition he supports a 3% withholding to promote long-term savings, although employees could opt out. Obama has also advocated a number of populist-type social programs, but at the same time publicly supports “pay-as-you-go” (Paygo) budgeting rules. His website describes the cost of the federal debt is a “hidden domestic enemy” and includes a section on restoring fiscal discipline to Washington via Paygo, cutting pork-barrel spending, ensuring government contracts over $25,000 are competitively bid, and eliminating wasteful, obsolete government programs that make no financial sense, and eliminating wasteful spending in the Medicare program. He would also eliminate the income tax for seniors making less than $50,000 per year.

Hillary Clinton’s website includes an “economic blueprint,” which includes a “move back toward a balanced budget and surpluses.” She refers to the federal debt as a birth tax. She announced a plan called American Retirement Accounts, which amounts to a $5,000/year IRA with a government match via refundable tax credits on the first $1,000 contributed for couples earning up to $60,000 a year, a 50% match (i.e., $500) for couples earning $60,000-$100,000, and phased out thereafter. Clinton’s retirement savings plan would be in addition to Social Security, and would be funded by freezing the estate tax at 2009 levels. Like Obama, Clinton has proposed a myriad of new social programs, but also supports the Paygo budget rules that would require funding new expenditures with new tax revenues or spending cuts in other areas. In a speech earlier this year she said that “we don’t need more Republican scare tactics about a social security crisis…” but that we need “to focus on the real crisis of health care and Medicare….”. She also claimed at least partial credit for the balanced federal budget in the 1990s and has vowed to fight any effort to privatize Social Security.

Potential Solutions

Some politicians and economists, generally Republicans and including McCain advisor Jack Kemp, will tell you we can grow our way out of the deficit problem. And I’ve personally felt pretty closely aligned with these so-called supply-siders over the years. But I’m aligned with CPAs too. And when the Comptroller General of the United States, with all he knows from 10 years on the job, tells us that growing our way out is impossible, and if we don’t act it could bankrupt America, I’m not going to doubt him.

So what can we do? For one thing, the populace needs to be reminded that Social Security was never intended as anyone’s sole source of retirement income. This initial target was somewhere around 40%, according to Social Security Commissioner Michael Astrue. Further, when the program was enacted, most people weren’t expected to live to be 65. Any solution will have to recognize that today’s longer life expectancies and the demographic reality that today there are only four workers for every retiree, decreasing to two workers per retiree in 20 years. Most importantly however, inflation in general and in health care costs in particular will have to be addressed.

In reality, I expect that we’re looking at a long series of incremental changes. I feel fairly certain the U.S. will continue to implement targeted programs that encourage savings for retirement. We will also see programs designed to drive employee productivity improvements, so employees will earn more, save more, and pay more in more payroll taxes. And while politically unpopular, a strong case can be made for immigration reform that allows an increase in the H-1B visa program so that foreign workers, particularly those educated in the U.S., can remain here longer and contribute their fair share of payroll taxes. I’m betting we also see social security indexed for prices, not wages, and ultimately we’ll see the retirement age pushed back from current levels. That in itself would delay both Social Security and Medicare eligibility and keep people working longer, paying more into the system. We’ll also see expanded means-testing, requiring wealthier seniors to pay higher premiums and co-payments. Finally we’ll see new attempts to promote wellness and market-based incentives in health care, including policies focused on reigning in inflation in health care costs. What we cannot afford is inaction. The longer we wait to address the issues, the more painful it will be to fix them.

Conclusion

The coming election promises to include debates over spending and taxes, the role and responsibility of business, and the role and size of government. I hope that most Americans will filter all the rhetoric with the reality that the next President’s actions and inactions over the next 4 or 8 years could likely impact the living standards for future generations of Americans via his/her approach to the budget and the federal debt.

Where’s David Walker today? He is now president of a $1 billion private research foundation funded by Peter G. Peterson, senior chairman of the Blackstone Group and former Commerce Department secretary, established to focus on national sustainability issues. I believe they found the right man for the job.

Tax Platforms and the 2008 Election

2008-01-24T07:45:00.001-06:00

To a great extent, our political races are all about where the money will come from and where it will go. Each party and candidate, of course, has its own view of how the government should raise money to fund its activities, and where or from whom it should come. In addition to a mechanism for raising funds, some view the tax code as a tool for social policy, others view it as an economic lever. In reality, it’s both, and we go through both economic cycles and social cycles, not necessarily in tandem. I personally believe our nation is moving in a more conservative direction on both fronts, and that the gravitational pull of the underlying socio-economic trends we are currently experiencing are larger and more powerful than any one political party, administration or legislature.

That said, the next Administration will be in office until 2013, and perhaps until 2017 and will certainly have the opportunity to leave their imprint on our nation’s fiscal and social direction. During that time certain issues will have to be addressed, and we CPAs will be directly impacted by the outcome, as we are directly involved in the execution and implementation of the nation’s tax policy. Even if we ignore the current economic malaise and the various proposals for short term stimuli, those elected in November will face:

Expiration of the Bush tax cuts;
An estate tax scheduled to expire all together and then come roaring back with a top rate of 55% for estates over $1,000,000;
The alternative minimum tax, which last year took an amazing 11 months to index for inflation, and could eventually snare over 50 million taxpayers if left unchecked;
Medicare, which is already paying out more than it’s taking in, will be stretched by a massive number of Boomers who will begin to be eligible for coverage in 2011, causing a projected insolvency by 2019; and
The fact that American corporations now have the second highest tax rate in the world, which ostensibly is hurting our competitiveness and ability to attract capital in the global marketplace.

Overview of the Platforms

While the hot issues of the primary season have bounced around between Iraq, health care, religious affiliations, the potential recession, and the need for an overall change in direction, I believe tax policy and how the candidates will address these issues may well take center stage in the fall after the conventions.

As of mid-January, the Democratic candidates had not made tax policy a central issue, probably because they share similar positions, and also because they haven’t forgotten about what happened to Walter Mondale when he was candid about raising taxes in 1984. The front-running Democratic candidates – Hillary Clinton, Barack Obama, and John Edwards – would each let the Bush tax cuts expire for “the rich,” who they define as taxpayers making more than $200,000 (Edwards) or $250,000 (Clinton and Obama). I’m looking forward to their response to their argument that the top one percent of individual taxpayers (earning more than $250,000) who already pay more than 40% of all federal income taxes, aren’t paying their fair share, especially when almost 50% of Americans pay no federal income tax at all. Also I’m curious to hear their explanation of why federal government revenues following the Bush tax cuts have so far exceeded the static CBO projections that we are on track to have a balanced budget by 2012. They would keep the estate tax for wealthy Americans. They have offered no position on AMT or shoring up Medicare, and if anything, want to sock it to corporations. Finally, they each support channeling tax breaks to low and middle income Americans in the form of increased earned income credits, child care credits, benefits for the elderly, and/or savings plans for college tuition and retirement.

The Republican candidates as a whole have been quite a bit more forthcoming with their tax proposals, albeit with nothing particularly new. Each wants to make the Bush tax cuts permanent, and several have proposed some kind of tax reform. Rudy Giuliani would give individuals an option of filing under the current system or by filing a “fast form” based on a broadening of the base and a simplified rate structure. Before exiting the race, Fred Thomson offered an optional flat tax, while Mike Huckabee proposed a national sales tax called the Fair Tax. Mitt Romney speaks of expanding tax free savings accounts and cutting rates. John McCain, who opposed the Bush tax cuts in 2001 but now favors keeping them, has proposed primarily business tax breaks and eliminating the AMT. McCain, Romney, and Giuliani each have proposed to cut the corporate tax rate.

Conclusion

While not a particularly high profile issue during the primary season, as we move past the primaries and the conventions and toward the general election in November, tax platforms will become a big differentiator among the candidates and a hot topic of debate, especially if the economy continues to take center stage. In the next few posts, we’ll drill down into the specifics of the candidates’ tax and economic platforms. Whoever wins in November will encounter huge issues for which there are no easy fixes and which can’t be ignored. Even those of us who find our livelihood directly or indirectly linked to the federal tax system are all aware that the status quo cannot continue indefinitely without reform. Personally I believe that directionally we are heading in a more conservative overall socio-economic direction, and that the current tax environment presents the most fertile opportunity for significant tax reform since Ronald Reagan et. al. rewrote the Code in 1986.

2008 Forecast----The Clouded Crystal Ball

2008-01-13T18:27:00.000-06:00

Looking back at our 2007 forecast (something most prognosticators never do), we see that we were mostly on target. A year ago we forecast that 2007 would be another in a string of winning seasons for the economy and for investors. More specifically, we forecasted that international stocks would outperform domestic equities, agreed with the Business Roundtable’s forecast of a U.S. economy growing 2.8%, and suggested that the private equity market was about to cool off. Perhaps more significantly, we have correctly forecasted for the last two years that the housing market would cool and perhaps decline a bit, that lending practices would tighten up, and the cash-out refinancing boom was over, translating into lower consumer spending and lower corporate profits, leading to softening GDP growth in 2007. While the private equity market cooled for reasons other than I had assumed, we were spot on just about all counts. Although the year overall was tainted by a dismal Q4 in the equity markets, international stock funds were up 14.57% in 2007, the Dow was up 8.88% for the year, and the Long-Term Treasury Index up 9.81%.

What’s happening today is that markets are reallocating capital following the run up of residential real estate during the early part of this decade when money was cheap (1% federal funds rate), borrowers were either stupid or naïve, bankers were greedy, if not deceitful, and the credit rating agencies were clueless. The Fed cut rates to the bone following the collapse of the tech bubble. (Hey, there are always going to be bubbles, and it’s not up to the government to protect us from ourselves. We need to do a better job of recognizing bubbles, whether they come from technology stocks, residential real estate, gold, the Chinese stock market, oil futures or whatever else seems like the next big thing.) Consumers overextended themselves, either sucked in by teaser interest rates and no-money-down mortgages, unwisely taking on Florida vacation home debt, or continually flipping their primary California residences, believing their home values would forever rise. The bankers, commercial banks, mortgage banks, and investment banks, are certainly not without culpability. They packaged (securitized) their loans and sold them off to investors, removing the loans from their balance sheets and onto the balance sheets of nonblank financial intermediaries such as hedge funds and off-balance sheet entities created by investment banks, which relied on artificially high credit ratings. This scheme minimized the banks’ capital requirements, enabling them to repeat the cycle in an endless manner. Now that this situation has come to light, we are seeing the equal and opposite reaction – declining home values, shrinking liquidity, multi-billion dollar write offs, and a massive amount of foreign investment in the U.S. banking system.

Domestically, the question in the media seems to be focusing on whether we are already in a recession and if so, how deep it will go. The Business Roundtable, comprised of CEOs of the nation’s largest 160 companies representing over 10 million employees and $4.5 trillion in revenues, forecasts slightly lower but steady economic growth in the first half of 2008 (2.1% GDP growth), with 70% expecting their revenues to increase, 86% planning to increase or maintain their capital spending levels, and 78% planning to increase or maintain hiring levels. These are the guys whose jobs are on the line (CEO turnover is about like that of baseball managers), so I place high stock in their collective wisdom. It’s worth noting that their CEO Economic Outlook index in their December ’07 quarterly survey was 79.5, up from 77.4 in September. Anything above 50 signifies a belief that the economy is growing, so they are feeling pretty good about things. They point to rising energy and health care as their greatest cost pressures.

Internationally, a recent McKinsey survey of global business executives indicated that worldwide, companies are adding workers, primarily in the same country as their corporate headquarters (as opposed to outsourcing), are generally not concerned with inflation outside of oil prices, and except for North America, expect their economies to be better off six months from now.

I felt darn good about things heading into 2007, based on a global view and wind at our backs coming out of 2006, and despite the current turbulence in the the global equity markets, I still do. I currently have 40% of my nest egg in international stocks and am thinking about increasing that. With Latin American mutual funds up 46%, emerging markets 36%, Pacific region 16%, and European region 12% in 2007, and with the dollar continuing to fall against foreign currencies, international investing will once again be where the highest returns are earned in 2008. Accordingly I plan to overweight international equities in my portfolio, as we expect global economic growth to outpace domestic GDP growth once again and expect the dollar to continue to weaken. We also believe domestic exporters, which account for over half the growth in the U.S. economy, to continue to prosper. Growth stocks will outpace value stocks, and on a more granular level, agriculture and larger technology companies should do well, along with defense, health care, and utilities. I am about ready to bail on my small caps for awhile, as they may well be in the red all year. Bond funds make me nervous but did extremely well in 2007, and so far in 2008 are the lone bright spot in terms of YTD returns. For those looking for a value play, I would look at REITs focused on commercial real estate – retail, office, and industrial properties – in about six to nine months. These investments were beaten down quite heavily in 2007 and may not have hit bottom; however, with interest rates coming down, overbuilding not the same problem as is apparent with residential real estate, and high dividend payouts of REITs, I would put commercial REITs on my “Investments to Watch” list.

My biggest concern heading into 2007 was the tightening labor markets in the U.S. While at a macro level, I haven’t changed my mind, we are probably looking at higher unemployment in certain sectors in the near term, most notably in housing construction, manufacturing, and in the banking sector. On the flip side, professional and business services, health care, food services each added more than 300,000 jobs in 2007, and should continue adding headcount in 2008. Our economy has clearly evolved into a service-based economy, and beyond that, into an information-driven, or knowledge economy, and that’s where the demand for talent is. While U.S. firms are beginning to recruit globally, the tight labor situation in the knowledge economy will inevitably drive up wages and salaries.

Will the Fed continue to lower rates to stimulate the economy? Or will it have to raise rates due to the inflationary pressure caused by the tight labor markets? It seems like the Bernacke Fed has a much stronger bias toward economic stimulation than the Greenspan Fed, which focused almost exclusively on controlling inflation. We agree with Bernacke’s approach, and feel like the Fed has room to move the federal funds rate down to 3% in Q1 without causing inflation to spiral out of control. The Fed simply can’t let home prices drop 20% or let the big banks fail.

My nightmare scenario is that the rebalancing of the U.S. credit markets takes too long to unwind, as the subprime mortgage situation spreads to credit cards and auto loans, further jeopardizing the health of U.S. financial institutions; the global capital markets are too intertwined with the U.S., and we drag the rest of the world’s economy down with ours; and foreign investment moves elsewhere. This would be exacerbated by a new administration with a bias to move in a more protectionist, as opposed to a free trade direction. Do I think this will happen? No, there are still more positives than negatives, especially in Texas.

In conclusion, my clouded crystal ball (with due credit to Dave Campbell), we shows a slowing domestic economy coming out of 2007 with a fair amount of risk. Until the excesses from years gone by are wrung out of the economy, we will continue to be at risk. The slow-down in the housing market will lead to more foreclosures, fewer cash-out re-financings, and a slowdown in consumer spending. This will put more pressure on business to keep the economy humming, but certain sectors should continue to thrive. We expect service and knowledge-based businesses to keep spending, particularly in the IT and employee recruitment and training areas, and for U.S. exporters, who will continue to drive the growth in the U.S. economy, additional plant and equipment. The Fed will lower interest rates, and Washington will probably jump in with a fiscal stimulus package. The financial sector is due for a Darwinian restructuring and revamped regulatory structure to ensure they remain responsible for loans they create. Closer to home, the Texas economy is slowing down and foreclosures are up. But the state’s unemployment is lower than the national average and we are adding new jobs at twice the pace of the rest of the country. Commercial construction is alive and well in the downtowns of Dallas, Fort Worth, and Austin, Houston is fueled by strong worldwide energy demand, San Antonio has a new Toyota plant and thriving military bases, and the Barnett Shale is a boom to thousands of property owners, drilling companies, and service providers in North Texas.

All this translates into two basic thoughts……carefully select your entry and exit strategies, and invest internationally in companies with solid fundamentals.

Socio-Economic Cycles and the 2008 Elections

2007-11-23T14:10:00.000-06:00

Every society or culture is defined by two dimensions, an economic dimension and a social dimension. These two dimensions evolve over time, and not necessarily in tandem. Accordingly, their intersection point, which largely defines a society during any given period of time, is a dynamic, as opposed to a static phenomenon, evolving as the underlying economic and social dimensions evolve.

For Americans, it’s fairly clear the economic direction will continue its momentum in the direction toward free markets, laissez faire capitalism, and less government involvement in economic matters, but from a social perspective, the U.S. seems to be experiencing a shift in values …. to the right. Stated differently, from a socio-economic perspective, we seem to be moving (or have moved) from a Libertarian Era to a Conservative Era. While those elected in 2008 will certainly have the opportunity to leave their imprint on our nation’s fiscal and social direction, I believe these underlying socio-economic trends we are experiencing are larger and more powerful than any one administration or legislature. Against this backdrop, we’ll explore the economic issues facing our nation and state in the next few posts, leading up to the 2008 elections.

The Shifting Social Dimension

We Boomers, as well as many of our parents, reached adulthood and began our careers and have always worked In an era of social liberalization, a period in which we experienced the introduction of the New Deal, the Great Society, Social Security, Medicare, Medicaid, unemployment insurance, tolerance, civil rights, gay rights, abortion rights, the feminist movement, deregulation, and gun control. What we’re seeing now is the beginning of a movement in the opposite direction, including greater individual responsibility, more religious influence in the political arena, increased focus on family values, less regulation, faith-based initiatives at all levels of government, stronger law enforcement, increased charitable giving, and greater organizational accountability. This trend can be seen by the impact of such influencers as Elliot Spitzer, Sarbanes Oxley, James Dobson, the political clout of the Religious Right, and in Warren Buffet’s gift of his fortune to the Gates Foundation. The impact of the immigration of Latinos to the U.S. (and Texas in particular), with their strong focus on religion and family values, will further propel the trend, which will probably last for decades.

Impact of Socio-Economic Trends on Health Care

While we tend to think of economic policies and social policies as independent of one another, the reality is that social values can significantly impact economic policies and the business environment. Nowhere else will this be more evident than with health care, and how the U.S. deals with the funding of federal health programs, beginning with Medicare and Medicaid. According the GAO in its recent report “The Nation’s Long-Term Fiscal Outlook,” the current federal policy is unsustainable, creating potentially disruptive and destabilizing risks resulting from the large and persistent gap between revenues and spending, primarily for federal health care programs. The report goes on to point out that the gap is too large to grow our way out of, and the only solution is some combination of higher taxes or lower benefits. I believe that intuitively or explicitly, we already knew this to be the case. What we also know is that universal coverage will be a hot topic of discussion in this election year. With over 15% of the population (47 million people) without health insurance, and the cost of quality health care continuing to outpace inflation, we as a society have to address the issue. While none of the Presidential candidates have made an attempt to take a holistic view at government health programs, I don’t believe we can effectively address universal coverage without addressing the viability of the existing federal health care programs, else we risk accelerating and exacerbating existing problems. Medicare is already paying out more than it’s taking in, and a massive number of Boomers will begin to be eligible for coverage in 2011. The Medicare HI Trust Fund will be exhausted by 2019. Which begs the questions that must be asked of the Presidential candidates in 2008:

“How can you talk about universal health coverage without simultaneously addressing the existing federal health programs?” And the next question should be: “Whose responsibility is the funding of health care … individual’s, business’, or government’s?” And force the candidates to address the issues.

The Status Quo

Today’s private health care system in the U.S. is the world’s finest when it comes to talented doctors and nurses, the finest hospitals, and cutting-edge research. However access to top-notch private health care is problematic due to the rising costs, and an increasing number of Americans depend on government assistance. Further, the current system is not based on consumer-based individual accountability. Patients have little sense of the economics underlying their health care decisions, are provided little information with which to make such decisions, have no effective way to shop around, and for all practical purposes, have little incentive to do so. Insurance companies continue to raise premiums until they reach the point where people and businesses can’t afford coverage. Fewer self employed and small businesses are able to provide health insurance for themselves and their employees, and even larger companies are forced to think twice before adding headcount simply due to the cost of insuring their health care. This is why we have 47 million people in the United States without health insurance.

The Inevitable Solution

Republicans and Democrats alike understand the problem. We will see a wide-ranging array of proposals during the election season. Democrats will speak of controlling costs and universal coverage, funded by rolling back the Bush tax cuts. Republicans will talk about expanding coverage via tax incentives, without mandates from the federal government. Regardless of who wins the election and which party controls Congress, there are certain outcomes of the health care debate that seem inevitable in light of the larger socio-economic shifts we are experiencing. With the gravitational pull toward increased personal accountability and responsibility, the ultimate outcome, I believe, will include both increased individual accountability for health care decisions by consumers and increased responsibility for funding one’s own health care for those who can afford it. It will also include improved productivity within the health care sector itself, partially enabled by the digitization of patient records and partially via economic policy incentives that promote innovation. It will also continue to include participation by businesses, which will use health insurance as a recruiting and retention tool in their competition for talent, as opposed to a mandate from union negotiations or from the government. We’ll also see health insurance policies become portable, to enable people to change jobs without losing coverage, especially as the trend of Gen Y individuals changing jobs a dozen times before they turn 35 continues. Government participation will continue to be required to ensure that those who can least afford to care for themselves will not fall through the crack.

I believe we will see legislation in the next four years that allows deductibility of health insurance premiums regardless of who pays them, in effect leveling the playing field between the self employed, small businesses, and major employers, enabling everyone to pay for health insurance with pretax dollars. Just as the deductibility of mortgage interest led to widespread home ownership, the universal deductibility of health insurance premiums will help more Americans afford coverage.

In addition to health insurance, tax-free medical savings accounts for out of pocket medical expenses, will become the norm rather than the exception. It may take the form of today’s Healthcare Savings Accounts or some other form, perhaps in tandem with high-deductible, catastrophic care coverage. In any event, Congress and the next President will realize that if they are going to provide tax incentives to save for college and retirement, it makes no sense to not provide a similar incentive to save for health care. Since IRAs and 401(k)s were invented, the majority of American are accepting responsibility for funding their retirement and now participate in the capital markets. As is the case with both the home mortgage interest deduction and tax deferred retirement savings, Congress knows it can direct the behavior of the population with tax incentives. It will cost the government far less to defer or forego the tax on the earnings from these accounts than let 47 million people go uninsured and then cover their health care expenses with public funds.

Finally, I believe the era of increased individual accountability and responsibility will in turn drive free market forces, competition among providers, and a level of transparency that has not been possible before. We’re already beginning to see web-enabled consumer information about the cost and quality of different providers. Enabling consumers will create market pressures to lower costs and improve the quality of care. This is exactly what we’ve seen with elective procedures like Lasik eye surgery and plastic surgery not covered by traditional health insurance.

Politics As Usual

We’ve seen several health care reform proposals advanced to date by various Presidential candidates. Hillary Clinton has announced a $110 billion plan called American Health Choices that would require everyone to have health insurance, either through their employers or from a Medicare-like government plan. Employers generally would be forced to provide coverage or pay a new tax. Small businesses would be incented through tax credits. Lower income taxpayers would receive a refundable tax credit, while households earning more than $250,000 would have their exclusions capped. Additional funding would come from repealing the Bush tax cuts and from modernization of health care delivery and promoting wellness. Similarly, John Edwards would cover all Americans, asking employers to “do more,” while the government would promote more competition in health care markets. Barack Obama would emphasize reducing costs while taking on the insurance companies and drug companies.

Rudi Giuliani’s focus would be on increasing competition to reduce costs and improve the quality of care. He would promote tax credits for the purchase of health insurance, opposes government mandates, and would expand and simplify health savings accounts. Although Mitt Romney shepherded universal coverage into law in Massachusetts, as President, he would not extend that plan to the entire nation. Rather, Romney’s plan would focus on reforming state insurance markets, allow states to use federal money to design their own programs to expand private insurance, provide portability, and let everyone pay premiums with pretax dollars. John McCain similarly favors limited federal government intervention, opposes universal health care mandates, would provide refundable tax credits, favors portability, and wants to bring greater competition among drug companies.

Conclusion

Personally I look at the various health care reform plans proposed by the Presidential candidates as each candidate’s attempt at differentiation. I find it disappointing that none of the candidates have taken a macro, holistic look at all federal health care programs in aggregate, as we are all aware that the status quo cannot continue indefinitely without reform. While I am certainly no expert in health care economics, I believe that ultimately the underlying shift toward a more conservative overall socio-economic direction will have a greater impact on the eventual health care landscape in the U.S. than the outcome of a single election cycle. At the end of the day, politicians want to either get elected or remain in office and won’t ignore the will of the populace.

The Coming Golden Age (Fifth in a Series)

2007-10-07T16:27:00.000-05:00

In the first three posts in this series, we reviewed the macro, business, regulatory, technology, and people trends affecting our profession. In the fourth post we discussed how I believe these trends will manifest themselves in public accounting firms, and in this fifth and final installment, we’ll take a look at their impact on CPAs in corporations.

While the changes affecting CPAs in public practice seem to make all the headlines in trade journals, I’ll contend that CPAs in the corporate world, specifically those in the CFO, Controller, and Tax Executive roles, have been more dramatically impacted by the trends we’ve been discussing in this series. Simply stated, their roles are shifting in several material respects.

The Brave New World of the CFO

When I began my career in the late 1970s, I observed the corporate CPAs who had reached the top of the ladder in public companies….the CFOs, Controllers, and Tax Executives….and generally sensed they had clearly defined responsibilities: financial types either headed the treasury function, responsible for financing and cash management, or the accounting function, responsible for budgeting, accounting, and financial reporting. The tax executives were responsible for tax compliance and devising schemes to save tax dollars. For those who don’t like change, these were the good old days.

Today, CFOs are increasingly responsible for the execution of the company’s strategy, despite a lack of formal training in this area. While the CFO has historically had a seat at the table, the CEO, with input from the executive committee will typically design the company’s strategy, make the initial round of communications, and then rely on the operational folks, beginning with the CFO, to execute, monitor, and report on its implementation. This frequently involves evaluating future growth opportunities and reviewing the performance of key functions such as research and development and sales and marketing, in addition to the traditional financing, cash management, accounting, and financial reporting functions. For some, this shift in responsibilities has been exhilarating, for others challenging, but in any event, it requires a different set of skills and competencies than those required 10-20 years ago, including a high level of business acumen, analytical, creative problem solving, collaboration, and communication skills.

Another significant shift in responsibilities involves compliance with the proliferation of regulations, both broad-based and industry-specific. In the U.S. alone, over 100,000 regulations have been introduced in the last 25 years, with international regulations creating an exponential effect. Whether they originate at the SEC, FASB, IASB, Sarbanes-Oxley Act, Department of Labor, OSHA, HIPPA, or the Patriot Act, it’s often someone reporting up through the CFO’s chain of command that’s responsible for ensuring compliance. This comes with an overall reduction in materiality thresholds, meaning that companies are requiring greater precision in compliance in order to avoid public disclosure of noncompliance, including restatement of the financials (and the related impact on the stock price that’s sure to follow). The unfortunate aspect of this trend is that CFOs and those in their organizations spend more and more time dealing with investigations and responding to new regulatory challenges, at the expense of the more value-added functions they may prefer to perform.

In this light, I’d like to suggest that risk management has become the new core competency of the corporate CPA. Risk management is light years away from risk aversion, which has defined the comfort zones of many CPAs in the past. Not only does risk management refer to the regulatory-related risks referred to above, but also managing risks associated with information technology and the electronic infrastructure of the business (including its ROI), public relations and other risks associated with executive compensation, and transaction risks associated with investments and mergers and acquisitions. I’ve even heard it said that the CFO’s job description going forward is to make sure bad things don’t happen. It’s no coincidence that this shift in responsibility has come at a time when an ever-increasing portion of a company’s value has shifted from tangible to intangible assets, including brand, customer lists, employee base, and intellectual property. A new paradigm indeed!

In some companies, the risk management function has been formalized in a function increasingly referred to as Governance, Risk Management, and Compliance (GRC). In a way, this emerging GRC focus is the natural extension of Sarbanes-Oxley. The objectives of the GRC function are to (a) align the corporate strategy with an enterprise view of risk management, including compliance with regulatory requirements; (b) turn risk management and regulatory compliance into a coordinated set of processes; (c) test, evaluate, and report on the risk management and compliance processes, and correct problems before they spin out of control.

One manifestation of the emergence of the GRC trend is that the internal audit role is increasing in visibility and importance. In the past, internal auditors focused on fraud detection and financial controls and worked in the background. Today, internal auditing is also focused on meeting SOX and other regulatory mandates, identifying and mitigating operational and I.T. risks, and evaluating and communicating the effectiveness of the organization’s overall risk management efforts. With these additional responsibilities, the demand for internal auditors, particularly those who are certified, has gone through the roof. Just look in the Tuesday Marketplace section of the Wall Street Journal; starting salaries for internal audit managers are at times topping $100,000, and for those who get promoted to Corporate Compliance Officer, their salaries may even double.

Running parallel to the GRC function is the more traditional CFO role of ensuring the company hits its targets. What’s different today is that information travels around the world at the speed of light, suppliers of capital are increasingly global and institutional, and meeting investor expectations is never far from the center of consciousness. In moments of candor, CFOs will tell you that “hitting the target” still overrides everything. Managing risk is simply one of the tools to ensure you get there. Another lever is of course managing costs, which translates in many companies into business process outsourcing, or BPO. Whether it’s customer service, accounting, payables, insurance administration, or human resources, BPO is growing at exponential rates and often managed through the CFO’s office.

Another new frontier for CFOs is investor relations. Many CFOs report spending an increasing amount of their time in face to face meetings with institutional investors, who increasingly demand face time with the CFO to get their information directly from the source.

The New Corporate Tax Function

Looking at the tax function within corporations, we see many parallels to the changing financial and accounting functions. In general, increasing demands and responsibilities, coupled with ever-increasing complexity, define the role of today’s corporate tax executive. They too are keenly aware of the importance of ‘hitting the target,’ and the role that tax accounting plays. Whether it’s the budgeting process or preparing the tax-related financial statement disclosures, managing the effective tax rate (ETR) is the center of their universe. That said, managing the ETR in today’s world is not as simple as it once was, requiring a keen knowledge of the tax accounting rules (FAS 109), compliance with state, local, and international tax return preparation and filing rules, devising and implementing tax saving strategies, managing regulatory audits, and the new skill set for the 21st Century corporate tax executive, tax risk management.

When Sarbanes Oxley came along and required companies to look at how they applied controls to the tax provision under FAS 109, a lot of material weaknesses were identified, which in turn led to new controls, systems, and processes. Tax executives are now a lot more concerned with internal controls and financial reporting, which almost by definition, has to come at the expense of tax planning. They have to be concerned not only with the financial risk but the company’s market risk and thus increased scrutiny by executives, audit committees, tax authorities, regulators, investors, and the media. They are increasingly being evaluated on their risk management, financial disclosure, and communication skills. This increased scrutiny is not all bad. It has created a much higher level of visibility and influence for the tax executives, who are increasingly being asked to communicate tax strategies to non-tax stakeholders, including company executives and directors.

The increased visibility of the tax function, and the increased focus on tax risk management as a key element in the overall enterprise risk management strategy, has been exacerbated by the issuance of FIN 48, which prescribes the criteria for reporting uncertain tax positions (federal, state, or international) in the financial statements. Under FIN 48, all tax positions have to be identified and each has to be evaluated independently…none can be netted. Companies have to assume they will be audited and meet a more likely than not standard to record a tax benefit. The term ‘tax position’ includes a position not to file a return, which is troublesome when dealing with nebulous rules of many state, local, and international jurisdictions. Tax executives describe FIN 48 as something they deal with every day, concerned that uncertain tax positions will generate FIN 48 disclosures that will provide a roadmap for taxing authorities, and that FIN 48 will require reclassifications between current and deferred liabilities and between deferred tax and tax liability accounts.

Amid this increasing complexity, scrutiny, and level of risk, it’s clear to me that many companies will be forced to invest more in their tax function…..increasing budgets for people, training, processes, and technology. Not doing so will only increase the risks they are trying to manage. Attracting and retaining people and developing the new skills needed is as critical to the tax function as to any other part of the business. Managing the ETR, supplying more information to stakeholders, and complying with changing financial reporting requirements, along with the traditional tax compliance, tax planning, and audit management functions, in an environment of increasing transparency, is not for the faint of heart.

Conclusion

We’ve discussed the significant trends facing the CPA profession and the relentless pace of change that is resulting as they take root in corporations. Corporate financial and tax executives are under more pressure than ever and deserve every dime they get paid, and often more! Not only are they performing their traditional roles, but coping with increasing complexity amid increased transparency, often while taking on the role of risk manager. That’s quite a leap from the traditional roles played by CPAs in the corporate world. With all the new responsibilities comes increased visibility, opportunity, influence, and stature. It may be a bit of a stretch, and I may be a bit biased, but I’m beginning to look at CPAs as the new rock stars of Corporate America.

The Coming Golden Age (Fourth in a Series)

2007-07-28T19:08:00.000-05:00

In the last three posts. we’ve reviewed the macro, business, regulatory, technology, and people trends affecting our profession. In this article, we’ll consider how these trends will manifest themselves in public accounting firms, and despite their disruptive nature, lay the groundwork for what should be the best of times for CPAs in the coming years.

Solid Business Climate Will Drive Continued Growth

Some might argue that the best of times have already begun, and who can argue? The national, regional, and local firms that take advantage of scale and leverage to drive growth have enjoyed double digit growth for several years. And given the healthy economic outlook for their business clients, there is no reason to believe that demand for their services will do anything but increase. Among the largest U.S. corporations, 92% of CEOs believe their revenues will maintain or increase in the near future, according to The Business Roundtable’s June forecast. In addition, they indicated their companies are hiring and investing. From a financial executive’s perspective, 67% of CPAs participating in the January 2007 AICPA Business and Industry Economic Outlook Survey are optimistic or very optimistic for their organizations’ prospects, and 68% expect their businesses to expand.

For better or worse, much of the growth currently enjoyed by American business is driven by international trade and investment. In the S&P 500 space, more than half of revenues now come from foreign countries. Foreign earnings by US companies grew 16% in Q1, while their domestic earnings grew 4%. Their overseas capital expenditures grew 18% while their domestic cap-ex grew 9%. And while the S&P 500 grabs the headlines, we’re seeing a definite trickle-down effect, as globalization increasingly creates opportunities for small and midsize American businesses. Case in point: Foreign Trade Zones are stimulating business activity in Texas and across the country; FTZ #196, consisting of 9,600 acres in north Fort Worth, produced $3.8B of products in 2006 (up from $302m in 2005).

Sarbanes Oxley Continues to Ripple Through the Profession

Since its enactment in 2002, Sarbanes Oxley has had a profound impact on the profession. While the breakup of Andersen, the churn of partners and staff, and the changing service mix among national, regional, and large local firms have been the most conspicuous impact, SOX continue to impact the profession in unforeseen and far-reaching ways. At a macro level, SOX has forced corporate governance and risk management into the forefront of American business, ushering in a new core competency for CPAs. The accelerating convergence of U.S. A&A standards with international standards, increased focus on internal controls, risk based audit requirements, more frequent and far reaching GAAP changes, more audits of large private companies owned by private equity firms, and the increase in forensic accounting and fraud detection services all directly or indirectly tie back to SOX and CPAs as professional risk managers.

Tax Planning Opportunities Will Abound

Regardless of how the 2008 elections turn out, Congress will be forced to address a host of issues with significant tax effects. We have simply outlived the days of simple, annual fixes to the alternative minimum tax, as 24 million taxpayers will be hit with the AMT this year, and that number may double in the near future. The 15% maximum rate on dividends and capital gains is scheduled to expire soon. The estate tax will expire after 2009 but return in 2011 at its pre-2001 rates (applying to $675,000 taxable estates with rates maxing out at 55%). These are the knowns, and by themselves are huge in overall significance and could drive tax law changes of the magnitude not seen since the Reagan years. Add health care and social security legislation to the mix, and we could see federal tax law changes of epic proportions over the next five years. Such changes will undoubtedly create many opportunities for CPAs to provide tax planning services to individual and business clients.

The opportunities for tax professionals won’t be limited to the federal tax arena, however. Clients will increasingly need help in international tax matters, driven by the exponential increase in international trade, offshore manufacturing, the international diversification of client investments and offshore assets, the increased scrutiny by the IRS of non-US issues in the post 9/11 world, and FIN 48 exposure of uncertain international tax positions. International trade in particular is a natural adjacent market for CPAs, since tariffs and duties on importing and exporting activities are essentially excise taxes, and proper planning can drive significant savings for companies.

Talent Shortage Will Drive Fundamental Changes

While I don’t have any doubt the demand for CPA services will grow exponentially in light of the healthy business and dynamic regulatory environment, the ability of firms to grow could be significantly constrained by the talent shortage and their reluctance to pursue nontraditional solutions. Conversely, for adaptive firms, the years ahead will offer unique solutions to the staffing shortage. Productivity improvements (increasing output without increasing headcount) via technology may be the most obvious solution. While many firms have made the plunge into LAN-based paperless audit software and document management systems in recent years, we can think of that as Paperless Office 1.0. The day of firm-wide, web-based document management platforms with built in collaboration and workflow tools extending to all engagements and enabled by the imminent explosion of wireless broadband will replace the current generation of locally installed engagement products and become the ‘hub’ of each firm’s operations. Such platforms will usher in a new era of efficiency and productivity improvements, as entire firms standardize on a single platform, accessible from anywhere, anytime, much more secure and cheaper to maintain than their current environments.

Productivity improvements via technological advances won’t be the complete solution to the staffing shortage, however. With the growth opportunities discussed above, generational differences, and the sheer volume of work flowing into CPA firms, adaptive firms will turn to novel work arrangements & online marketplaces as part of the solution to their staffing (and succession) issues. Many industries, from software programming (rentacoder.com) to manufacturing (mfg.com) are currently addressing their manpower needs with online marketplaces that bring together buyers and sellers of talent. In addition to rentacoder.com and mfg.com, think about the technologies developed by websites such as MySpace, eHarmony, Linked In, EBay, and Craigslist that in one way or another connect people, and it’s not a stretch to imagine an online marketplace focused solely on meeting the staffing and succession needs of CPA firms.

The Holy Grail of XBRL

By leveraging XML (Extensible Markup Language), a method for tagging and identifying data so that it can be read by disparate systems, web services may finally deliver the ultimate promise: integration of data, processes and systems. Of special interest to CPAs is the financial reporting version of XML, known as XBRL (Extensible Business Reporting Language), a data tagging system designed to make the analysis and exchange of business and financial information easier and more reliable, even when generated by disparate systems in varying formats. Think of XBRL as bar coding of financial statement data. Information provided in the XBRL format can be electronically extracted, exchanged, and analyzed automatically. The SEC recently announced a $54 million project to extend XBRL tagging technology to financial statement disclosures, management’s discussion and analysis, and to the unique accounting aspects of six distinct industries. Public companies will soon be required to submit SEC filings in XBRL, and banks and credit agencies will soon require XBRL as well. Software developers are adding XBRL capabilities to their products, and it will soon be essential for CPAs to learn to manipulate and analyze XBRL data within their clients’ accounting systems and financial reports. For those CPAs who embrace it, XBRL will enable them to take financial analysis, whether for audit engagements, financial consulting, business valuations, or helping clients with regulatory or banking filings, to a totally new level. XBRL will not be the sole domain of CPAs however, as bankers, consultants, analysts, and other users of financial information will be quick to provide enhanced financial analysis as well.

Conclusion

We’ve discussed the significant trends facing the profession and the relentless pace of change that is resulting as they take root in accounting firms. To condense it all into one brief elevator speech is impossible. However, upon closely analyzing these trends, my concluding takeaways with respect to CPA firms are as follows:

Understand that risk management has become a common and visible requirement in business today, and that risk management is the new core competency for CPAs.
Don’t ignore globalization, regardless of your size of firm and area of practice.
Firm-wide, web-based document management systems with collaboration features and workflow tools will become the hub of activity for firms where standardized workflow and economies of scale matter.
If you’re affected by the talent shortage, be open to new web-based staffing solutions that are sure to emerge.
Embrace XBRL and take advantage of the opportunities it creates to add value.

Our final column in this series will focus on the impact of these trends on CPAs in industry, specifically corporate tax departments and CFOs and controllers. Stay tuned!

The Coming Golden Age (Third in a Series)

2007-07-08T16:45:00.000-05:00

In the last two posts, we’ve reviewed the macro trends, business trends, regulatory trends, and technology trends affecting our profession. In this post, we’ll take a look at some emerging people and management trends that are creating discontinuities but also opportunities for proactive CPAs looking for ways to improve their effectiveness and competitiveness.

Labor Markets, Demographic Trends, and Innovative Solutions

The single most impactful trend I foresee in the U.S. is the continually tightening labor markets, particularly in knowledge-intensive industries. CPAs, of course, have been feeling this for years, and it may well get worse before it gets better, as the majority of CPAs will be eligible to retire within the next 10 – 15 years. Accordingly, locating, recruiting, hiring, training, and retaining talent is the most critical issue we will face in the years ahead. Not limited to the accounting profession, the talent shortage will eventually eclipse the escalating cost of health care as American business’ number one issue. (Who cares how much it costs to insure workers if you can’t find the workers to begin with?)

The increasingly tight labor market will transform the human resource function from protecting businesses from employee litigation to workforce planning and talent procurement and management. Many businesses will realize that they are better off re-educating and re-training existing workers. Others have developed an open business model approach to staffing with remote work arrangements and independent contractor pools no one would have imagined a decade ago. An increasing number turn to low cost offshore talent, with the market for global finance and accounting outsourcing set to grow 30% this year. Other businesses look to bring in knowledge workers from outside the U.S., but that solution is structurally limited, as the U.S. government issues only 60,000 H-1B visas a year, far short of demand for highly educated, specialized knowledge workers.

Talent Management

Recruiting workers is just the first step, however. The Knowledge Economy will require new and unique approaches to managing people. Knowledge workers are the most important assets of companies in the 21st Century, and management’s job is to preserve the assets of the business and do what is needed to increase the productivity of its assets. Accordingly, managing (and improving) knowledge worker productivity will be the number one management challenge of the 21st Century, in an environment where workers:

are immersed in information in every task they perform;
continuously seek an enhanced level of decision support; and
multi-task up to “31 hours a day.” (According to a New York Times survey of how knowledge workers spend their time, results actually exceeded 24 hours worth of work each day.)

Workers in corporations are spending an increased amount of time gathering (as opposed to analyzing) information, and today spend over 12 hours a week on all information tasks. Accordingly, part of the solution to the productivity challenge will undoubtedly be digital tools and applications that reduce task time and make information more relevant and easier to use. In the CPA’s world, workflow platforms that integrate research, return preparation, and document management are redefining the tax return preparation workflow. Similarly, broadband cellular communications capabilities are quickly becoming the defacto standard for auditors, enabling a virtual auditing environment.

Generational Challenges

If managing knowledge worker productivity is the number one management challenge for employers, managing multigenerational differences may well be number two. We have the “digital natives” entering the workforce, and the “grey ceiling” keeping older workers from exiting and limiting the upward mobility of those Gen Xers caught in the middle. What an interesting paradox! On the one hand employers are facing a talent shortage of epic proportions, and part of the solution is hiring and training these digital natives (aka Millennials) with their free agent, gaming mentality and expectations of instant communication capabilities and ubiquitous availability of information. They think in a non linear, non-hierarchical manner, which for older managers who think and act in a more traditional, structured way, often creates communication challenges. On the other hand, we have 78 million Baby Boomers who are living and working longer and blocking the career advancement of the younger workers. Employers are getting nervous about a potential “brain drain” when Boomers do retire, as the Gen Xers coming along behind are far fewer in number and feeling squeezed from both directions.

24/7 Expectations

Another trend to note is the increasing blur between work time and personal time. While Blackberries are not exactly new, they are increasingly a source of frustration for employees (and family members) who can’t ever seem to leave it at the office. The Wall Street Journal recently ran a story about corporate-issued iPODs that enable employees to access the latest directives from senior management, HR policies, training courses, and product information. As companies increasingly expect employees to be available 24/7, we’ll see increasingly sophisticated personal communication devices that integrate phone, email, calendars, technical (e.g., tax and accounting) information, news, and your favorite blogs. In the media of your choice!

Conclusion

We’ve now discussed the significant trends facing the profession. There is no doubt the pace of change is relentless. It’s also accelerating, yet client and employer expectations are higher than ever, and we’re discovering new management challenges that didn’t exist before. In future posts we’ll discuss how these trends will manifest themselves in accounting firms and in the corporate world, and despite their disruptive nature, creating the best of times for CPAs. Stay tuned!

The Coming Golden Age (2nd in a Series)

2007-03-31T13:46:00.000-05:00

In our last post, I submitted an hypothesis that the next five years may well be the best of times for CPAs. Why am I so optimistic? From an entrepreneurial perspective, we are beginning a period of accelerating change in our profession, and entrepreneurial CPAs know that change creates discontinuities for their clients and employers, providing new, exciting opportunities to add value for those who can spot them. Looking beneath the covers at the causes of change, we reviewed the macro trends, current business trends, and regulatory trends creating change in our last post. However, no discussion of change would be complete without a review of technology trends and people / management trends, which will be the subject of this post. We’ll tie it all together in an upcoming post with a look how these trends will manifest themselves in CPA firms and in the corporate world.

Technology Trends

At least one recent survey showed the percentage of CPAs with broadband Internet access exceeding 90%. With this proliferation of bandwidth and with the cost of storage shrinking to immaterial levels, the Internet will soon be faster and cheaper than a desktop’s CPU. This may be the tipping point at which time the masses switch to a true browser-based computing environment, where all applications are accessed within a web browser and data is stored on a commercial server, not on a local hard drive. With data tagging mechanisms like XML (and its financial reporting derivative XBRL) in place, people will theoretically be able to work anywhere, anytime, on any type of device, and data from disparate systems will be compatible, enabling workers and investors to look at and use information in new and different ways.

The media likes to collectively refer to a number of intriguing developments in the Internet world as Web 2.0. To most people, this refers to user-created content like blogs, podcasts, wikis, and YouTube, where people upload video, photos, audio, and text. The most common applications are consumer-oriented and have become such a powerful social phenomenon that Time magazine recognized “You” as its 2006 Person of the Year. The Web’s potential to harness collective intelligence of communities of people, described in a book titled The Wisdom of Crowds, is powerful enough to impact the stock market and political campaigns, and is beginning to appear in business settings. Companies are using blogs for marketing, advertising, and public relations. Intuit launched Tax Almanac, a wiki-based tax site that currently claims to have over 38,000 articles, where tax practitioners, academicians, and others can post their favorite tax strategy or interpretation of the tax code and see it reviewed and edited over time by a community of users. U.K. publisher Pearson has partnered with the Wharton School and MIT to create a business book being developed using Wiki technology. The site is open to anyone, and all the key leaders had to do was choose the chapter headings to create a starting point.
Another common Web 2.0 phenomenon is the emergence of social networking sites such as MySpace and Facebook which are connecting students and an increasing number of adults who use these personalized websites to chat, exchange photos, and collaborate. Social networking is spreading like wildfire in the business world, with business networking sites like LinkedIn, which works like a digital Rolodex, allowing its nine million users to post biographical information and contact lists and link to their contacts’ contacts, looking for jobs, expertise, service providers, sales leads, etc. Big 4 accounting firms have created recruiting pages on Facebook targeting prospective applicants. Users are able to tag specific skillsets or interests and can even add video clips to their profiles. IBM has developed its own internal social networking system that connects over 300,000 employees and points to rising productivity as a direct result. Social networking technology has also entered the stodgy investment world, where collaboration sites allow investors to communicate with and even rate each other’s recommendations and performance.
It’s not a stretch to see how these applications can increase productivity and even extend the reach of local and regional CPA firms, for example, if a collaboration site were established for a CPA association that linked CPAs from all member firms to share expertise and referrals. Check out Microsoft Sharepoint, an online service that allows workers to create project-specific websites where they can store and share documents, link to other sites, communicate with team members, etc. Microsoft recently launched a beta site described as a “MySpace for financial professionals,” targeting corporate controllers and financial managers and featuring blogs, forums, data tagging, and other collaboration features.
Web 2.0 also includes software services like RSS feeds and mashups, which expose their content and functionality in a way that allows other applications to leverage and use them. RSS (Really Simple Syndication) technology is the Internet's answer to the notification needs of individuals and organizations, as people use it to connect data and systems. You can subscribe to immediate updates from various information sources, from blogs to news to sport scores to traffic and weather forecasts. You can even get the latest tax and accounting developments emailed directly to your handheld device.

Finally, Web 2.0 includes rich internet applications that allows websites to provide the level of interactivity and speed that people expect from desktop applications. This has been a big focus of Google with G-Mail, Google Calendar, Google Spreadsheets, and Google Notebook. Microsoft is developing new applications that will run on a new hybrid local drive - web platform. The first product based on this hybrid model is Windows Live, a Web site launched late last year that includes Microsoft’s new search service along with news and e-mail. Using Windows Live, Microsoft is hoping to provide online e-mail for large organizations. The value proposition is to use Windows Live technology to host e-mail so that companies don't have to operate and maintain their own servers, as they historically have with Microsoft Outlook. In contrast, Microsoft is planning to use its own servers to offer customers huge amounts of online storage of digital data. It even has a name for that future service: Live Drive. With Live Drive, all your data – client information, videoconferences, webcasts -- will be accessible from anywhere, on any device. While these applications may be months or even years away from widespread adoption by corporate America, I wouldn’t bet against them taking off in the next few years either.

By leveraging XML (Extensible Markup Language), a method for tagging and identifying data so that it can be read by disparate systems, web services will finally deliver the ultimate promise: integration of data, processes and systems. We are moving into a world of shared standards, which is to say that businesses have realized that if they play by the same rules as everyone else, everyone is better off. Before, disparate software systems, such as a company’s ERP, CRM, and supply chain software could not share data or work together, let alone work with systems of other companies. That’s all changing as companies and software standardize on XML. Of special interest to CPAs is the financial reporting version of XML, known as XBRL (Extensible Business Reporting Language), a data tagging system designed to make the analysis and exchange of business and financial information easier and more reliable, even when generated by disparate systems in varying formats. Information provided in the XBRL format can be electronically extracted, exchanged, and analyzed automatically. The SEC recently announced a $54 million project to transform the financial statements in its Edgar database into XBRL-based interactive information. Banks and credit agencies will also require information to be submitted in XBRL. Software developers are adding XBRL capabilities to their products, and thus it will soon be essential for CPAs to learn to manipulate and interpret XBRL data within their clients’ accounting systems and financial reports.

In 2007, the big news will be the release of Microsoft Vista and Office 2007. While Vista has been described as nonexciting by pundits and techies alike, the fact remains that 95% of the world’s computers run on Windows, and with a new user interface and navigational system, believe me, this will be a big event in both corporate America and in households around the world. Although we haven’t seen people standing in line outside computer stores like we did in 1995 when Microsoft first released Windows to the Rolling Stones playing “Start Me Up,” all of us will either upgrade directly or acquire Vista the next time we upgrade computers. Vista reportedly offers enhanced graphics, improved security, faster searching over both the hard drive and the Internet, improved synching, collaboration tools, and improved multimedia capabilities, and will be the platform on which Office, Outlook, and all of our other desktop applications reside.
And it’s worth pointing out that XML is the default data format in Office 2007’s versions of Word, Excel, and Powerpoint.

People Trends and Issues

The single most impactful trend I foresee in the U.S. is the tightening labor markets, particularly in knowledge-intensive industries. CPAs have been feeling this for awhile, for various reasons we don’t need to get into here. I can tell you from first-hand experience, locating, recruiting, hiring, training, and retaining talent is to me becoming the most critical issue U.S. businesses will face in the years ahead and will eventually eclipse the escalating cost of health care as American business’ number one issue. (Who cares how much it costs to insure workers if you can’t find the workers to begin with?)

The increasingly tight labor market will cause a transformation of the H.R. function within U.S. businesses, from protecting companies against employee litigation to workforce planning and talent procurement and management. Many companies will realize that they are better off re-educating and re-training existing workers. Others have developed a global staffing approach with remote work arrangements no one would have imagined a decade ago. An increasing number turn to low cost offshore talent, with the market for global finance and accounting outsourcing set to grow 30% this year. Other businesses look to bring in knowledge workers from outside the U.S., but that solution is structurally limited, as the U.S. government issues only 60,000 H-1B visas a year, far short of demand for highly educated, specialized knowledge workers.

Recruiting workers is just the first step, however. The Knowledge Economy will require new and unique approaches to managing people. Knowledge workers are the most important assets of companies in the 21st Century, and management’s job is to preserve the assets of the business and do what is needed to increase the productivity of its assets. Accordingly, managing (and improving) knowledge worker productivity will be the number one management challenge of the 21st Century, in an environment where workers:

are immersed in information in every task they perform;
continuously seek an enhanced level of decision support; and
multi-task up to “31 hours a day” (according to a New York Times survey of how knowledge workers spend their time).

Workers in corporations are spending an increased amount of time gathering (as opposed to analyzing) information, and today spend over 12 hours a week on all information tasks. Accordingly, part of the solution to the productivity challenge will undoubtedly be tools and applications that reduce task time and make information more relevant and easier to use. In the CPA’s world, tax workflow applications that integrate research, return preparation, and document management are redefining the tax return preparation workflow. Similarly, broadband cellular communications capabilities are quickly becoming the defacto standard for auditors, enabling a virtual auditing environment.

If managing knowledge worker productivity is the number one management challenge for employers, managing multigenerational differences may well be number two. On the one hand we have the “digital natives” entering the workforce, and the “grey ceiling” keeping older workers from exiting and limiting the upward mobility of those Gen Xers caught in the middle. What an interesting paradox! On the one hand employers are facing a talent shortage of epic proportions, and part of the solution is hiring and training these digital natives (aka Millennials) with their free agent, gaming mentality and expectations of instant communication capabilities and ubiquitous availability of information. They think in a non linear, non-hierarchical manner, which for older managers who think and act in a more traditional, structured way, often creates communication challenges. On the other hand, we have 78 million Baby Boomers who are living and working longer and blocking the career advancement of the younger workers. Employers are getting nervous about a potential “brain drain” when Boomers do retire, as the Gen Xers coming along behind are far fewer in number and feeling squeezed from both directions.

Another trend to note is the increasing blur between work time and personal time. While Blackberries are not exactly new, they are increasingly a source of frustration for employees (and family members) who can’t ever seem to leave it at the office. The Wall Street Journal recently ran a story about corporate-issued iPODs that enable employees to access the latest directives from senior management, HR policies, training courses, and product information. As companies increasingly expect employees to be available 24/7, we’ll see increasingly sophisticated personal communication devices that integrate phone, email, calendars, technical (e.g., tax and accounting) information, news, and your favorite blogs. In the media of your choice!

Conclusion

We’ve now discussed the significant trends facing the profession. There is no doubt the pace of change is relentless. It’s also accelerating, yet client and employer expectations are higher than ever, and we’re discovering new management challenges that didn’t exist before.

In our concluding article we’ll discuss how these trends will manifest themselves in accounting firms and in the corporate world, and despite their disruptive nature, creating the best of times for CPAs. Stay tuned!

The Coming Golden Age (First in a Series)

2007-02-24T13:05:00.000-06:00

The accounting industry trade journals and MAP conferences these days are replete with fearless forecasts by peerless prognosticators, eager to tell everyone What’s going to happen next. All too often, however, we don’t take the time to understand the Why behind the What. In the next few posts, we’ll take a look at certain trends that are shaping What our profession will become over the next five years, and Why it’s happening now.

Relentless Change

While the current business environment and demographics are strong, the pace of change in business today is relentless. Some people view this rapid, continuous pace of change as breathtaking and exhilarating, albeit at times disruptive. These are the people who pick up the newspaper each day looking for opportunities, and always seem to come at the world with a glass-half-full outlook. For those types of people, being a CPA during the next five years may well be the best of times. Why do I seem so optimistic, when most of the forecasters focus on staffing shortages and an impending succession crisis, not to mention standards overload and workload compression? First, keep in mind that I’m speaking about those who look at change as opportunity, because they know that change creates discontinuities for their clients and employers, providing new, exciting opportunities to add value for those who can spot them. Accordingly, let’s look beneath the covers at the underlying trends, or causes of change, beginning at a macro level. With that background, we’ll be better equipped to understand What will happen in the next few years and Why I feel so optimistic.

Macro Trends

In a previous post, I introduced the concept of the Knowledge Economy, a global, boundryless economy driven by the use of information, as opposed to property, plant, and equipment, to produce economic benefits. In this Knowledge Economy, the ease of access to information and developing knowledge, especially when leveraged by communication technologies, will raise the bar for everyone, including CPAs. Because information – the key natural resource in the Knowledge Economy -- is so abundant, the ability to effectively filter the mass quantity of information available and focus on quality information that is relevant to clients, lenders, investors, and government agencies – will be a core competency required of CPAs, as will effective communication skills.

In this Knowledge Economy, geography is simply not a constraint on economic activities. Goods and services can be developed, bought, sold, and in the case of many CPA services, delivered online over secure electronic networks. Location often doesn’t matter. For that reason CPA firms of all sizes can outsource work around the corner or around the world, can provide more flexible work arrangements and telecommuting, and can just as easily provide services to clients in far away locations as to clients next door.

Today’s Business Environment

As I mentioned in this column a year ago, I believe we are on the cusp of a great new wave of economic growth to be sparked by the convergence and exponential effect of the various trends cited in Thomas Friedman’s book, The World Is Flat. In the past 5 years we’ve seen isolated trends like open sourcing, insourcing, supply-chaining, off-shoring, and mobilization enabled by personal wireless technology. We’re beginning to see the confluence of all these trends and the exponential impact that such synergies will create. It’s a pretty exciting time, and assuming no cataclysmic event, a reason for optimism. Layer on top of that some interesting demographic data espoused by Harry S. Dent, author of The Great Boom Ahead and The Roaring 2000s. While most of the media attention is on the impact of the retiring baby boomers and their impact on the workplace and government entitlement programs, Dent suggests that it will be during the years 2008-2012 that the majority of boomers reach their peak spending years. And yes, the first boomers (born in 1945) reached 60 in 2005, but they don’t seem to be retiring in droves. To the contrary, with longer life expectancies, low savings rate, decline of corporate welfare (defined benefit pensions and retiree health care) and unending increases in the cost of health care relative to inflation, boomers will be working longer and saving more over the next 10-20 years.In the more immediate future, one group I pay attention to is The Business Roundtable, comprised of CEOs of the nation’s largest 160 companies representing over 10 million employees and $4.5 trillion in revenues. They foresee steady economic growth in 2007, with 69% expecting their revenues to increase, 87% planning to increase or maintain their capital spending levels, and 77% planning to increase or maintain hiring levels. These are the guys whose jobs are on the line (CEO turnover is about like that of baseball managers), so I place high stock in their collective wisdom. Also in the near term, just about everyone sees continued growth in M&A activity in general and private equity in particular. The huge increase in private pools of capital in the past decade has created a fertile environment for the Blackstones, Texas Pacifics, and Bain Capitals of the world to thrive. They have lots of cash, and in 2007 we’ll see not only more deals and bigger deals, but probably more unsolicited, or hostile deals (Barbarians At The Gate II ?). As for “hot” industries, I call them the Big 4 --- alternative energy, biotech, financial services, and business productivity improvement---these will all remain hot in terms of investment activity and overall opportunity for the foreseeable future.

While the Knowledge Economy certainly creates opportunities for those who see them, it also creates a Darwinian business environment where competitors can develop improved capabilities in fairly short order, and globalization, deregulation, and commoditization can quickly eliminate a business’s competitive advantages. Cycle times – the time it takes to go from start up to boom to bust – are shorter than ever. As a result, many companies – our clients and employers -- have to continuously reinvent themselves in order to survive. Some are simply better at this than others. Pattern recognition skills at the senior management level are key.

The Tax and Regulatory Environment

2007 brings with it a unique political environment in Washington. Amid early pledges of bipartisanship, there is no doubt that everything that happens in the next two years will be done with an eye on the 2008 elections. There is also the inescapable reality that at least three major events will occur by the end of this decade that will alter the federal tax landscape in a big way:

– The AMT will soon ensnare more than one in four American taxpayers, and the eight states with the highest percentage of filers subject to AMT all voted heavily Democratic in 2006;

– The Bush tax cuts, particularly the 15% maximum rates on dividends and capital gains, will expire after 2010;

– The estate tax is scheduled to expire at the end of 2009 and will then be reinstated in 2011at its pre-2001 rate structure.

These are only the givens. Health care and social security reform are also on the radar screen and will certainly be hot topics of debate until the elections in 2008. While we can’t predict which way the political winds will blow, it isn’t a stretch to assume the impact of whatever legislation is enacted to address these issues will be far reaching for taxpayers and tax practitioners at all levels.

Not to be outdone, accounting and auditing practitioners face their own set of cataclysmic events during the next few years.

– FASB Codification – FASB plans to develop a single, topically organized codification that integrates all existing GAAP. There are currently over 20 types of accounting and financial reporting literature (including APB, FTB, FIN, FSP, AIN, EITF, SOP, SFAS, TIS, AICPA PB, ARB, AICPA Audit Risk Alerts, AICPA TIS, AICPA Audit and Accounting Guides, and numerous SEC materials). All of these will be incorporated into a single codification in which FASB will reduce the GAAP hierarchy from four levels to two – authoritative and non-authoritative, the codification will become the sole source of all authoritative GAAP, and all prior guidance will be superseded. FASB’s current schedule is to release a draft by late 2007 for verification, with the final codification available in 2008.

– FASB Conceptual Framework - To be principles-based, standards cannot be a collection of conventions; rather, they must be rooted in common fundamental concepts. Also, a common FASB/IASB conceptual framework promotes international convergence. This project has eight phases that will extend over the next several years.

– FASB/IASB Convergence – Approximately 11 joint projects are currently underway, including Revenue Recognition, Earnings Per Share, and Income Taxes. Converged standards tend to be somewhat more complex, and principals-based standards create a need for interpretive guidance.

– Fair Value Reporting – FAS 157 will be effective for fiscal years beginning after November 15, 2007 and for interim periods within those fiscal years. It establishes a framework to measure fair value within GAAP. Over 60 other standards, interpretations, and staff positions refer to fair value, and approximately half of those are changed by this standard, increasing both the subjectivity and complexity of GAAP standards.

– Differential GAAP – This Committee on Private Company Financial Reporting is not set up to create a separate, new set of GAAP requirements for private companies, but to provide input from a private-company perspective and embed differential reporting requirements within the standards. This will lead, in some cases, to different reporting requirements for public and private companies.

– Audit Risk Assessments -- The eight new audit Risk Assessment Standards are effective for 2007 year-end audits of nonpublic companies and is the most pervasive change in fundamental audit methodology in many years.

– FIN 48 – GAAP financials must include tax positions that the company feels are more likely than not to hold up upon audit (e.g., by the IRS, state, or international taxing authority). For purposes of this calculation, companies have to assume they will be audited and all tax positions challenged, with full knowledge of all relevant information by the taxing authorities. Onerous disclosure requirements will create an audit roadmap.

– PCAOB – The previous PCAOB standard was Auditing Standard No. 2 and referred to as AS2. The revised standard is being referred to as AS5. All PCAOB standards must be approved by the SEC.

Conclusion

While a deep understanding of the macro trends, current business trends, and regulatory trends are certainly important to CPAs, the discussion would not be complete without a review of the concurrent people trends and technology trends. Those trends will be the subject of future posts, and we’ll tie it all together with a look how these trends will manifest themselves in CPA firms and in the corporate world. Stay tuned!

2007 Forecast----The Clouded Crystal Ball

2007-01-07T16:18:00.000-06:00

Looking back at our 2006 forecast (something most prognosticators never do), we see that we were mostly on target. A year ago we forecast that:2006 would be a great year. More specifically, we forecasted:· no slowdown in economic or corporate profit growth,· an end to the interest rate hikes,· an improved situation in Iraq,· stabilizing if not declining energy prices,· strong corporate balance sheets,· a pick-up in capital spending and hiring, and· a pro-business Supreme Court.With the exception of Iraq, we were right on target. We said that stocks would to do very well, especially international stocks with a built-in boost from exchange rates. The Dow rose 16.3%, the S&P 500 rose 13.6%, and the NASDAQ rose 9.5%. Foreign stock mutual funds grew 23%. This was when the Wall Street experts’ consensus forecasted about 7% gains, so I’m feeling pretty good for the second year in a row. We also forecasted that the housing market would cool and perhaps decline a bit in the Northeast and California, again, right on target.

Regarding politics, we predicted very slight Democratic gains at both the state and the national levels, and that the overall balance of power would not change. We missed that one, probably as a result of my feeling about the situation in Iraq improving.

So where are we heading in 2007, now that I’m on a roll. The consensus of the “experts” points to a U.S. economy growing 2.6%, corporate profits slowing to 5.5% growth rate, inflation at 2.5%, flat-to-slightly declining interest rates, a 4.8% unemployment rate at the end of 2007, and home prices declining 1.7%, all according to a Business Week survey of major financial institutions and investment houses. To add some perspective, the historical GDP growth rate has been 3.1%, the current unemployment rate is 4.5%, The S&P’s P/E ratio is 17.8, down from 18.4% a year ago, but still a little ahead of historical averages of 16%.

As I mentioned a year ago, I believe we are on the cusp of a great new wave of economic growth to be sparked by the convergence and exponential effect of the various trends cited in Thomas Friedman’s book, The World Is Flat. In the past 5 years we’ve seen isolated trends like open sourcing, insourcing, supply-chaining, off-shoring, and mobilization enabled by personal wireless technology. We’re beginning to see the confluence of all these trends and the exponential impact that such synergies will create. It’s a pretty exciting time, and assuming no cataclysmic event, a reason for optimism. Layer on top of that some interesting demographic data espoused by Harry S. Dent, author of The Great Boom Ahead and The Roaring 2000s. While most of the media attention is on the impact of the retiring baby boomers and their impact on the workplace and government entitlement programs, Dent suggests that it will be during the years 2008-2012 that the majority of boomers reach their peak spending years. And yes, the first boomers, born in 1945 reached 60 in 2005, but I haven’t noticed them retiring in droves. To the contrary, with longer life expectancies, low savings rate (reportedly), decline of corporate welfare (defined benefit pensions and retiree health care) and unending increases in the cost of health care relative to inflation, boomers will be working longer saving more over the next 10-20 years.

The youngest boomers, born in 1964, are in their early 40s. Dent believes that as a result of these demographics, we are on the greatest economic boom in history, and while he has proved to be very prophetic and directionally correct with most of his predictions, I’m not going that far. But I will tell you I feel darn good about things heading into 2007. This is based on a global perspective, and I can tell you that while I’m generally a “slow and steady wins the race” kind of guy, I currently have more than 34% of my nest egg in international stocks and am thinking about increasing that. With Latin America mutual funds up 40%, Pacific/Asia (excluding Japan) up 34%, Europe up 31% in 2006, with the dollar continuing to fall against foreign currencies, international investing is where the real action will be in 2007.

Domestically, I don’t take exception to the consensus of the experts discussed above. The Business Roundtable, comprised of CEOs of the nation’s largest 160 companies representing over 10 million employees and $4.5 trillion in revenues, forecasts slightly lower but steady economic growth in 2007 (2.8% GDP increase), with 69% expecting their revenues to increase, 87% planning to increase or maintain their capital spending levels, and 77% planning to increase or maintain hiring levels. These are the guys whose jobs are on the line (CEO turnover is about like that of baseball managers), so I place high stock in their collective wisdom. They point to rising health care as by far their greatest cost pressure, with increased energy prices a distant second. Part of the solution to the health care situation, according to The Business Roundtable, is better information technology (e.g., electronic medical records) and improved transparency over the flow of money within the health care system and not things like government price controls on pharmaceutical companies that have proved to not work.

As for 2007 trends, just about everyone sees continued growth in M&A activity in general and private equity in particular. The huge increase in private pools of capital in the past decade has created a fertile environment for the Blackstone Groups, Texas Pacific Groups, Bain Capitals and investment banks of the world to thrive. They have lots of cash and lots of people are getting rich I assume. While there are certainly pros and cons to the private equity movement, those of us who have been around the block a few times know from experience that what goes up……. See my previous post on private equity if you really want to know what I think. What 2007 will bring is not only more deals and bigger deals, but also more unsolicited, or hostile deals as buyers awash with cash look for ways to put their money to work (Barbarians At The Gate II).

As for “hot” industries, I don’t see it changing from the Big 3 --- alternative energy, biotech, and business productivity improvement---for many years.

The biggest new trend I foresee in the U.S. is the tightening labor markets. CPAs have been feeling this for awhile, for various reasons we won’t get into here. But I can tell you from first-hand experience, locating, recruiting, hiring, training, and retaining talent is, to me, becoming the most critical issue U.S. businesses will face in the years ahead and will eventually eclipse the escalating cost of health care as American business’ number one issue (who cares how much it costs to insure workers if you can’t find the workers to begin with?). This trend will cause a transformation of the H.R. function within U.S. businesses from protecting companies against employee-driven litigation to workforce planning and talent procurement and management.

Our economy has clearly evolved into a service-based economy, and beyond that, into an information-driven, or knowledge economy (see my previous post titled “The Knowledge Economy.”) The tight labor situation will inevitably drive up wages and salaries and create inflationary pressures by driving up prices where competitive forces allow. The higher wages and salaries (up 7%-9% for certain skilled workers in certain industries) will also negatively impact corporate profit margins, because not all the increases can be passed through to customers via price increases. This is another reason, in addition to the falling dollar, to look at investing globally. While many developed nations are in the same boat, or worse, many emerging markets have plentiful labor pools, fewer regulatory issues, and a newfound entrepreneurial culture driven by the flattening world described by Thomas Friedman.

In the technology world, we’ll continue to see the advancement of what some call Web 2.0, including the prominence of user-created content like blogs, wikis, mashups, and the like. The social networking concept will hit the business world, with business networking sites like LinkedIn, and the investment world, with sites that provide a forum for investors to communicate with and even rate each other’s recommendations and performance. We are approaching a day where the cost of storage and bandwidth becomes a nonconsideration, along with exponential growth and worldwide availability of bandwidth. What this means is that it will soon be cheaper and faster and easier to use software on the web than software on PCs, and with data tagging mechanisms like XML (and its financial reporting derivative XBRL), in place, the game will change. People will be able to work anywhere, anytime, on any type of device, and data from disparate systems will be compatible, enabling workers and investors to look at and use information in new and different ways. In 2007, the news will be the release of Microsoft Vista and Office 2007. Believe me, this will be a big event in both corporate America and in households around the world. Collaboration platforms, or virtual workspaces, will spread like wildfire, with Microsoft Sharepoint a likely must-have tool by the end of 2007.

As mentioned above, we correctly forecasted that the housing market would cool and perhaps decline a bit in 2006. Again, no stroke of genius……what comes up, must come down. While the middle part of the country has not seen the stratospheric growth in home prices that those on the left and right coasts have experienced, we’ll all be affected by the housing market’s slowdown, as foreclosures are way up (even here in Fort Worth), lending practices are tightening (it’s about time), and the cash-out refinancing boom is over for the most part. This translates into lower consumer spending and lower corporate profits, since over 70% of the economy is driven by consumer spending. This is one of the reasons why the GDP is expected to grow less than 3% in 2007.

Will the Fed lower rates to stimulate the economy? Or will it raise rates due to the inflationary pressure caused by the tight labor markets. The smart money says they will wait and see for at least Q1 and possibly Q2 and see which of these forces has the stronger gravitational pull.

In conclusion, in my clouded crystal ball (with due credit to Dave Campbell), we see a domestic economy coming out of 2006 with a fair amount of momentum, but with an emerging labor shortage that creates both inflationary pressure and a constraint on corporate profit growth. We also see the slow-down in the housing market leading to more foreclosures and fewer cash-out refinancings, in turn leading to a slowdown in consumer spending and even more pressure on business to keep the economy humming. Businesses will keep spending, particularly in the IT and employee recruitment and training areas, and for U.S. exporters, additional plant and equipment. We don’t see any movement in interest rates, in either direction, in the first part of the year, as competing pressures leave the Fed without any clear direction. And all this translates into two basic thoughts for investors……moderate growth in U.S. stocks, a stable bond market for the first half of the year, and above-average (and perhaps way above average) gains from investing internationally. And as for politics, while nobody will win from two years of gridlock, everything will be about 2008.

Talk to you then.

The Knowledge Economy

2006-12-23T19:11:00.000-06:00

In our careers, we Baby Boomers have seen the U.S. economy evolve from a domestic, manufacturing-based economy to a global, information-based economy driven by the use of knowledge, as opposed to property, plant, and equipment, to produce economic benefits. In contrast to traditional economic principles, the information, or knowledge-based economy is based not on scarcity, but on abundance, thus turning traditional economic principles upside down. I get the sense we are just beginning to see the far reaching effects of this evolution, and CPAs, as knowledge workers, need to understand and plan for its impact. In this post, we’ll look at a few of the ways the knowledge economy is affecting our profession.

Higher Expectations

In a March 2006 survey of global business executives by the McKinsey Quarterly, the greater ease of obtaining information and developing knowledge was cited as the most important business trend shaping global businesses in the next five years. This trend, according to the survey, particularly as it is impacted exponentially by communication technologies, will have the effect of raising the bar for everyone.

CPAs, of course, have always been considered knowledge workers, but I don’t believe there is any doubt that expectations of clients, employers, and the general public has increased in recent years. Clients and employers have always expected CPAs to know their stuff, and indeed, it was the body of rules and standards, along with an overriding set of ethical principles, that established accountancy as a profession. In today’s world, however, it is not enough to simply know the rules. In our profession, just as in medicine and law, there is an infinite amount of information available to anyone, and instantaneous access to that information is universal. Accordingly, our clients and employers will no longer turn to CPAs information…..they are looking to us for knowledge. Compliance services, where the work product is a financial statement that few clients can easily understand or a tax return that is e-filed directly from the preparer’s computer to a government agency, can no longer be the end game. The key for making the leap from information provider (e.g., home mortgage interest is deductible) to knowledge provider (while home mortgage interest is currently deductible, there are proposals in Congress that would limit the deductibility of interest, and if that happens, the demand for housing could soften and the price of building materials could fall) is the ability to effectively filter the mass quantity of information available and focus on quality information that is relevant to clients, lenders, investors, and government agencies. It may result in a new business reporting model containing less complex and more useful information, including nonfinancial information.

The Management of Knowledge Workers

The knowledge economy will require new and unique approaches to managing people. Peter Drucker, probably the foremost business thinker of all time, known to many as the Father of Modern Management, predicted the rise of the knowledge worker as far back as 1969 in his book The Age of Discontinuity. In his 28th and final book, Management Challenges for the 21st Century, Drucker cited managing knowledge worker productivity as the # 1 challenge of business leaders and managers in the years ahead.

Knowledge workers, according to Drucker, are the most important assets of companies in the 21st Century, much as production equipment was considered the primary asset of companies of the 20th Century. Management’s job is to preserve the assets of the business and do what is needed to increase the productivity of its assets. Companies will discover they need their knowledge workers more than knowledge workers need their companies. The knowledge workers will discover that they will often outlive their companies, and must learn how to manage themselves. The key then to the success of both the business and the knowledge worker is a shared commitment to continuous learning, training, and reinvention.

In the coming years we will see a new breed of knowledge worker with unique skillsets. These younger workers, aka Gen Y, Millennials or Digital Natives, have grown up in the knowledge economy -- messaging, sharing, collaborating, gaming, multi-tasking, blogging, podcasting, and assembling random information. They don’t think of these activities as technologies, just like people don’t think about breathing or fish don’t think about swimming. They will be used to manipulating information on multiple levels, making quick decisions, and functioning in a non-hierarchical environment. They will not be deterred by information barriers, will not see the need to be chained to a desk for 8-10 hours a day, and will probably not embrace repetitive, linear activities. Smart organizations will figure out a way to capitalize on and leverage these unique, albeit new and different, skills and competencies.

Demographics and the Market for Knowledge Workers

Peter Drucker once referred to demographics as the future that already happened. Most people are familiar with the broad demographic trends, but I don’t believe too may people have really stopped to look at the numbers, which are compounded in a knowledge-based economy. The unprecedented aging of the population combined with the shortage of educated Gen X’rs and the exponential growth of health care costs will have a profound effect on the pension, health care, and taxation systems of our country that is difficult to imagine. The aging population in Europe and Japan is even more extreme.

The impact of the aging workforce on business will be exacerbated by the shift to a knowledge-based economy and a shortage of knowledge-based talent, at least for a generation and probably longer. The inevitable result will involve some combination of higher taxes, fewer benefits, higher retirement ages, more immigration, more outsourcing, continuous retraining, innovative productivity improvements, and an emphasis on effectively managing a new set of generational issues brought about by the “digital natives” now entering the workforce, as discussed above.

Disappearing Geographical Barriers in the Knowledge Economy

In this knowledge economy, geography is simply not a constraint on economic activities. I live in Fort Worth and most of my reports live and work in New York. At first it was a bit strange, but now I don’t even stop to think about it. Thomas Friedman of the New York Times recently told the story of a young man who runs a global business completely through his Blackberry. The young man, who lives on the West Coast, developed a software application now being used by Fortune 500 companies. The logo on his business card was designed by someone located online in Romania, his database and web server are freeware, he outsources the marketing and sales support to India, and he has phone numbers in India, Boston, and Palo Alto. He simply has never stopped to think about geography as a limitation.

In a knowledge-based economy, goods and services can be developed, bought, sold, and in the case of many CPA services, delivered online over secure electronic networks. Location often doesn’t matter. For that reason CPA firms of all sizes can outsource work around the corner or around the world, can provide more flexible work arrangements and telecommuting, and can just as easily provide services to clients in far away locations as clients next door.

Shorter Cycle Times and the Increasingly Competitive Business Environment

Businesses are discovering that in a knowledge economy, their competitors can develop improved capabilities in fairly short order, and globalization, deregulation, and commoditization can quickly eliminate their competitive advantages. Cycle times – the time it takes to go from start up to boom to bust – are shorter than ever. As a result, many companies – our clients and employers -- have to continuously reinvent themselves in order to survive in what often seems like a Darwinian world. This simply was not the case in a manufacturing economy.

This environment has created both peril and opportunity for CPAs, who are increasingly being called upon by organizations to help them identify, understand and manage risks. Effective risk management is viewed by business leaders as a key to survival when change is the only constant, and CPAs are increasingly at the forefront of helping businesses manage risks through designing effective internal control systems, and in the ongoing measurement and monitoring of those systems.
Conclusion

There is no doubt the evolution of the knowledge economy will impact CPAs in unforeseen ways. We’ve discussed higher expectations and new management challenges. We’ve seen how geographic boundaries matter less, and in some cases not at all, in a knowledge economy. The knowledge economy will drive demand for new services by CPAs, such as risk management in a more competitive business environment. And we’ve discussed how the shortage of younger knowledge workers will likely exacerbate an already bleak demographic situation as we Baby Boomers begin to retire in large numbers. Something tells me though, that for all the change and all the unknowns, the knowledge economy may actually usher in what turns out to be the golden age for CPAs. Stay tuned.

The Case for Permanent Tax Cuts

2006-12-03T18:02:00.000-06:00

Several months ago, a Wall Street Journal editorial caught my eye. It was titled “Reaganomics at 25.” It hit especially close to home for me, as I cut my teeth, so to speak, on the Economic Recovery Tax Act of 1981, or ERTA as we called it. ERTA was the first major piece of federal tax legislation during my budding career as a tax professional. I had recently transferred from the audit department of a Big 8 accounting firm into the tax department, and soon thereafter Ronald Reagan was elected President of the United States.

A quick review of TSCPA demographics tells me that many of our members will remember what the U.S. economy was like when Reagan took office. Mortgage rates were around 18%, inflation was rapidly rising, unemployment was extensive, and the Dow was around 800. In our CPA world, the top individual income tax rate was 70% and long-term capital gains were taxed at 50%. The top corporate rate was 48%. Reagan came along and promptly cut both the ordinary and capital gain tax rates, indexed the brackets for inflation, and shortened depreciable asset lives (to 3 years for cars, 5 years for furniture and equipment, 15 years for real estate) to encourage savings and investment. He also appointed Paul Volcker to head up the Federal Reserve and bring down inflation.

While at the time I knew ERTA was big by virtue of the massive amount of changes in the tax law, I didn’t grasp exactly how big it’s impact would be on the U.S. economy and on a generation of baby boomers who would begin saving and investing in the years to follow. For that matter, I doubt even Reagan or his advisers knew how far reaching it’s impact would eventually be. The Dow has grown to around 11,600 as of this writing, accounting for an increase in national wealth of around $25 trillion, according to the Journal article. Americans’ standards of living are notably higher; a number of new industries have been created in an economy build on entrepreneurship, research, and development; unemployment is below 5%; and inflation, outside of energy and health care, remains in check.

The economy since the time Reaganomics was introduced through ERTA and later the Tax Reform Act of 1986, has been amazingly resilient. Especially during the last five years, our economy has taken its share of hits in the form of recessions, corporate scandals, hurricanes, the dot-com crash, 9/11, Iraq, and spiraling oil prices and health care costs. But the economy continues to bounce back and is fundamentally strong today. President George W. Bush obviously learned a lesson or two from the Gipper, and sadly from his father who raised tax rates and paid for it with his political career. So did the rest of the industrialized world, where on average, both individual and corporate rates have come down by approximately one-third over the past 25 years.

President Bush’s tax cuts of 2001 and 2003 proved to be the perfect anecdote for a sluggish economy that was coming out of a recession, where GDP was growing less than 2% per year, where businesses were not hiring or spending, and where unemployment was 6.3% and climbing. He lowered the tax rates on ordinary income, significantly reduced tax rates on dividends and capital gains, created a 10% individual rate bracket, doubled the child tax credit, and reduced the marriage penalty. Once again history repeated itself. Just like with the launch of Reaganomics in 1981, the stock market has taken off again. Today, roughly half of America’s households own stocks in some form. Per capita household wealth has grown, again. Business investment has grown considerably. Dividend payouts have almost doubled. Unemployment is below 5%. And many state and local governments are running surpluses. Of course the Bush tax cut provisions are set to expire after 2010. And therein lies the rub. Those of us who have seen Reaganomics work for the past 25 years want (and need) the prosperity to continue for the next 25.

Of course, Reaganomics, in the form of the Bush tax cuts, has its critics. Everyone, especially President Bush, is aware that current federal spending on Medicare, Medicaid, and Social Security cannot be sustained. Accordingly, counter the Rubinites, named for Clinton Treasury Secretary Robert Rubin, tax increases will be necessary to meet these obligations and reduce the budget deficit. Some Rubinites would even say Congress should impose a temporary tax to fund the War on Terror and the Katrina cleanup. They claim that making the Bush tax cuts permanent will do permanent harm to the standard of living for our children and grandchildren.

I’m certainly no economist, but I must admit that I have benefited from Reaganomics, including the Bush tax cuts. I have to admit also that I would like to see history repeat itself over the next 25 years. Does that mean I’m not concerned about the deficit or about entitlement spending? Of course not. But I’ve seen Reaganomics work. While it’s true we are running a deficit, as a share of GNP it is close to its historical average. Federal tax receipts are way up, exceeding forecast by over $120 billion in 2005, reducing the planned deficit by about one-third. This followed an increase of over $55 billion over forecast in 2004. Many experts attribute these additional tax receipts to taxes on the increased economic activity spurred on by the Bush tax cuts. Critics counter that these are one-time receipts based on capital gains, stock options, and bonuses that may not recur. That seems like flawed logic … if the tax cuts are made permanent, people and businesses will continue to repeat and replicate the wealth generating activities as often as they can. Why wouldn’t they? Critics also say the Bush tax cuts favor the rich. For starters, everyone benefits from lower tax rates, either because they have more disposable income to spend, which helps the economy grow, or because they take their tax savings and invest it in startup businesses that create jobs and opportunities for others. Growth in federal tax revenues is a byproduct of these activities.

The Treasury recently released a report titled “A Dynamic Analysis of Permanent Extension of the President’s Tax Relief, ” that illustrates the positive contributions of tax relief. Dynamic analysis, unlike the static methodology currently used by the Congressional Budget Office, takes into account both the short term and long term impact of tax cuts, providing a more comprehensive and complete picture. See the report at www.treas.gov/press/releases/reports/treasurydynamicanalysisreporjjuly252006.pdf. It should be required reading for our new Congress. Someone, please send them a copy.

Private Equity: The Next Enron?

2006-07-20T21:37:00.000-05:00

Not long after Business Week ran a cover story titled “Going Private” in February, I ran across the following quote on the Business Week internet message board:

“As a CPA who is involved in private equity, I can assure anyone who will listen that the next big Enron-type financial reporting scandal will be in private equity. There are no serious standards for valuing their portfolio companies. The roof will cave in, and Private Equity will be regulated, as it should be. Human nature never changes.”

Obviously, you can’t believe everything you read on blogs or message boards, but there is something intriguing about a secretive world where investment funds acquire high profile businesses like Neiman Marcus, Burger King, Hertz, Metro-Goldwyn-Mayer, SunGard Data, Toys ‘R’ Us and can attract high profile executives like Jack Welch, Lou Gerstner, George H.W. Bush, and Jacques Nasser, as well as the crème de la crème from top business schools like Harvard, Wharton, and Stanford.

The Good

From the corporations’ perspective, with capital abundant, cost of borrowing low, and returns on investment high, private equity may be the best path to restructure the business, pursue aggressive new growth strategies, and/or focus more on the long term. If and when the private equity firms eventually take their acquisitions public again, they are operationally stronger than before they were taken private. And of course it generally costs a lot less to be privately held than publicly traded, especially in the day of Sarbanes Oxley compliance.

From the executives’ perspectives, there is the freedom from SOX and its penalty provisions, but I think more appealing is the freedom to truly show what they can do in terms of building long term value without being continuously judged on short-term quarterly results. In addition, executives are attracted by not having to disclose their compensation, and obviously by the financial upside, as 20% of the profits are typically distributed among the partners and executives when they sell the stock or take the company public, and of course those profits are taxed as long-term capital gains.

From the investors’ perspective, there are certainly some solid, reputable private equity firms that have been around for years, know what they are doing, and are able to attract top talent and deliver solid, if not at times, spectacular returns to their investors. Firms like Blackstone Group, Carlyle Group, Texas Pacific Group, Kohlberg, Kravis, Roberts & Co., Silver Lake Partners, and a handful of others actually control over half of all the private equity capital, said to be $800 billion. All well and good.

The Bad

Peel back the covers, though, and you may see a different picture. While there are several hundred private equity firms that manage at least $1 billion, over 2,700 private equity firms have sprouted up worldwide. To me this sounds like the Internet bubble all over again. These firms typically take 2% of the fund balance each year as management fees, plus 20% of the profits on deals. Fair enough. However, they typically don’t put down more than 20%-30% of the purchase price, typically partner with other private equity firms to spread the risk, don’t have to disclose what they are doing, and often incur substantial amounts of debt to leverage their investments and pay dividends to shareholders (themselves). Wall Street loves it, as the big investment banks generate huge fees on all the buying, selling, and borrowing. What’s more, with all the money pouring into private equity (over $100 billion last year alone), with much of it coming from pension funds and going to private equity firms that are not the ones with the solid long-term track records, it looks to me like we have too much money chasing too few “good” deals. This results in inflated valuations, which is what the CPA on the message board was referring to, and unrealistic assumptions to make the deals work on paper.

Forbes reported that pension plans provide 40% of the money pouring into private equity funds, and as we know from looking at the automakers, steel companies, and airlines, many pension funds are underfunded. I fear that these pension funds are looking to private equity as a magic solution to help them close their funding gaps. General Motors, Eastman Kodak, and Delta Airlines --- not exactly pillars of strength these days --- all have more than 10% of their pension assets in private equity investments. Guess who stands to lose if these deals don’t make it? I’m afraid it will be the employees and taxpayers.

The Ugly

Two additional trends in this area compound my concerns. One is that returns on investment in private equity investments have steadily declined in recent years. While still generating annual returns of 15%-20%, they are not the 40% ROI of the Eighties or 30% ROI of the Nineties. This is partially due to the higher valuations, plus I would expect that many of the plum investments have been picked. Indeed, many of the deals today are battered tech companies and slow-growing or losing divisions of public companies that need to sell off any operations that are depressing their own quarterly or annual performance. Thus what type of assets are the investors in these 2,700 private equity funds (read: pensions) actually getting? Underperforming assets, that’s what. Whether these funds can restructure and clean up these businesses and install new management teams that can turn them around is the $800 billion question.

Connect, Communicate, Collaborate

2006-06-10T20:53:00.000-05:00

Since I’ve been writing this blog, we’ve seen inexpensive computing and communications technologies advance at a rate that exceeded everyone’s expectations. It's hard to imagine a world without personal computers, the Internet, and cell phones. Broadband access and WiFi networks are now ubiquitous. Computing and communications have merged. At work, at home, in hotels, and at Starbucks, laptops have become our ‘virtual office' where we retrieve, store, and share information and interact with clients and colleagues. Pretty cool stuff when you stop and think about it.

We see it again and again…..the new technologies of today become the “gotta-haves” of tomorrow. In prior posts, we’ve discussed Blogs and the Wikis as significant emerging trends; now they're mainstream and are moving into the business world. Simple solutions like GoToMyPC and GoToMeeting provide intuitive, inexpensive ways to remotely access PCs and online meetings. We’ve also discussed the ubiquity of mobile messaging devices such as the Blackberry. Voice-over-internet protocol (VoIP) is gaining traction fast – especially with Skype’s web-based long distance services.

So what are the next big things on the horizon….the gotta haves of tomorrow? While I’m not even close to being a technologist, here are several trends I see coming, or in some cases are already here, that may change the way we work in the next 5 years.

Web Services---Combining Software and Services

Ray Ozzie is well known in technology circles for creating Lotus Notes, a communications and collaboration platform for corporate networks. When IBM bought Lotus in 1995, Ozzie left and founded Groove Networks, which took a Web-based approach to collaboration, this time for workers both inside and outside the office. Groove had a unique value proposition -- merge desktop and Web-based software to create something that's better than either. A good example is MSN, which lets users search their hard drives and the Web simultaneously. Microsoft acquired Groove in 2005, and Bill Gates appointed Ozzie Chief Technology Officer. While Ozzie’s first job was to integrate Groove's technology into Microsoft Office, his greater mission is to apply the Groove model of combining software and services to everything Microsoft offers, from Windows and Office software to the Xbox gaming device.

Microsoft is developing new applications that will run on a new hybrid local hard drive-web platform, in contrast to Office and other software that runs exclusively on local Windows PCs. The first product based on this hybrid model was Windows Live, a Web site launched late last year that includes Microsoft’s new search service along with news and e-mail. Using Windows Live, Microsoft is hoping to provide online e-mail for large organizations. The value proposition is to use Windows Live technology to host e-mail so that companies don't have to operate and maintain their own servers, as they historically have with Microsoft Outlook. In contrast, Microsoft is planning to use its own servers to offer customers huge amounts of online storage of digital data. It even has a name for that future service: Live Drive. With Live Drive, all your data – client information, videoconferences, webcasts -- will be accessible from anywhere, on any device.

In addition to being interactive, web services will also be what I call “idiot-proof,” like the iPod and iTunes. This represents a fundamental shift for technology in general and software in particular. In a way, I believe we can expect a shift from a software model built on continually adding new features to one based on simplicity and more intuitive ways to use existing features. And web-based software and services may in fact cost less, should require little, if any IT support, and can be continuously updated by the providers.

Collaboration As a Way of Life

We’ve seen collaboration platforms emerge in the last five years, initially in paperless audit engagements, where members of the audit team can share workpapers and review notes, store documents, etc. This concept is now spreading to tax engagements and other areas of CPA practice and corporate life, without regard to traditional boundaries….the enterprise, departmental, or geographical boundaries that had previously defined how and with whom we worked. Firms and businesses will be adapting their workflow processes to leverage these collaboration platforms.

As the so-called Millennials, a.k.a. digital natives, enter the workplace, online communities will take off. The next generation of popular social networking sites like Facebook and MySpace will be business networking sites such as LinkedIn (already with over 5 million users) and VisiblePath, which are like digital Rolodexes that allow users to link to, sort and search their contact lists and their contacts’ contacts, both outside and within an organization. These services are expected to grow exponentially as the digital natives enter the workforce.
Email, the killer app of the 1990s may be beginning to fade as the collaboration platform of choice, in favor of online applications that function as real-time virtual workspaces. Instant messaging is now entering the business world, allowing immediate responses to questions. The Millennials now entering the workforce grew up with instant messaging, and can’t understand life without it, including work life.

The communities of tomorrow for tax and accounting professionals will be use next-generation groupware centered around projects where teams come together to serve clients or accomplish tasks. Take your typical audit, estate planning engagement, M&A deal, or other types of CPA services that require engagement teams, and it’s not difficult to visualize. Check out Microsoft Sharepoint, an online service that allows workers to create project-specific websites where they can store and share documents, link to other sites, communicate with team members, etc. The need for geographic proximity to other team members goes totally out the window.

These new communities will also be able to harness the collective intelligence of their users or members. What are now known as message boards will become Wiki’s, both public and private. We may see some information providers give away their content, perhaps with advertising driving their new business models, in return for thousands (or millions) of community members contributing their expertise in a searchable, archivable environment.
Cell phones, Blackberry’s, laptops, and wireless networks will continue to shape the way we live and work. We’re always on, always connected, and expectations have been set. Clients and employers expect us to be available 24/7/365, and that’s not changing anytime soon. We can leverage the skills and expertise of team members, be they firm members in another office or employees telecommuting from home, from anywhere on a client engagement. As a result, we need access to our information services and workflow tools regardless of where we are. Really Simple Syndication (RSS) technology is the internet's answer to the notification needs of individuals and organizations, as people use it to connect data and systems. You can subscribe to immediate updates from various information sources, from blogs to news to sport scores to traffic and weather forecasts. You can even get the latest tax and accounting developments emailed directly to your handheld device.

Workflow, Workflow, Workflow

CPAs will develop workflow efficiencies using advanced integrated solutions that streamline workflow processes and organize data into a more logical, useable format. Accounting, auditing, and tax research information will be integrated with the corresponding software applications. Document management systems will be able to take paper-based documents and incorporate them into a virtual, online filing system hosted from data centers that are far more secure than any accountants’ office. Online data mining, data extraction, analytical, benchmarking, forecasting, and business decision-making services will grow as the number of integrated information solutions available to support such activities proliferates. These tools are enabling accountants to slice and dice historical information more effectively to gain unique insights and enhance their value to their clients and employers.

In addition, we are moving into a world of shared standards, which is to say that businesses have realized that if they play by the same rules as everyone else, everyone is better off. Before, disparate software systems, such as a company’s ERP, CRM, and supply chain software could not share data or work together, let alone work with systems of other companies. That’s all changing as companies and software standardize on Extensible Markup Language (XML), a method for tagging and identifying data so that it can be read by other systems. What we will ultimately see as a result of these common standards is machines communicating with machines, automating processes, without human intervention. This is not to imply that accountants will be disintermediated; rather, they will interact with this data flow in new and different ways, whether on the front end, back end, or as an auditor or tax adviser.
After years of promise, hype, and great expectations, the financial reporting version of XML, known as Extensible Business Reporting Language (XBRL), is becoming a standard financial reporting format for many accounting and finance professionals. XBRL is a data tagging system designed to make the analysis and exchange of financial information easier and more reliable, even when generated by disparate systems in varying formats. Information provided in the XBRL format can be electronically exchanged, extracted and analyzed automatically by computers.

While its adoption seems more prevalent internationally than in the U.S., the SEC has created an XBRL Voluntary Filing Program that some registrants have adopted. In other countries, government agencies, financial institutions, and stock exchanges are requiring digital financial data from their constituents to be submitted in XBRL. Tools have been developed that allow XBRL documents to be created and exported to Microsoft Word and Excel without requiring advanced knowledge of XBRL, making the data truly interactive. The early adopters are realizing that the move to interactive data will represent tremendous advantages for both internal and external financial reporting. They are able to use interactive data that isn’t tied to specific software applications, nor is it locked in proprietary data formats that require specialized report retrieval tools.

The Harmonic Convergence of 2006, Part 3

2006-03-26T11:29:00.000-06:00

In prior posts, we’ve examined the 10 forces of change identified by Pulitizer Prize winning author and New York Times columnist Thomas Friedman in his best selling book The World Is Flat,1 and how they are affecting CPAs today. Friedman suggests that the real impact of the 10 forces, or “flatteners,” will be felt in years to come as they converge and amplify, reinforce, and leverage one other. Accordingly, in this issue we’ll explore the potential impact of the convergence of the 10 flatteners on our business and personal lives.

We’ve seen how one of the 10 flatteners, the fall of the Berlin Wall, has led to a single economic system, global capitalism, and how another, the massive investment in internet infrastructure during the dot com era, has created a single, web-enabled global marketplace for products and services. This global, web-based capitalistic business environment has been further enabled by the other flatteners, including workflow software, open-sourcing, insourcing, outsourcing, offshoring, supply chaining, instant information retrieval, and personal wireless technology.

Horizontal Collaboration

As these flatteners began shaping business practices during the first half of this decade, we began to see a new form of collaboration take root. Businesses and individuals began sharing knowledge and work without regard to traditional boundaries….the corporate, departmental, or geographical boundaries that had previously defined how and with whom we worked. Friedman calls this horizontal collaboration, and predicts it will result in new business models, enable new business practices, and require new skills to be effective in the new, flatter world. Partnering will be a key skill set required for effective business people, and the old command-and-control structure will be less relative and potentially counter-productive for those who don’t get it.

A Bigger Pond

As the world flattened, the pond suddenly grew exponentially larger. Not only do we have a new playing field, we also have new players. The global workforce previously measured by workers in North America, Western Europe, and Japan suddenly grew from 2.5 billion workers to 4 billion, and the global marketplace for goods and services doubled from 3 billion people to 6 billion people as China, India, Russia, Eastern Europe and Latin America entered the global economic picture. Factor in an aging population in the U.S., Western Europe, and Japan, and contrast that with a much younger population in India, China, and other places, people who are growing up with capitalism for the first time, people who are risk takers, people who are ambitious and well educated in math, science, and engineering who are willing to enter the workforce for modest wages and work their way up, people with no legacy systems to hold them back, and you’ve got a fundamentally new paradigm in the way businesses operate. In the new flat world, efficiency, creativity, and competitiveness, in addition to collaboration, will become the core competencies for both success and survival.

Surviving and Thriving in the Flat World

Does a flatter world pose a threat to U.S. businesses and their employees? Not necessarily. On the one hand, the flatter world may usher in a new wave of innovation like we’ve never seen before. Given that the U.S. has the most successful system of capital markets, including stock exchanges, securities laws, intellectual property protection, labor laws, research universities, and political stability in the world, we are in a good position to thrive in an increasingly innovative world. Yes, we might have to work faster, smarter, and perhaps even harder to maintain our leadership position, but for those not afraid of change and willing to develop new skills and competencies that cannot be digitized and exported, new opportunities will undoubtedly be there.

Conversely, we need to get up to speed with our educational system, particularly encouraging more young people to pursue math and science, build out our broadband infrastructure, support more globally aware government policies, and embrace lifelong learning as a way of life. At an individual level, continuously upgrading our skills and learning how to reinvent ourselves is the single most important thing any of us can do. Our institutions, businesses and governments can encourage lifelong learning, but it takes an individual commitment to make it happen. The alternative is to risk commoditization, and get this….Friedman points to basic tax and accounting as work that is fungible and easily transferable to lower wage locations! That sure got my attention.

DejaVu All Over Again

I would strongly recommend Thomas Friedman’s The World is Flat to anyone who wants to understand what is going on in the world around us and how the developments of the past few years are shaping our future. But guess what? We’ve heard this before. We didn’t need Thomas Friedman to tell us this was coming. To their credit, the AICPA and our state societies told us what was beginning to happen back in 1998. It was called the CPA Vision Project. I don’t think too many people took it seriously at the time, but it was right on point in several areas, particularly that the world is going global and moving faster. The Vision Project concluded that embracing our profession’s core values, including lifelong learning, while developing new core competencies are the keys to not only remaining relevant but prospering in the years ahead.

1. Thomas L. Friedman, The World is Flat: A Brief History of the Twenty-First Century (New York, NY; Farrar, Straus and Giroux, 2005)

The Harmonic Convergence of 2006, Part 2

2006-02-12T13:28:00.000-06:00

In a previous post, we took a look at 10 forces of change, or “flatteners,” as identified in the best selling book The World Is Flat1 by Pulitizer Prize winning author and New York Times foreign affairs columnist Thomas Friedman. In this issue we’ll further explore these 10 forces or trends and how they are impacting CPAs.

The 10 flatteners, beginning with the fall of the Berlin Wall and fueled by the massive investment in internet infrastructure during the dot-com era, has enabled capitalism to flourish and created a single, web-enabled global marketplace for products and services. This global, web-based business environment is further enabled by the other flatteners, including workflow software, open-sourcing, insourcing, outsourcing, offshoring, supply chaining, instant information retrieval, and personal wireless technology.

Each of these flatteners affects CPAs, both directly, and indirectly via their impact on clients and employers. It’s not difficult to relate many of the changes we’ve seen in the CPA profession over the past five years or so to the 10 flatteners identified by Thomas Friedman. Consider:

· International accounting standards and international auditing standards are converging with corresponding U.S. standards. This will result in a more level, or flat, playing field, as investors, lenders, and managers, whether in Bangalore, Singapore, Milan, or New York, will be able to view financial information consistently and base business decisions accordingly. They will also have the comfort of knowing their global competitors don’t have an unfair advantage because of their access to capital resulting from more liberal accounting rules.

· The Internet is playing a huge role in the explosion of regional firms and associations of firms, eliminating geographic barriers and enabling technology-enabled collaboration to flourish. The cost of making a phone call or transmitting a document around the world is simply not a factor in today’s business environment. Collaboration platforms such as paperless engagement software and tools allow teams to complete projects (e.g., audits) more efficiently than ever, regardless of physical location of the clients or team members.

· Common standards like XML have allowed disparate software programs to work with each other, sharing, manipulating, and storing data without regard to hardware limitations or physical location of people or machines. And often, the CPA is directly involved in this data flow, whether on the front end, back end, or as an auditor.

· Insourcing and outsourcing (not to be confused with offshoring) continue to impact the profession in significant ways. Some firms offer controllership-by-the-hour, allowing clients to outsource their accounting function completely. Others, especially national firms and large regionals have established compliance centers where mass quantities of tax returns are prepared from client data scanned in and accessed via the Internet by small armies of return preparation specialists. While the offshoring of tax returns to India caused all the noise, the practice makes good business sense for many firms, regardless of whether it’s outsourcing to India or to some location in the U.S. This trend is causing firms to change their return preparation workflow, and is coming to be known as paperless tax engagements.

· Friedman offers an interesting take on offshoring tax returns, based on a first-hand observation of a business in Bangalore that hired Indian accountants to prepare U.S. tax returns for American CPA firms. After seeing that, Friedman concludes that anything that can be digitized can be outsourced to someone smarter, cheaper, or both, and suggests that American professionals should focus on interpersonal skills and adding value or will be at risk.

· Instant information retrieval is taken for granted, not just in the U.S. but around the world. Google performs a billion searches a day, and only one-third originate in the U.S. It’s a scary thought, but I’ve talked to CPAs that use Google as a first stop for tax research. More common, I suspect, is clients that turn to Google or a favorite site on the web for answers to routine tax and business questions that formerly would have triggered a call to their CPA (and a chargeable hour). I know I usually visit mayoclinic.com before I go to the doctor. Why should we expect CPA clients to be any different?

· Personal wireless technology --- cell phones, Blackberry’s, laptops, and wireless networks have profoundly shaped the way we live and work. We’re always on, always connected, and expectations have been set. Clients and employers expect us to be available 24/7/365, and that’s not changing anytime soon. Plus, we need to have access to our information services and workflow tools regardless of where we are. Computing is becoming more ubiquitious and devices increasingly smaller and more portable, enabling us to deliver services from anywhere, anytime. It’s both a blessing and a curse.

While there is no doubt the 10 flatteners identified in The World is Flat represent a massive amount of change for any business or individual to absorb, Thomas Friedman suggests the emergence of the 10 flatteners are just the beginning of the change we can expect to see. The real impact of the 10 flatteners will be the exponential effect of their convergence with one another, which is just beginning. Today, suggest Friedman, we are at the beginning of a period where the 10 flatteners are starting to amplify, reinforce, and leverage one other. In the third installment in this series, we’ll explore the potential impact of the convergence on our business and personal lives.

1. Thomas L. Friedman, The World is Flat: A Brief History of the Twenty-First Century (New York, NY; Farrar, Straus and Giroux, 2005)

2006 Forecast----The Clouded Chrystal Ball

2006-01-07T09:39:00.000-06:00

Looking back at our 2005 forecast (something most prognosticators never do), we see that we were mostly on target. A year ago we forecast that:

· the economy would do pretty well overall in 2005;
· interest rates would continue rising gradually;
· corporate spending would drive economic growth; and
· corporate earnings would be up, assuming oil would remain in the 30-40s.

We saw the biggest challenges to be the cost of health care, litigation, and energy, and we predicted a big year for legislation at both the federal and state levels…we even predicted the coming of the Internal Revenue Code (IRC) of 2006.

How did we do?

It was indeed a good year for the economy overall, with GDP up close to 4%. We were right on with interest rates. However, it wasn’t corporate spending but housing, low interest rates, cash-out refinancing, and consumer spending that drove the economy in 2005. And if you believe the supply-siders, the impact of 2001 and 2003 tax cuts were instrumental in driving both investment and spending. We really missed the boat on oil prices, but the surprising fact is that they didn’t hold the economy back…..if they did, no one, even Alan Greenspan, figured it out. Who knows, if oil prices had remained in 30s – 40s, we might have seen corporate earnings go through the roof, with GDP growing so fast that the Fed would have gone berserk with interest rates. What I’ve come to realize in middle age, as I tune in more acutely to the economy, the stock market, and my personal nest egg, is that slow and steady really does win the race! What you want is an economic environment that’s not too hot and not too cold….just good enough with no surprises. By historical measures, with relatively low interest rates, strong corporate profits, and healthy GDP growth, the stock market should have grown 20%. But it didn’t. In fact, it was flat…..a wasted year for the stock market in light of overall corporate performance. Why? Oil prices, Iraq, natural disasters, the twin deficits, rising interest rates, fear of inflation, and politics as usual kept investors in a cautious mode. Average trailing P-E multiples continued to decline, from 20 to 18, meaning investors are paying less for each dollar of earnings. If that trend continues for another year, stocks will be priced at about their historical levels. While that might hold stocks down a bit, it would also create some good opportunities for bargain hunters.

I’m so disappointed and in fact, disenfranchised, by our political system at both the state and national levels. Sure, we’ll be ‘ok,’ but compared to what we could be if we put the politics aside and pulled together as a state and as a nation, it’s a sad situation. Unfortunately it’s going to keep getting worse until we see some sort of ‘unifying event,’ and that’s what scares me. The unifying event is not going to be pleasant, I’m afraid. We’re all going to have to share in some level of common pain before Republicans and Democrats get off their political ____ and start governing for the greater good. We all thought we were there after 9/11 but apparently we weren’t.

I had, perhaps naively, believed that with a Republican in the White House, Republicans controlling both houses of Congress, a Republican governor in Texas, and a Republican majority in the State House, that we would see the foundation of a true ‘Ownership Society’ laid…..with lower tax rates, less government spending, less regulation, and a more pro-business, pro-investment agenda in both Washington and Austin. Instead, what we see is politics as usual, which means total gridlock….nothing happening. And that’s so disappointing. The Republicans are truly squandering a golden opportunity that comes around maybe once in a lifetime.

So what do we see for 2006?

Again, assuming no cataclysmic event like 9/11 or a bird-flu pandemic, 2006 will be a great year! You heard it here first. I’m optimistic that we’ll see:

· no slowdown in economic or corporate profit growth,
· an end to the interest rate hikes,
· an improved situation in Iraq,
· stabilizing if not declining energy prices,
· strong corporate balance sheets,
· a pick-up in capital spending and hiring, and
· a pro-business Supreme Court.

How’s that for a rosy picture? If that scenario develops, investors should lose some of their nervousness, enabling stocks to do very well, especially international stocks with a built-in boost from exchange rates. The housing market will cool and perhaps decline a bit in the Northeast and California, but good grief, why not? Housing prices in those areas have been out of control for a long time. What I see is more like the end of a cycle, not necessarily a crash. And the beginning of a trend of smaller-but-nicer and closer-in homes, including a lot of tear-downs and re-do's driven by the approaching retirement of Baby Boomers, as opposed to mansions and sprawling estates in the suburbs and exurbs. While the housing market will no longer be driving overall economic growth, business capital spending and investment will more or less offset it. In fact, I believe we are on the cusp of a great new wave of economic growth to be sparked by the convergence and exponential effect of the various trends cited in my previous article. It’s what Thomas Friedman of the New York Times calls a flattening world. In the past 5 years we’ve seen isolated trends like open sourcing, insourcing, supply-chaining, off-shoring, and mobilization enabled by personal wireless technology. What we’re beginning to see is the confluence of all these trends and the exponential impact that such synergies will create. It’s a pretty exciting time, again, assuming no cataclysmic event.

Back to politics. 2006 is an election year. I predict we’ll see very slight Democratic gains at both the state and the national levels. Nothing that will change the overall balance of power (as if that is worth anything). It will begin with the governors’ races in 2006, and then we’ll begin to see the posturing begin for 2008. Again, it makes me sad. What’s so ironic is that the Democrats are in such a good position to take advantage of the Republicans’ stumbling and bumbling, yet they are so disjointed (can you spell Howard Dean?) that the Elephants are perspiring but not quite sweating.

Will we see significant tax legislation in 2006? I don’t think we’ll see a major overhaul based on the President’s Tax Reform Panel’s recommendation like I predicted last year. However, we will see some AMT-related legislation. That the AMT hits Blue State residents so hard because of their high state taxes will bring Dems to the tax negotiating table. Republicans are sure to use that as leverage to enact, say, estate tax legislation and/or extend the 15% rates on capital gains and dividends.

Another bit or irony is that both politicians and ordinary citizens are beginning to realize that President Bush was right on trying to drive Social Security reform. As discussed in a previous post, he erred by beginning with the end game—private accounts—before creating a sense of urgency, and that killed it. But history will applaud Mr. Bush for having the fortitude to try to get something done when it would have been far less painful for everyone involved---retirees, workers, and the younger generation. Reform is still on the horizon, it will just be that much more painful the longer it takes.

There you have it. The Clouded Crystal Ball (with all due respects to Dave Campbell).

The Harmonic Convergence of 2006

2005-12-23T10:12:00.000-06:00

The purpose of this column is to highlight events, trends, emerging issues, and forces of change that will affect CPAs, their jobs and their lives, in the future. One of the most well conceived analyses of the forces shaping the world in the early 21st Century is a recent book by Pulitizer Prize winning author and New York Times foreign affairs columnist Thomas Friedman, titled “The World Is Flat.” 1 The title is another way of saying that the playing field of business has been leveled by ten forces that have emerged in recent years and are now converging with and leveraging one other. Anyone who expects to be in business for any length of time needs to understand these forces and more importantly, understand that the changes they have brought to our world are just beginning. Relative to the major disruptive events of the past, today’s change is occurring at warp speed and is unparalleled in its breadth. The remainder of this column will be devoted to discussing the ten forces of change, or flatteners, identified by Thomas Friedman in The World is Flat.

The Fall of the Berlin Wall. Once the Berlin Wall fell in 1989, the world was essentially left with a single economic system, capitalism. Countries like India, China, Brazil, and Russia began to relax trade controls and allow their businesses to compete globally, turning the entire world into a single marketplace.

The World Wide Web. Once Netscape developed the first widely available web browser, allowing data, music, voice, and photos to be transmitted all over the world by anyone with Internet access, investors went crazy, sparking what is now referred to as The Internet Bubble. The Internet attracted so much capital, beginning when Netscape went public in 1995, that an oversupply of fiber optic cable was laid around the world, driving down the cost of transmitting data and making a phone call to almost zero. While the telecoms went belly-up, the cable remains, enabling simple and inexpensive movement of data, voice, etc. throughout the world.

Workflow Software. We are now moving into the world of shared standards, which is to say that businesses have realized that if they play by the same rules as everyone else, everyone is better off. Before, disparate software systems, such as a company’s ERP, CRM, and supply chain software could not share data or work together, let alone work with systems of other companies. That’s all changing with the development of XML, a standard method for tagging and identifying data so that it can be read by other systems. What we will ultimately see as a result of these common standards is machines communicating with machines, automating processes, without human intervention. Think of the productivity gains this trend will generate for businesses.

Open-Sourcing. The Internet has opened the door for an entirely new form of collaboration. Once data could be easily moved around the world and shared with others, ad hoc groups of people began coming together online to develop and improve software source code, which is then made available free to others. People developing this “open-source” software, such as the Linux operating system, the Apache web server technology, and the Firefox web browser, generally do it for fun, for intellectual stimulation, and to earn the respect of their peers who review and improve their work. Another notable example is the Wikipedia, a user-driven online encyclopedia with close to a million articles in over 50 languages. Friedman calls open-source software development collaborative innovation.

Outsourcing. Friedman begins The World is Flat with a first-person account of a trip to Bangalore, India’s Silicon Valley, in Spring 2004, where one of his first observations was a company that hired Indian accountants to prepare U.S. tax returns for American CPAs. I was impressed by Friedman’s conclusion that regardless of one’s profession, anything that can be digitized can be outsourced to someone smarter, cheaper, or both, and the American professional better be good at interpersonal relationships and adding value or will risk being commoditized.

Offshoring. Once China joined the WTO in 2001 and agreed to treat foreign businesses no differently than domestic Chinese businesses, many other developing nations noticed and began offering competing incentives, tax breaks, and subsidies, not to mention cheap labor, to attract foreign business and investment. This in turn has created entirely new business models developed around global competition. And now, by leveraging new technologies and modern business practices, China is moving up the value chain, beyond manufacturing and into services. With a strong focus on education, particularly in math, sciences, and computer skills, China’s leaders are pushing to move China to the top of the global economic pyramid within a generation.

Supply Chaining. Led by Wal-Mart and Dell, successful companies are differentiating themselves by collaborating horizontally, between suppliers, retailers, and customers. Such supply-chaining is driving the adoption of common standards between companies so each link in the chain can interface with every other link. The end result is more intense competition and lower costs.

Insourcing. Take a look around and you’ll see businesses of all sizes getting deeply involved in their customers’ businesses. Friedman points to UPS as an example, in that UPS now helps its customers manage their entire supply chains, enabling small companies to compete globally, and who better to do so? There are countless other examples….IBM, Home Depot, John Deere….companies serving their customers far beyond the initial sales of their core products.

Information Retrieval. I’ll bet everyone reading this article, at one time or another, has used Google as a verb. Ten years ago, search was a novelty. Today, however, Google and other search engines have set an expectation that practically any bit of information is instantly accessible, and in most cases, free. The same concept extends to television, with TiVo and related services. Retrieve the programming you want when you want it and watch only the commercials that apply to you.

Personal Wireless Technology. Cell phones, Blackberry’s, laptops, and wireless networks have profoundly shaped the way we live and work. We’re always on, always connected, and expectations have been set. People expect to have access to their information, games, news, and services anytime, anywhere. In addition to ubiquitous mobility, the cost of storage is dropping rapidly, computing speed continues to grow, and quality, affordable video conferencing capabilities will soon be available, enabling a higher level of online collaboration than anyone imagined just a few years ago.

In the second part of this series, we’ll explore the potential impact of these flatteners and their convergence on our beloved profession.

1. Thomas L. Friedman, The World is Flat: A Brief History of the Twenty-First Century (New York, NY; Farrar, Straus and Giroux, 2005)

....And Here's To You, Mrs. Robinson.....

2005-09-12T07:37:00.000-05:00

“Plastics!”

We all remember that sage advice delivered to a young Ben Braddock by a well-intentioned Mr. McGuire in the 1969 classic film, The Graduate. Have you ever wondered what advice you would give a bright, young college graduate if you found yourself in the same position as Mr. McGuire? I recently found myself in such a position when my son, Samuel, graduated from college. As all parents know, the opportunity to provide a little advice, albeit increasingly rare for 22 year-olds, is too good to pass up. While I couldn’t distill my fatherly advice into a single word like Mr. McGuire, I narrowed it down to two.

Dear Samuel:

Congrats on the job offer. I hear Boston is a great city for young people…a big college town. And I’m sure you’ll learn a lot about what makes businesses tick at your new consulting firm. Before you begin your professional career, I just wanted to suggest you keep your eye on two industries that will likely see plenty of innovation and change during your working lifetime: energy and biotechnology.

Energy

I’m not talking about the old fashioned wildcatting here, Samuel…..not picturing you as the second coming of Jett Rink. I just paid $3.19 a gallon this morning. Something’s gotta give! Global demand is growing, especially as India and China begin to consume significantly more oil than they did a few years ago. The refining and
distribution system in the U.S., especially after Hurricane Katrina, is a mess. And the risk of interruptions from a terrorist attack, particularly on the Saudi Arabia oil producing infrastructure, adds a risk premium to already inflated oil prices. Those drivers are here to stay.

There is no silver bullet solution, but collectively, a number of things can and will be done to improve the situation. $3.19 gasoline, not to mention shortages, will provide a powerful catalyst for automakers to develop more fuel-efficient cars and trucks. Hybrid gasoline-electric cars are rapidly gaining in popularity, and automakers have the know-how to produce ultra-light materials that can drastically improve fuel consumption. Buildings and factories can be made more efficient, particularly if incented through the tax code…..it always works. Biofuels will also play a role, can leverage existing infrastructure to a degree, and will boost the farming sector in the meantime. “Clean coal” technologies would enable the U.S. to capitalize on one of its most abundant natural resources. Renewable energy generated from wind and solar devices, will certainly have a place, as will geothermal and hydroelectric power. Nuclear energy is becoming a more viable option, too, particularly for India and China, as plant designs become more standardized and cost effective and technological innovations enable reactors to reprocess nuclear waste.

Look at these solutions as disruptive technology. It may be painful for established oil companies, with profits and stock prices at an all-time high. However, many of them are already transforming themselves to “energy” companies. One thing I’ve learned during my career is that change creates opportunity, and if I were beginning my career at this point, Samuel, I’d learn as much as I could about alternative sources of energy and be ready to jump on the opportunities.

Biotechnology

At the intersection of biology and information technology is indeed a brave new world. The human genome has been mapped, opening the door for personalized medicines. This will fundamentally change the health care and pharmaceutical industries, as the traditional blockbuster drug model that gave us Vioxx is becoming increasingly outdated. It seems like every other day that we’re reading about new breakthroughs in the detection and treatment of cancer, including drugs that attack only the cancerous cells themselves. Treatments for other diseases, from heart disease to diabetes to Parkinson’s are also on the horizon. In addition, information technology is enabling development of bionic body parts, from mechanical hearts to artificial retinas. Finally, don’t forget that the world’s population is getting older; the percentage of people over 65 is growing at an unprecedented rate, and that will drive a significantly increased demand for a wide range of biotech solutions. The current business model is about to change.

Many of these breakthroughs are taking place in the smaller, entrepreneurial biotech firms, as opposed to the big pharmaceutical companies. As a result, we’re likely to see a radically different marketplace that will commercialize these breakthroughs. New players will become household names and established companies may not last. It’s a Darwinian world out there, and there will ultimately be a major shakeout. I expect we’ll see a lot of partnerships of biotech startups, big pharmaceuticals, and research institutions, as well as a significant amount of M&A activity. As a result, finance majors like you, Samuel, will see many opportunities in this exploding new marketplace.

That’s about it, Samuel. Remember that 10 years ago we had barely heard of the Internet, cell phones were a luxury item, and most people bought their movies and music on cassette tape. No doubt we’ll see an unprecedented level of innovation and change in the next 10-20 years as well. My advice to you…..look for essential industries undergoing significant change, for in that change lies opportunity.

Good luck in Boston.

Love, Dad

Texas School Finance Reform: Missing the Boat

2005-07-24T15:49:00.000-05:00

As I’ve watched our elected officials in Austin this Spring and Summer struggle with funding public education, I’ve become increasingly concerned that they are missing the boat. Most of the debate has centered on how we raise the money, not what we need to accomplish. Perhaps they should borrow a few principles from the corporate world.

A well-run business would begin by establishing its strategic objectives, and then developing strategies to achieve them. One of the primary strategic objectives of our state government should be to educate the children of Texas in a way that will ensure they can carry on the rich tradition and heritage, the innovative, entrepreneurial spirit, and the sense of boundless opportunity that has made Texas what it is today. Determining whether I pay the State a property tax or sales tax, or whether businesses pay a franchise tax or a business activity tax is not the objective. What we need to focus on first is not alternative methods for raising $30 billion for public education, but first what we want to accomplish with public education in Texas, determine how much it will cost using sound business, financial, and management principles, and then figure out a way to raise the money.

Texas prides itself on its low-tax, business-friendly culture. Yet I’ve seen absolutely no discussion relative to public education’s role in creating a climate of innovation and competitiveness for Texas businesses, which ultimately are the keys to our quality of life and standard of living. The starting point for creating and maintaining a climate for innovation and competitiveness is to invest in developing the creative skills of students, all the way from grades K through college. I’m talking about improving our schoolchildren’s skills in math, science, art, etc……the skills that ultimately produce scientists, engineers, architects, and other types of innovators. I’m worried that in the interest of maintaining a low tax base and business-friendly environment, we’re forfeiting the ability to develop a future generation of Texans that start the next Texas Instruments, Dell Computers, Southwest Airlines, and Perot Systems and develop cures for cancer and alternative sources of energy.

In addition to strengthening the math, science, and engineering programs in Texas schools, Texas needs to incent students to make career choices in these fields. We need to invest in basic research in these areas, and make it attractive to students in high schools and colleges. This is what Texas needs to ensure a strong economy, create jobs, and generate wealth in the days ahead when more and more people are migrating down to Texas from the Northeast, the Rust Belt, and over-priced California, at the same time as millions of immigrants are moving here from Spanish-speaking countries to the south. We can count on a population explosion….we need a robust economy to support it or we will likely not be able to maintain the standard of living Texans have come to enjoy.

Not confined to Texas, there are certain other trends nationwide, that contribute to my concern. Increasingly, foreign students that formerly flocked to the U.S. are choosing to go to school elsewhere. Why should this concern us? What if Andy Grove (Intel) or Sergey Brin (Google) had gone to school and work in China rather than the U.S.? What if we lose a generation of innovators because we haven’t laid the proper foundation? The number of U.S. students majoring in sciences and engineering is down relative to other countries, as is government investment in basic scientific research. It is therefore no wonder that the percentage of U.S. patents issued to foreign companies and inventors is way up. It is also no wonder that the venture capitalists that invested in Silicon Valley and Austin startups 10 years ago are investing in the emerging entrepreneurial culture in China and India today. If these trends continue, the level of innovation that leads to job and wealth creation will migrate to other countries. The only way we can reverse it, and cope with the population explosion in Texas, is to invest in future generations of Texans by making sure they get a solid foundation in the skills and competencies that lead to creativity and innovation. If we can’t do that, at some point it won’t matter how we do pay for our schools.

The world is an increasingly competitive place, and we can’t afford to assume that the U.S. in general, or Texas in particular, will remain the leader in innovation and entrepreneurship. To remain competitive in a global economy, Texas must do a better job of investing in its most precious asset --- its schoolchildren. Under-investing in education will ultimately lead to a loss of competitiveness and innovation, and that means a loss of what has kept Texas at the top of the U.S. and the global economy. Conversely, if we do it right, we should see a sustainable return on investment that will ensure Texas has a prominent role in the global economy for generations to come.

Change Management, Washington Style

2005-05-08T21:44:00.000-05:00

Change is often painful. Even for those of us who like to view change as opportunity, change can difficult when it hits too close to home. Good leaders know this, and understand that change is a process that can be managed. Conversely, when change is not well managed, results can be disastrous.

President Bush has a vision he calls the Ownership Society. It is a vision of open markets, reduced taxes and regulation, enhanced individual property rights and responsibilities, and minimal government. These were the bases of his campaign, and indeed the primary tenants of the Republican platform that has been gaining momentum since 1994. Why then, with a clear Republican majority in both the House and the Senate (and in state governorships for that matter), is President Bush having such a hard time gaining traction making the Ownership Society a reality? Maybe the answer lies in how well he is managing the change process.

The Change Management Process

Retired Harvard Professor John Kotter outlined an eight-step process for change management in the corporate world in a 1995 article in the Harvard Business Review, based on his observation of hundreds of companies trying to reinvent themselves. While it may not always be appropriate to compare the modus operandi of corporations and governments, when we’re dealing with human behavior, I don’t think we need to differentiate the two.

Key to effective change management, Professor Kotter points out, is to get the sequence right. Step # 1 is to begin by a creating a sense of urgency among those who will be directly affected by change and those whose buy-in the leader seeks. In the present case, President Bush needs the buy-in of Congress, and ultimately the American voters (who will be voting again in November 2006), if he is to be successful creating the Ownership Society.

Change Management and Social Security Reform

In the case of Social Security reform, the President began by promoting private accounts as the solution to a problem that many people didn’t know existed. He jumped straight to the vision, which is Kotter’s Step # 3. Had he instead appealed first to the electorate’s emotions…..i.e., the fear created by the prospect of a bankrupt Social Security system at the time the Baby Boomers are reaching full retirement with longer life expectancies, and the anxiety of reducing benefits and/or raising taxes on our children and grandchildren, he might have been able to create the sense of urgency that is necessary to create support for change. What was he thinking? Probably, with Karl Rove as the man behind the curtain, he started out in a politico / negotiating mode, knowing that he would have to make concessions in the end to garner at least 60 votes in the Senate. While that may be true, the American people weren’t ready to negotiate at that point. They still had to be convinced of the need for change. They clearly lacked a sense of urgency. Big Mistake # 1.

Step # 2, according to Kotter, is to create the right leadership team to guide the change process. Again, President Bush and his advisors ignored fundamental change management principles. Soon after the election, President Bush hit the road selling private accounts, as if he were still campaigning. No guiding coalition. No bipartisan team. He thought he could do it all by himself, with all the political capital he had accrued. Big Mistake # 2.

Change Management and Tax Reform

While the President’s management of the Social Security reform process looks rather amateurish at this point, it appears that the other key element of his domestic agenda, federal tax reform, is being steered by John Kotter himself. The complexity of the tax code is a pain that all Americans feel. Even the professional tax compliance community has testified to the impact of complexity on overall compliance. Honest people, especially business owners who attempt to comply with the tax law, are sensing that others are not paying their fair share, not due to an innate desire to game the system, but because it’s so difficult to comply with all the rules and regulations. Thus, President Bush did not have to work hard to create a sense of urgency. The anger Americans already feel toward the tax system provides the emotional driver for changing the status quo. In this case President Bush wisely chose to not fast forward to the end game, although I bet he has had a vision of a better system all along.

Instead of taking his solution directly to the people, President Bush created a nine-member bipartisian tax reform panel, led by former Senators Mack and Breaux, a Republican and a Democrat. The panel has been busy at work, interviewing knowledgeable people with a big-picture perspective, including former IRS Commissioners, Federal Reserve Chairman Alan Greenspan, various Harvard law professors, state and local tax administrators, and assorted Washington think-tankers, all in clear public view. From all appearances, the panel will meet its July 31 deadline for reporting out their findings and recommendations.

It has been interesting to watch this time around. Unlike the flamboyant 1994-1995 tax reform debate, when Ways and Means Chair Bill Archer vowed to pull the current income tax Code “out by its roots so it can never grow back,” and replace it with a national sales tax and House Majority Leader Dick Armey led a flat tax crusade void of any attempt to build a guiding coalition, President Bush’s panel is quietly going about its work without the edgy political rhetoric that could derail fundamental tax reform before it ever gets started.

Chances for Success

So where is it all going? I personally feel that, despite some noise early on about a national sales tax (which the media inferred from President Bush saying “everything is on the table”), we’ll see a 1986-like tax act later this year or next, while privatization of Social Security fades into the background. I’m not saying Social Security reform will disappear, just that the focus in Q3-Q4 will shift to tax reform.

What we’ll likely see is an income tax that looks more and more like a consumption tax. We won’t see another passive activity loss scheme that could decimate an entire industry like Section 469 did to real estate and savings and loans after TRA ’86. What we’ll likely see is some combination of:

Making permanent many of the 2001 and 2003 tax cuts, perhaps with some modifications;
Savings and investment incentives for individuals (tax favored treatment of interest, dividends, and capital gains);
Simplification provisions (a consolidation of education and retirement savings incentives into one massive Roth-IRA-like account);
AMT reform or elimination;
More favorable expensing provisions (and a revised capital cost recovery system) to encourage business investment;
Estate tax reform, with a higher exemption equivalent, e.g., $3-5 million (a compromise here will be necessary to garner enough Blue votes to overcome the filibuster threat);
Expanded tax benefits for charitable contributions by individuals and businesses;
Preservation of the home mortgage interest deduction, perhaps with some tighter ceilings;
Pro-business reform of international tax provisions, such as reduced taxation on foreign-source income;
Equal treatment of all industries; and
A revised itemized deduction scheme with fewer overall deductions.

A couple of interesting twists to consider:

(1) If President Bush’s desire to eliminate income tax on savings (i.e., interest and dividend income) becomes reality, have we not created a system of defacto privatized Social Security accounts for those who choose to contribute? We could see the President drop the private accounts portion of his Social Security platform in the spirit of compromise and creating solvency in the Social Security system, while effectively creating the same end result via changes in the income tax code instead.

(2) The current alternative minimum tax is about as close to a flat tax as we may ever see. With personal exemptions and many of the deductions added back to the tax base, and a tax rate of 26% or 28% applied to the base, how much flatter could we realistically get? The charitable contribution and home mortgage interest deductions would be preserved as President Bush requested, without having to change anything. I would not be totally surprised if the AMT survived in the name of simplification, perhaps with a different name (a wolf in sheep’s clothing?)

What makes this tax reform movement different and more likely to succeed than private social security accounts is that the President is going about it the right way, using sound change-management techniques. Putting Kotter-esqe change management theory into practice, President Bush began with an attack on the status quo to create a sense of urgency, sharing the people’s emotional disdain for the status quo. Going back to the Presidential debates and continuing with the early witnesses to testify before the Panel….Alan Greenspan, Fred Goldberg, and others all began with a condemnation of the current system. Kotter’s second step is to create a guiding coalition, and the third step is to get the vision right. President Bush accomplished these steps with the creation of the nine-member bi-partisan panel with a clear, non-controversial directive (pro-saving, pro-investment, make our businesses competitive abroad….who can argue with that?) and a tight deadline (July 31). There is no intra-party disagreement among the Republicans like in 1994-95, no partisan politics (with a Democrat and a Republican as co-chairs), a universally compelling cause (a tax code that is out of control in its complexity).

Take all those factors, add them together, and what have you got? A good chance of enactment. What do you call it? The Ownership Society.

Foreign Outsourcing and Workplace Trends

2005-03-11T21:38:00.000-06:00

Most people who get a lot of heartburn over foreign outsourcing don’t really grasp that it’s but one element in a larger economic picture. Let’s begin this discussion with a lesson from Economics 101---that value is a function of supply and demand. Demand for workers in the U.S. is affected by:

(1) increasing productivity which in turn is a function of technological innovation. Workers today are getting more done for the time invested. This is certainly true in the CPA profession, as firms go paperless, practitioners become tethered to their Blackberries, and software becomes smarter and smarter, each of which enables firms to get more done with fewer resources.

(2) continually escalating non-salary costs of employment….specifically healthcare. With year-in-and-year-out double digit increases in the cost of group health insurance, I doubt there’s a partner in a CPA firm or head of a corporate accounting department in Texas who doesn’t consider the cost of fringe benefits when making a hiring decision.

(3) demographic and generational trends…..retirement of the baby boomers with a shortage of Gen X’rs following along behind…..will supposedly result in a shortage of 10 million workers by 2010, according to the Bureau of Labor Statistics. In addition, traditional firms are finding that today’s younger workers are placing greater emphasis on work-life balance, expect to change jobs much more frequently, and don’t expect to put in the hours that partners expected from their staff members a generation ago.

(4) industry-specific factors, including the 150-hour rule for CPA candidates, the emergence of IT and finance as suitable career alternatives, and the migration of accounting graduates directly into private industry, bypassing the stint in public accounting that was the norm 25 years ago when I graduated from college.

These trends indicate that the American workplace is changing in a structural and permanent way. This includes the accounting profession, as these trends will directly affect CPA firms and organizations that employ CPAs. Get used to ‘just in time’ employment, as free agent independent contractors become the exception rather than the rule, as workers come together on a short-term, or project basis, and if they seek employment status at all, workers will demand (and get) flex time or part time arrangements from employers who will be forced to adapt. And don’t blame the Gen X’rs…older workers will drive much of the free agent economy, as they really won’t be retiring in waves, simply because they are living longer, are healthier, and haven’t saved enough. They will, however, be dealing from a position of strength in a seller’s job market.

In addition to looking at supply and demand for workers in the U.S., take a global view and you’ll see an increasingly integrated global service economy. The U.S. is running a $60 billion and growing annual trade surplus in services. Just as foreign investors choose US stocks and real estate, foreign businesses increasingly turn to US accountants, lawyers, bankers, and other service professionals to facilitate global business and investing. That’s why U.S. and international accounting and auditing standards are converging. Local firm practitioners who participate in firm alliances and associations already understand this.

I am not denying there will be some displacement and short term pain, as 3.3 million U.S. jobs move overseas by 2015 (according to Forrester Research), equivalent to 2% of the American workforce………but that’s after we’ve added 12-15 million jobs in the U.S., assuming the economy grows at a reasonable rate, and it’s also in light of a possible shortage of 10 million skilled workers by 2010 due to retirement of the baby boomers, according to the Bureau of Labor Statistics. The net effect is that we’re expected to add more jobs than we can fill, and some will move overseas.

The important thing is that we make sure that the jobs outsourced to India and other places are the manual, low-end jobs like data input and routing transaction processing, and that those whose time is freed up as a result seize the opportunity to move up the value chain. This is what happened with manufacturing….the media sensationalized the outsourcing of manufacturing jobs overseas, but what happened was that U.S. workers adapted and seized the opportunity to replace the lower cost outsourced jobs with higher paying jobs that reflected the higher value those workers were able to add. The McKinsey consulting firm recently published a study that concluded that every $1 spent on offshore outsourcing generates $1.12 of direct and indirect benefits, including the value from redeployment of labor in the U.S. Alan Greenspan regularly points out that the U.S. economy has always been able to generate enough jobs in cutting edge industries to replace jobs displaced in highly competitive low-wage industries. For decades, automation and productivity growth have eliminated jobs in the U.S. Shoe makers, horse and buggy dealers, ice box makers, and more recently travel agents and grocery store clerks have all found themselves displaced by technological innovation. That’s the same thing that is happening with foreign outsourcing of services. Ultimately such trends open the door for Americans to obtain better jobs and improve their standard of living. Former Labor Secretary Robert Reich opined in the Wall Street Journal that the only growing category of jobs in the U.S. that is characterized by higher pay and benefits involves identifying and solving new problems….work he calls “symbolic analytic” work….analyzing, manipulating, and communicating through numbers, shapes, words, and ideas. Technology provides the tools for thinking, creating, and communicating. There will be plenty of these jobs to go around, according to Reich, and to me this sounds like the role of the 21st Century CPA.

The Keys to Ensure Success

The keys to a successful transformation of the service sector are education, innovation, adaptability, and solving the problem of increasing health care premiums. And we must avoid the temptation of protectionist trade legislation, which would be a sure path to stagnation.

Lifelong learning and retraining of American workers, including CPAs, will be key to a healthy U.S. job market. In the CPA world, many CPAs think of our 40-hour annual CPE requirement as overhead. That will change for several reasons: (1) employees in the 21st Century will be looking to reinvent themselves every few years, and will be increasingly attracted to employers who enable them to do so; (2) as we advance into an era of smarter and more integrated applications, as mobile and wireless technologies enable new types of working relationships, and as the role of the CPA evolves, training will become a competitive advantage. Firms that are able to generate maximum efficiency and productivity (i.e., ROI) from their hardware and software, and more importantly from their people, will be in the strongest competitive position in a world where the market for professional services may look quite a bit different from the world we know today. Whereas in the past, CPE meant taking an annual tax update course, tomorrow’s employees will need training in hardware, software, workflow techniques, and soft skills, in addition to technical developments. Such training will enable firms to add value in an increasingly competitive world, by using historical data to look forward to help clients and employers achieve their goals.

Government policies will need to be designed to encourage innovation and investment by U.S. businesses and support retraining of workers and lifelong learning. This includes making the R&D credit permanent, enacting investment tax credits or similar measures designed to encourage investment and new business formation, and improving the current patchwork system of programs for educating and training workers. The Business Roundtable, an association of American CEOs with a combined workforce of more than 10 million employees and almost $4 trillion in revenues, has proposed a national initiative to design a worker education and training system for the 21st Century that builds on best practices and provides portable health and retirement benefits. Hopefully, Washington will take note.

In addition, as Chairman Greenspan points out, we must avoid legislation that would amount to isolationist trade policies. We must oppose protectionist policies that will not create new jobs and could ultimately cause inflation and have harmful effects on our relationships with our trading partners. 95% of the world’s population lives outside of the United States, and we simply cannot afford to cut off those markets from U.S. producers. Over the long term, protectionist trade policies end up hurting workers, as Japan has learned over the past 10 years.

CPAs will be directly affected by these trends, in addition to helping their clients and employers take advantage of tax laws and perhaps labor laws and other government policies designed to promote lifelong learning, innovation, and free trade.

Conclusion

Global outsourcing of finance and accounting services is close to a $50 billion market growing at nearly 10% a year. It has only recently registered on the radar screens of local accounting firms, as U.S. businesses offering tax return preparation in India has caught the attention of practitioners and professional organizations. The AICPA has weighed in by calling for disclosure to clients, which is fine. The IRS may soon require disclosure. Clients are technologically proficient and understand that outsourcing leads to lower costs and redeployment of resources. Many also realize that their banking transactions and insurance claims have been processed overseas for the last 20 years. CPAs I’ve spoken with tell me that if it helps their firms cope with the staffing shortage, workload compression, embrace a younger generation that doesn’t want to sacrifice February through April of every year, and move up the value chain in the public’s perception, it’s not a bad thing.

CPE will take on a new and more strategically important role, as employee expectations in a seller’s job market, coupled with new and evolving needs to master technology, streamline workflow, and add new value change the CPE paradigm significantly.

Employers will have to evolve and look at the employer-employee relationship a bit differently in years to come, as just in time employment and free agent independent contractors become the norm.

Finally, government policies must continue to support the evolution of America’s labor markets in a way that encourages innovation and investment that creates new jobs and that promotes lifelong learning and worker retraining. In addition, government policies must promote free trade and enable historical patterns of moving the American worker up the value chain to continue. Despite the noise from certain TV pundits that have their own agendas that benefit from the fear factor they help to perpetuate, it will become abundantly clear that outsourcing is not a threat to our economy or our workforce.

Tax Reform and The Underground Economy

2005-03-09T22:09:00.000-06:00

After watching federal tax laws evolve for 25 years, I am rarely surprised by the actions and inactions of our policy makers in Washington. However, I am presently a little puzzled by what appears to be an absolute indifference on the part of President Bush and our U.S. Congressmen toward the impact of the “underground” economy during the current Social Security and tax reform discussions. While significant energy and mindshare is directed at privatized Social Security accounts, and a blue ribbon committee led by former Senators Mack and Breaux are evaluating ways to simplify the tax code while stimulating growth and investment, very little mention is made of the impact of the vast amount of unrecorded, unreported, and illegal income on these and other initiatives. Such income, by going unreported and untaxed, ultimately forces the government to raise taxes on legitimate businesses and honest individuals, reducing the amount they have left to invest in initiatives that lead to economic growth. The last time fundamental tax reform was seriously debated at the federal level, capturing tax dollars from the underground economy was a central policy issue. Former Ways and Means Committee Chair Bill Archer pointed out in his infamous “pull the income tax out by the roots” speech that the underground economy causes honest taxpayers to “pay 10%-15% more to make up for what is lost to the cheaters and avoiders.”

Several economists have taken various approaches to quantify the unpaid taxes from the many types of activities that never get reported, and it’s very material. Former IRS Commissioner Charles Rossotti has pointed out that the IRS is losing out on about $200 billion a year of uncollected taxes. That’s almost enough to balance the budget, so you would think the politicians would be all over it. At a macro level, we’re probably running about 10% of the GDP, or more “off the books.” And it’s not just an American phenomenon….the impact is far greater in other parts of the world, particularly in developing nations.

Why the indifference? To begin with, it’s simply easier to stick our heads in the sand and ignore the problem than to try to fix it. In addition, Congress went on a bit of a witch hunt a few years ago with its attacks on the IRS and is reluctant to reverse field at this point. Plus, there’s a certain portion of the underground economy that we (Americans) may not want to acknowledge. By “underground economy,” I’m referring to monies paid for everything from migrant farm labor to illegal drugs to nannys, maid services and gardening, and from amounts paid to certain construction workers, restaurant employees, and street vendors, as well as moonlighting auto mechanics, carpenters and electricians that deal largely in U.S. dollars, the unofficial currency of the worldwide underground economy. We should also include tax dollars lost through fraudulent tax shelter schemes.

Not only do individuals and businesses participating in the underground economy avoid paying income and social security taxes, they also avoid product quality and safety requirements and compete unfairly with legitimate businesses. Many also ignore minimum wage and other employee-protection laws. On the flipside, they may not be able to do business with legitimate businesses, including lenders, and are not entitled to protection from law enforcement institutions and the court system.

Our policymakers essentially ignore the underground economy as a way to create jobs for unskilled and uneducated workers. They also would like us to believe that as businesses grow, they will eventually join the mainstream economy. Recent research published by the McKinsey Global Institute refutes these theories, concluding that the underground economy negatively impacts productivity and economic growth. Underground businesses tend to resist opportunities to modernize, fear the increased scrutiny that comes with growth, and establish supplier and vendor relationships that essentially ‘trap’ their workers in an inefficient and low-productivity environment.

What should our policymakers do? To begin with, Congress can allocate more dollars to the IRS for enforcement and to educational institutions (e.g., community colleges) for training programs to provide legitimate career options for individuals that may otherwise look at underground economy alternatives. They can also make it “easier to do business” by reducing and simplifying regulations. And perhaps the single most logical and practical thing they can do is to adopt a tax system that reaches all ‘consumers’ in the U.S., regardless of income. By simply taxing more businesses and individuals, fewer will be incented to remain part of the underground economy, and tax rates can come down for all businesses and individuals, improving economic efficiency and stimulating growth. For those who are concerned that such a fundamental change in our nation’s tax system would be problematic for our tax practitioner community, I would respond by pointing out that any system designed to collect over $ 2 trillion a year will leave plenty of opportunities for both tax compliance and planning work, and that any system that stimulates economic efficiency and growth is good for CPAs.

The Transformation of the American Workplace

2005-02-13T19:48:00.000-06:00

The term ‘globalization’ means many things to many people. To some it refers to U.S. companies manufacturing goods in developing nations. To others it means importing and exporting products for resale. In the past couple of years, the concept of globalization has expanded to include U.S. service sector jobs that have been or could potentially be moved offshore. Hitting close to home for CPAs, outsourcing of tax return preparation and other data entry jobs to English-speaking accountants in India has been a hot topic in many industry forums recently. This article will examine foreign outsourcing within the context of several overall employment-related trends in the U.S. workplace.

Consider that we are experiencing the creation of a globally integrated service economy. Much has been written about places like India, the Philippines, Brazil, and Costa Rica becoming the new back offices for many American businesses. Computer programming, call centers, credit card and insurance claim processing, billing services, investment and legal research, architectural and engineering services, and radiology analysis are all being outsourced overseas. Forrester Research predicts 3.3 million white-collar jobs will migrate overseas by 2015. To put that in context, there are an estimated 138 million jobs in the U.S. today, and a growing economy creates approximately 150,000 new jobs a month.

What is driving the overseas outsourcing trend? Certainly technology, as the Internet and broadband deployment have become ubiquitous, is a key enabler. The ever-present pressure on American businesses to cut costs and increase profits is certainly another factor, as knowledge workers in developing countries seem to be very happy earning 20% of what their American counterparts make. The escalating nonsalary costs of U.S. employment, specifically health insurance, causes employers to think twice before approving staffing requisitions. A large pool of college graduates --- India alone graduates more than two million English speaking college students a year---provides ample capacity in a supply and demand driven marketplace. The desire to better leverage existing domestic employees is another driver cited by companies that outsource. Declining transportation costs is certainly another factor behind globalization of services. In a nutshell, it’s capitalism playing itself out on a worldwide stage. Inefficient operations are being displaced by more efficient ones, freeing up capital to be redeployed to follow innovation.

When combined with related trends, the net result of globalization will be a realignment, or transformation of the traditional American workplace. Should we be worried? That’s the million dollar question. To answer that riddle, let’s look at outsourcing within the context of several overall workplace trends.

(a) Demographic trends. American Baby Boomers will begin to turn 65 in 2010, and the Gen X generation simply does not have the numbers to fill the jobs vacated by all the retiring Boomers….the jobs that drive the economy. The Bureau of Labor Statistics predicts there will be a shortage of 10 million skilled workers in the U.S. by 2010. Certainly that forecast involved a number of assumptions, but if it is even close to accurate, it is far more than enough to offset the 3.3 million jobs that Forrester predicts will migrate overseas. It will make the labor shortage of the late 1990s seem like a hiccup.

(b) Generational differences. Most CPAs I speak with on the subject of staffing point out that today’s young people “just don’t want to work like we did.” What we’re seeing is a generation of students and young professionals who saw their parents get burnt out if not laid off by corporate America and realize that the gold watch probably won’t be there in 40 years and isn’t worth it anyway. They are more mobile, internationally adept, more casual, and less loyal. We will see more job churning than ever, as long-term tenure with a single employer becomes a career liability. Combine that with the demographic trends discussed above, and the result is a seller’s job market. Employers will be forced to adapt to it. They will have to be more collaborative and flexible with their employees. The recruiting function specifically and HR in general will become much more strategically important. Evaluating and rewarding talent will be more critical than ever. And organizational structures may look quite a bit different.

(c) Productivity growth. As the productivity boom of the last decade demonstrates, businesses have learned how to grow without adding employees. Technology enables workers to produce more than was previously thought possible. Businesses can find temporary workers and contractors who are willing to forego fringe benefits and conventional employment. Business processes are continuing to be improved and automated. Certain types of jobs can be outsourced overseas. And Baby Boomers, with their longer life expectancies and penchant for consumption at the expense of saving, will certainly not all be able to retire when they turn 65. All these factors add up to a new type of workplace that some refer to as “just in time employment.” This, I believe, will be the shape of things to come.

(d) Service sector jobs surplus. One fact that doesn’t receive as much media hype as the outsourcing “fear factor” is that foreign countries outsource more white-collar service work to the U.S. than American companies send overseas, by a significant amount. The Commerce Department reported in March that the U.S. actually runs a rather large and growing trade surplus in services. For this reason alone, the worst thing we could do is enact some far-reaching, innovation stifling protectionist legislation to curb foreign outsourcing, as some politicians have proposed. It works both ways.

As we can see, the overseas outsourcing of services is but one element in a complex picture. One should not try to evaluate its impact on the U.S. economy or the American jobs outlook in isolation. While it’s true that foreign outsourcing of American service jobs is here to stay, and that initially may be unsettling, there will be plenty of good jobs to go around in the long run. That doesn’t mean there aren’t issues and challenges, but the net result is that while the American workplace as we know it is changing, such change is not necessarily bad.

Trends, Issues, Challenges, and Opportunities for CPAs

2005-01-19T20:45:00.000-06:00

The beginning of a new year always seems like a good time to pause and reflect on where we’ve been as a profession and anticipate where we’re headed. To do so requires an examination of trends and issues so that we might in turn be able to articulate the challenges and opportunities facing CPA firms in the months and years ahead. While the pace of change we face today is certainly unprecedented, it’s also true that the more things change, the more they stay the same, too. So in no particular order, here are 10 trends worth noting as we head into 2005 and beyond:

There seems to be a growing chasm between healthy, growing, vibrant firms and those that seem to be treading water or even declining. While this is not a big firm-small firm distinction, it is true that over the last 10 years, net income per partner is growing in larger firms while it is relatively flat in smaller firm segments, according to a comparison of the 1994 and 2004 TSCPA/PCPS MAP Surveys. Just looking at 2003, 48% of the firms in the U.S. grew more than 5%, while 19% actually reported lower revenues year on year. While many firms would admittedly like to grow, staffing shortages, turnover, the volume of technical developments, the need to get all existing work out the door, and lack of attention to marketing, in aggregate, create a barrier to growth for smaller firms and sole practitioners that lack economies of scale. Larger firms seem to have better luck attracting staff, adding services, and creating synergies through mergers, enabling them to grow their revenue bases as general business conditions improve, although they have their own unique set of issues.

The paperless trend will continue to proliferate. Today approximately 22% of firms have “gone paperless” through adopting products and reengineering processes that enable them to electronically collaborate on engagements, share and store digital information, and communicate with clients and third parties with minimal use of paper files and documents. According to the MAP survey, approximately 60% of firms have not yet but are planning to or considering going paperless.

Firms are facing more intense competition, both from inside the profession and from nontraditional competitors. In some parts of the country, especially where the local economy is not growing, firms are growing more from taking market share from other CPA firms than from organic growth through adding new services and growing their existing client bases. In other areas, private banking institutions are offering wrap accounts that package an array of services, including tax return preparation, estate planning, investment management, etc., and are recruiting talented professionals to join their staffs.

Analytical, advisory, benchmarking, forecasting, and business decision-making services will grow as the number of software tools available to support such activities proliferates. Analytical and forecasting tools have been added to many of the common accounting software packages used by companies, enabling their accounting managers and controllers to slice and dice historical information more effectively and enhance their value to their employers. Similarly, practitioners have a growing number of new financial analysis and business planning software products available to help them identify and provide more value-added service opportunities for their compilation, review, and audit clients.

In 2005 more than 7,000 publicly traded European companies (and an unknown number of privately held companies in over 90 countries) will begin reporting financial results using “international GAAP.” U.S. companies will still abide by U.S. GAAP, promulgated by the FASB, although U.S. and international standards are becoming more similar in the post-Enron environment. International auditing standards are also receiving more attention and visibility in the U.S. As globalization continues to affect almost every industry, it seems that the inevitable convergence of international GAAP and GAAS will occur sooner than later.

Foreign outsourcing of basic data entry for tax and accounting services will continue to grow, as but one element in an accelerating globalization trend. There may be some hiccups along the way, but the staffing shortage, need for work-life balance, demographic trends, and pure economics are too strong to derail this trend. Clients will not resist, and the recent AICPA ethics ruling requiring disclosure of outsourcing activities will not have a significant impact.

Changing demographics will result in accelerated consolidation in our industry, a buyer’s market for firms caught without a solid succession plan, an increase in female partners, and eventually more young people entering the profession. Today, 68% of CPAs are over 40 (compared to 47% ten years ago), and approximately 40,000 out of the 44,000 total practice units on the AICPA’s membership roster are firms with 1-4 professionals. Today, women comprise only 12% of partners but represent the majority of staff accountants. What this tells me is that there are lots of small firms owned by aging male CPAs who are planning to retire in the next 5-15 years and who will be looking for a way to cash out. Fortunately, accounting enrollment is up 17%, but that alone will not create enough buyers to absorb the number of practices that will be for sale.

The trend of accounting firms coming together to form professional associations continues to grow exponentially. Reasons given for joining associations include sharing best practices and expertise at the managing partner level and at the practice level, plus the ability to serve larger and growing clients that demand a wider array of services than a single firm must be able to offer. Association members say they enjoy the open dialog with peers that are not considered competitors.

CPAs will experience a continued trickle-down effect from Sarbanes Oxley (i.e., beyond the public company arena), and the PCAOB will impact the profession in unforeseen ways. Already we are seeing the ripple effect of SOX in hiring and salaries (up 5.7%), as public companies and larger public accounting firms are hiring experienced audit staff from smaller firms at significant premiums. Also noteworthy is the migration of clients and services from one firm to another, and new types of independence issues. The impact of the PCAOB has yet to be determined. To date, approximately 1,400 firms have registered with the PCAOB, with 80% having five or fewer publicly held clients. It will be interesting to see whether they train their staffs and perform audits using two sets of auditing standards, one for public companies and one for nonpublic clients, or if they ultimately adopt PCAOB standards for all engagements.

While ubiquitous adoption still seems several years away, the ASP model (online software) and the demand for real-time financial information will continue to gain momentum. Different drivers are impacting the trend in different market segments. Extensible business reporting language (XBRL) technology will be a major driver in the public company segment, enabling investors to use more relevant, useful, and current financial information in their analyses. The trend is also gathering momentum in the small business segment, as Quickbooks Online and other applications continue to grow in popularity, as users cite remote access and the ability to share information as key drivers. Quickbooks Online doubled its user base in 2004 and expects to double it again in 2005.