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The ABCs of activity-based costing

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Revenue and expenses, as reported on your company’s income statement, have limited usefulness to people inside the organization. Managers often need information presented in a different format in order to make operational and strategic decisions. That’s where activity-based costing comes into play. This costing system is commonly used in the manufacturing and construction sectors to determine which products and customers are profitable, to identify and eliminate waste, and to more accurately price products or bid jobs going forward.

4 steps 

With activity-based costing, you assign cost codes (think of them as price tags) to each activity completed based on the resources consumed. These cost codes define the activity; the equipment, materials and labor used to complete it; and how long it takes to finish the task.

Here are four basic steps used to create a cost code in activity-based costing:

1. Identify activities. Create a list of tasks your company performs to complete a job. Define each activity in such a way that there’s no overlap between them.

2. Allocate resources. For each activity, list resources used. These include material, equipment, labor hours and, if applicable, subcontracting costs.

3. Calculate the per-unit cost of each resource. Choose a standard, measurable unit of each resource and calculate the cost per unit. Sometimes, you’ll have to calculate an average cost based on purchase receipts for a specific period. For example, if a box of screw anchors holds 100 and costs $30, the per-unit cost of screw anchors would be 30 cents if you consider one “unit” to be a single screw anchor. For labor hours, the measurable unit would be the wage paid per hour.

4. Determine how much of each resource is used for each activity. Multiply the per-unit cost of each resource by the number of units consumed. Add indirect costs to determine the total cost. These may include rents, machinery payments, salaries and other expenses that don’t directly contribute to completing an activity.

Potential benefits 

Companies can use activity-based costing to learn what’s working — and what’s not. For example, let’s say a job is costing more than it should, or is taking too long to complete. Activity-based costing will quantify for each task: 1) the materials consumed, 2) which pieces of equipment were deployed, and 3) how many labor hours were spent to complete it. This process allows you to track the progress of jobs in real time, so you can correct mistakes and inefficiencies before losing money to them.

You also may be able to uncover excessive spending trends, so you can better control purchasing. For strategic planning purposes, the process can provide a clearer picture of what types of activities and jobs will likely boost the bottom line and enable you to grow your business. Likewise, it can help assess whether your current product mix needs to be modified to boost profits.

Furthermore, with price tags attached to everything, estimators can “cut up” a prospective job into well-defined activities and then calculate estimates for each of those tasks, resulting in a more accurate overall project estimate. If the scope changes, thereby increasing or decreasing the number of activities, it’s much easier to recalculate the estimate. Activities essentially become line items that can be added or deleted.

One size doesn’t fit all companies 

Activity-based costing can be used to supplement, but not replace, your company’s traditional cost accounting system. Although this process may seem confusing, software solutions can help shorten the learning curve. Contact us to learn how your business can benefit from activity-based costing and how to effectively implement this process based on the nature of your operations.

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EBSA increases penalties for ERISA violations

Book with title Employee Retirement Income Security Act (ERISA).

Any employer that sponsors a pension plan or a qualified retirement plan, such as a 401(k), is undoubtedly familiar with the Employee Retirement Income Security Act (ERISA). The law also applies to employer-sponsored health maintenance organization plans, Flexible Spending Accounts, and life and disability insurance.

Established in 1974, ERISA holds plan fiduciaries responsible for their actions related to the maintenance of applicable benefits plans. The Employee Benefits Security Administration (EBSA), an agency of the U.S. Department of Labor (DOL), is required by law to annually adjust ERISA penalties for inflation.

This year, effective for penalties assessed after January 14, 2022, the EBSA has increased for inflation the per diem and maximum penalty amounts for a variety of ERISA-mandated requirements. Here are some potential violations and their adjusted penalties:

Failure to furnish information to, or maintain records for, any employee. The penalty has been increased from $31 to $33 per employee for each failure. Employers might be able to avoid this penalty if they can demonstrate reasonable cause.

Failure or refusal to file a plan’s annual report with the DOL. The penalty has been increased from $2,259 to $2,400 per day, starting on the date of the plan administrator’s failure or refusal to file.

Failure by multiple employer welfare arrangements that provide health care benefits to timely file an annual report with the DOL. The penalty has been increased from $1,644 to $1,746.

Failure to provide plan information, such as a summary plan description, to the DOL in a timely manner. The penalty has been increased from $161 per day (not to exceed $1,613 per request) to $171 per day (not to exceed $1,713 per request).

Failure or refusal to provide notice to participants and beneficiaries of: 1) the provision of blackout period notice, or 2) the provision of notice of the right to divest employer securities. The penalty has been increased from $143 to $152 per day.

Failure by an underfunded multiemployer pension plan to timely adopt a funding improvement plan or rehabilitation plan, or to meet the applicable benchmarks by the end of the plan’s funding improvement period. The penalty has been increased from $1,419 to $1,507 per day.

Failure to provide employees with written notice of potential opportunities for state-provided premium assistance. The penalty has been increased from $120 to $127 per day.

Failure to provide disclosure of group health plan benefits to states for Medicaid- and CHIP-eligible individuals. The penalty has been adjusted to $127 per employee per day.

Failure to properly make a distribution. The penalty of $17,416 has been increased to $18,500 per improper distribution.

Willful failure by a group health plan to provide information to a participant or beneficiary. The penalty has been increased from $1,190 to $1,264 for each failure.

ERISA also imposes various penalties for the misuse of genetic information. Contact your benefits advisor for specifics about these.

The revised ERISA penalty amounts, which are generally payable to the DOL, will remain in effect until the effective date of the next adjustment for inflation. Our firm can help you manage the costs and financial risks of your benefits plans.

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Smooth sailing: Tips to speed processing and avoid hassles this tax season

The IRS began accepting 2021 individual tax returns on January 24. If you haven’t prepared yet for tax season, here are three quick tips to help speed processing and avoid hassles.

Tip 1. Contact us soon for an appointment to prepare your tax return.

Tip 2. Gather all documents needed to prepare an accurate return. This includes W-2 and 1099 forms. In addition, you may have received statements or letters in connection with Economic Impact Payments (EIPs) or advance Child Tax Credit (CTC) payments.

Letter 6419, 2021 Total Advance Child Tax Credit Payments, tells taxpayers who received CTC payments how much they received. Since the advance payments represented about one-half of the total credit, taxpayers who received CTC payments need to file a return to collect the rest of the credit. Letter 6475, Your Third Economic Impact Payment, tells taxpayers who received an EIP in 2021 the amount of that payment. Taxpayers need to know the amount to determine if they can claim an additional amount on their tax returns.

Taxpayers who received an EIP or CTC payments must include that information on their returns. Failure to include this information, according to the IRS, means a return is incomplete and will require additional processing, which may delay any refund owed to the taxpayer.

Tip 3. Check certain information on your prepared return. Each Social Security number on your tax return should appear exactly as printed on the Social Security card(s). Likewise, make sure that names aren’t misspelled. If you’re receiving your refund by direct deposit, check the bank account number.

Failure to file or pay on time

What if you don’t file on time or can’t pay your tax bill? Separate penalties apply for failing to pay and failing to file. The penalties imposed are a percentage of the taxes you didn’t pay or didn’t pay on time. If you obtain an extension for the filing due date (until October 17), you aren’t filing late unless you miss the extended due date. However, a filing extension doesn’t apply to your responsibility for payment. If you obtain an extension, you’re required to pay an estimate of any owed taxes by the regular deadline to avoid possible penalties.

The penalties for failing to file and failing to pay can be quite severe. (They may be excused by the IRS if your lateness is due to “reasonable cause,” such as illness or a death in the family.) Contact us for questions or concerns about how to proceed in your situation.

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How to look for missing 401(k) plan participants

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It’s a common problem every year. Employers discover that, when their 401(k) plans must make required minimum distributions, the addresses on file for some distributees have become invalid.

The U.S. Department of Labor (DOL) and the IRS have both offered guidance about dealing with participants and beneficiaries who are unresponsive or cannot be located — commonly referred to as “missing participants.” However, the guidance isn’t completely on point or highly detailed. The DOL’s most detailed guidance relates to terminating plans, and the IRS’s guidance relates to audits and the correction of distribution errors.

The DOL has also provided a list of best practices that sponsors of ongoing plans can employ to minimize and mitigate the problem of missing participants, but the practices are only examples of steps that plan fiduciaries should consider in light of a plan’s participant population, the size of a participant’s benefit and the cost.

Although all the guidance mentioned doesn’t offer a complete compliance roadmap, it collectively suggests the following approach to looking for missing participants of a 401(k) plan.

Initial search steps

When a participant is unresponsive or you reasonably believe your contact information is inaccurate, consider taking four steps:

  1. Use certified mail or, if more cost-effective, a private delivery service with similar tracking features,
  2. Review your employment records and all your benefits plans for up-to-date information,
  3. Attempt to identify and contact the individual’s designated beneficiaries under those plans for information, and
  4. Use free electronic tools such as internet search engines, public record databases and social media accounts.

The DOL’s best practices guidance includes other suggestions, such as reaching out to a participant’s colleagues or union, and registering the person’s name on public or private pension registries. The agency suggests that privacy concerns can be alleviated if the retirement plan fiduciary asks the employer, other plan fiduciary or beneficiary to have the missing participant contact the retirement plan administrator. Nevertheless, employer-sponsored group health plans shouldn’t use or disclose individually identifiable information unless the use or disclosure complies with HIPAA’s privacy rules.

Additional steps for larger balances

If initial search steps are unsuccessful, paying for a search may be appropriate if the account balance is large enough to justify the expense. This could mean using fee-based internet search engines, commercial locator services, credit-reporting agencies, information brokers, investigation databases and other similar premium services.

You might be able to charge the fee against the account if it’s reasonable and the allocation method is consistent with the plan’s terms and ERISA.

When search efforts fail

Some plan documents describe how to handle account balances when search efforts fail; others may authorize administrative committees to adopt policies for this situation. Following written policies and procedures for handling missing participants — and documenting actions taken — should help ensure consistency.

Some plan provisions or policies direct fiduciaries to allocate the funds in the account among the accounts of the remaining participants, subject to restoration if the individual should reappear. Under IRS regulations, such an allocation may be a permissible forfeiture so long as the plan is obligated to restore the missing individual’s account balance in the event the person is eventually found.

Ongoing practices

The DOL’s best practice guidance encourages plan sponsors to minimize future problems with missing participants by proactively maintaining an accurate census. Periodically prompt participants and beneficiaries to reconfirm their contact info. Regularly audit census data, paying special attention to contact info in business transactions or when recordkeepers change.

Even changing the way plan communications are written and designed can increase the likelihood that participants will recognize and engage with them.

Financial impact

A 401(k) is usually among the most valued benefits that employers can offer, but you’ve got to keep a close and constant eye on the details — including missing participants. We’d be happy to help you assess the financial impact of your plan.

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Entrepreneurs and taxes: How expenses are claimed on tax returns

While some businesses have closed since the start of the COVID-19 crisis, many new ventures have launched. Entrepreneurs have cited a number of reasons why they decided to start a business in the midst of a pandemic. For example, they had more time, wanted to take advantage of new opportunities or they needed money due to being laid off. Whatever the reason, if you’ve recently started a new business, or you’re contemplating starting one, be aware of the tax implications.

As you know, before you even open the doors in a start-up business, you generally have to spend a lot of money. You may have to train workers and pay for rent, utilities, marketing and more.

Entrepreneurs are often unaware that many expenses incurred by start-ups can’t be deducted right away. Keep in mind that the way you handle some of your initial expenses can make a large difference in your tax bill.

Essential tax points 

When starting or planning a new enterprise, keep these factors in mind:

  • Start-up costs include those incurred or paid while creating an active trade or business — or investigating the creation or acquisition of one.
  • Under the federal tax code, taxpayers can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs in the year the venture begins. Of course, $5,000 doesn’t go far these days! And the $5,000 deduction is reduced dollar-for-dollar by the amount by which your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized over 180 months on a straight-line basis.
  • No deductions or amortization write-offs are allowed until the year when “active conduct” of your new business commences. That usually means the year when the enterprise has all the pieces in place to begin earning revenue. To determine if a taxpayer meets this test, the IRS and courts generally ask questions such as: Did the taxpayer undertake the activity intending to earn a profit? Was the taxpayer regularly and actively involved? Has the activity actually begun?

Types of expenses

Start-up expenses generally include all expenses that are incurred to:

  • Investigate the creation or acquisition of a business,
  • Create a business, or
  • Engage in a for-profit activity in anticipation of that activity becoming an active business.

To be eligible for the election, an expense also must be one that would be deductible if it were incurred after a business began. One example would be the money you spend analyzing potential markets for a new product or service.

To qualify as an “organization expense,” the outlay must be related to the creation of a corporation or partnership. Some examples of organization expenses are legal and accounting fees for services related to organizing the new business and filing fees paid to the state of incorporation.

An important decision 

Time may be of the essence if you have start-up expenses that you’d like to deduct for this year. You need to decide whether to take the election described above. Recordkeeping is important. Contact us about your business start-up plans. We can help with the tax and other aspects of your new venture.

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Preparations vs. compilations

Portrait of happy waitress standing at restaurant entrance while looking outdoor. Portrait of young business woman attend new customers in her coffee shop. Smiling small business owner showing open sign in her shop while leaning against the door.

Your business needs financial statements so management can monitor performance, attract investment capital and borrow money from a bank or other lender. But not all financial statements are created equal. Audited statements are considered the “gold standard” in financial reporting. While public companies are required to issue audited statements, smaller, privately held organizations have options. CPAs provide three other types of financial statements, which, in order of descending level of diligence, are: reviews, compilations and preparations.

Here’s some insight into the newest and most basic financial reporting service available to private businesses — preparations — and how these engagements differ from compilations.

Preparations

Financial statement preparations are often created as part of bookkeeping or tax-related work. While some lenders may accept preparations in support of small lending arrangements, preparations are generally reserved for internal purposes to provide information on the business’s current financial condition and as a basis of comparison against future accounting periods.

Preparations provide no assurance regarding the accuracy and completeness of the financial statements. Assurance is critical if you plan to share the financial statements with third parties. Generally speaking, the greater the level of assurance, the more trust a reader will have in the accuracy and integrity of your company’s financial statements.

In addition, professional standards don’t require CPAs to be independent of a business when preparing its financial statements. In other words, it’s OK for an accountant to have a financial interest in a company that he or she prepares financial statements for.

To avoid misleading any third parties who might receive a copy of these statements, each page of a prepared financial statement must include a disclaimer or legend stating that no CPA provides any assurance on the financial statements. In addition, prepared financial statements must adequately refer to or describe the applicable financial reporting framework that’s used and disclose any known departures from that framework.

Compilations

Like preparations, compilations provide no assurance that the financial statements are accurate and complete. And independence isn’t required when issuing compiled financial statements. But there are subtle differences when moving from a preparation to a compilation.

A compilation involves the issuance of a formal report by a CPA who’s required to read the statements and evaluate whether they’re free from obvious material errors. The CPA’s report appears on the first page, before the financial statements. If the CPA isn’t independent of the business, he or she must disclose this fact in the report.

Notably, the use of a compilation of financial statements can extend beyond the business owner to third parties, including investors, business partners and lenders who may view the input of a CPA as beneficial.

Building for the future 

Preparations may be a cost-effective way for small business owners to monitor performance. But they provide limited usefulness as a business grows and needs to interact with third parties. Eventually, prepared statements may need to be upgraded to a compilation, review or audit to give stakeholders greater assurance about the company’s financial results. Contact us to determine what’s right for your current situation.

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