The CPA's Role in Navigating Troubled Economic Waters

Winter 2009

Be a Calming Force in Times of Financial Turmoil

By Larry S. Blair, CPA, JD

The recent meltdown in the economy is forcing all of us to face tumultuous times. This era of financial difficulty will affect us into the foreseeable future, so CPAs will find themselves advising clients on a wide array of concerns, some of which may not have been their areas of focus in the past. A primary reason CPAs are viewed by many as their most trusted advisors is because we are independent, rational, and steady in the advice we offer. There is no vested interest in advising a client, only the goal of providing the best advice and counsel to that client. This article highlights several important areas where CPAs may be called upon to calm the roiled waters of these times of uncertainty through their consultation and advice.

Wealth Preservation and Accumulation
The goal of an investment is to grow assets and produce income. Now, however, it is critical for CPAs to consider wealth preservation as part of the wealth strategy. Wealth preservation must take into account an individual’s age and the appropriate asset allocation, with a view toward a more conservative strategy to act as a hedge in the event of further declines in the market. Wealth preservation presents a unique challenge, and CPAs are in a position to look at the many dynamic and inter-related factors that affect a client’s investments and income. In this time of high emotion, CPAs need to be both responsive to concerns and active in determining the best process to follow for a preservation strategy.

Many clients may face a reduction in their wealth that cannot be recovered by relying solely on existing investments and market-condition improvements. CPAs hold a critical role in advising clients on how to structure their financial affairs to reaccumulate wealth. The financial knowledge of CPAs is key to helping clients achieve the short-term and long-term objectives of investment planning. Working with asset allocation models and the effects of taxes, coupled with the time horizon available to the client, CPAs can bring significant value to this process and help their client’s efforts to regain lost wealth.

Retirement Planning
Many of those who have retirement accounts have seen their retirement funds reduced dramatically in this chaotic economic environment. Depending on where a client is in their work life, recovery will be very difficult. CPAs must speak with their clients about their expected time horizon until retirement, then analyze the existing retirement assets, including possible Social Security, and determine what the client’s financial position will look like at the time of anticipated retirement.

When this analysis is done, it may well be that you may have to advise your client to delay retirement and work longer than originally planned. However unpleasant the analysis and discussion may be, it will provide a basis for real planning that will best serve the client. When looking at this analysis, do not underestimate an individual’s life expectancy. One of the most frightening things for retirees is the possibility of running out of money during their retirement. A thorough analysis can allay this fear. Many Americans, for whatever reason, have not started saving for retirement. Despite the tumultuous markets and gloomy forecasts, there is no time like the present to start saving. Younger people, obviously, have a much longer time horizon in which to deal with this issue, but as one approaches retirement age, saving enough for retirement becomes a difficult challenge. Individuals need to not only save, but also maximize savings for retirement. The CPA knows this challenge well and can make clients aware of this need by sharing information on tax-efficient and age-relevant ways to save for retirement.

Education
Many who have diligently saved money over the years for their children’s education have seen much of these savings disappear. As a result of the lending crisis, student loans will be less available than in the past, and, as a result of the market downturn, many colleges and universities will have less money to provide toward student aid. As this education funding crisis hits home, CPAs will be relied upon heavily by their clients. CPAs can assist clients in finding financial opportunities from the complex educational tax benefits built into the federal and state tax codes.

Some benefits, such as Section 529 plans, are a longer-term opportunity, whereas certain educational tax credits can provide a more current benefit. CPAs are equipped to look at other sources of educational funding, such as government programs. The application process for these programs is very complex, but dealing with complex paperwork is an area of CPA strength.

Obtaining Credit
As the banking industry stands today, obtaining credit may be the most difficult challenge clients will face in the months ahead.

Sources of credit that were readily available in the past are now, in many cases, nonexistent. Loans for starting a business, expanding a business, buying a home, buying a car, or purchasing other consumer items have become more difficult to obtain. Even lines of credit that existing businesses use to run their operations have become more limited. CPAs are in the position to both understand a client’s financial situation and advise on how to present the best picture of their financial circumstances when applying for a loan. CPAs also have a significant financial network that may help match a client’s needs with an available lending source.

From a personal lending standpoint, an individual’s credit rating score and credit report are important as lenders rely heavily on these factors when determining whether or not to make loans available and at what rate. CPAs can guide their clients through this process to help increase the client’s credit score, or correct it, in advance of a loan request.

Insurance
Insurance, by definition, is an asset protection vehicle. Whether it be life insurance, homeowners and personal property insurance, auto insurance, umbrella insurance, medical insurance, or long-term care insurance, these tools are critical for clients to consider and implement where appropriate. Especially in times of crisis, CPAs should review the adequacy of their clients’ various coverages. For example, does a client have enough life insurance? This is a question that is client-specific, based on the client’s personal circumstances, but with business owners, life insurance can play a critical role in converting what might otherwise be an illiquid ownership investment in a business into liquidity through the use of life insurance and the appropriate buy-sell arrangement.

An individual’s home is often their most valuable asset, regardless of whether the housing market stumble has caused its value to drop. It is important to provide the appropriate coverage to protect this asset. We have all read about the devastating flooding as a result of hurricanes and other severe storms. In many cases, the typical homeowner’s insurance coverage does not include damage due to flooding. This exclusion can result in a financial catastrophe for a client. In addition, in many parts of Pennsylvania, homeowner’s insurance does not cover mine subsidence damage.

There are many types of insurance coverages available to clients. The CPA is in a detached and independent position to review these complex, yet very important, coverages with their clients. The time for the insurance analysis and review is before an event occurs that may trigger the need for these policies. Once an event has occurred, and proper coverage is not in place, it is too late.

Charitable Planning
As a result of the economic downturn, many clients who otherwise give to charities may be cutting back dramatically. This is understandable in difficult times, when discretionary dollars are at a minimum. However, there are many options available to clients to satisfy charitable desires. These techniques may involve the use of gifting of appreciated property, life insurance planning, and various types of trusts that can be structured to produce more current income yet make a deferred gift to charity.

Business Planning
The many traditional roles of a CPA in assisting businesses take on even greater importance in a volatile economic environment. CPAs bring great experience in the areas of auditing and accounting, taxes and compliance, and operational issues. However, one specific area of planning does not always get addressed, and it is critical when the future is uncertain: succession planning. Whether a business is to be continued by existing owners, family members, or employees, a plan must be put into place that will appropriately accomplish the objective. No action is action at its worst.

If a business is to be continued by the remaining partners, it is important to have a tightly drawn buy-sell arrangement in place. The buy-sell agreement could be structured in a way that requires the surviving shareholders to buy out the interest of the decedent shareholder. This could convert an otherwise illiquid asset into a liquidity event for the family of the decedent shareholder.

However, planning with a tightly drawn buy-sell agreement is generally not enough. Once the buy-sell obligation is triggered, the question then becomes how will the decedent’s ownership be purchased by the surviving members. The funding of a buy-sell agreement is often funded through the operations of the business on a going-forward basis. This obligation by the company or the shareholders can create an impossible financial burden for the company, a burden that could kill a business during hard economic times. By having to pay out certain amounts for the purchase of the decedent’s ownership interest, corporate assets are diverted from business operations.

Another funding vehicle is the use of life insurance. Whether the life insurance is owned by the business entity itself, the owners of the business, or an irrevocable life insurance trust, the use of life insurance can be an effective funding vehicle for the purchase of shares upon an owner’s death.

Conclusion
Many clients look at the above areas as specific, independent issues to be dealt with. CPAs, however, must look at the issues as very much interrelated. The planning for one will have an impact on several of the others, as well as other areas not mentioned, such as income tax and estate planning. Thus, the knowledge that CPAs can bring to a complex client situation will provide a calming effect through appropriate planning for these interrelated issues.

In difficult financial times, many clients do not know where to turn for advice. One of the best services that a CPA can bring to a client during a state of unease is to proactively reach out and offer to discuss the issues, challenges, and opportunities facing the clients and their businesses. CPAs can bring order to an otherwise chaotic situation.

Larry S. Blair, CPA, JD, is a partner with the law firm of Metz Lewis LLC in Pittsburgh, and is a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at lblair@metzlewis.com.

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Banking Crisis or Accounting Crisis?

By Francis X. Ryan, CPA

You would think it would be intuitively obvious to most observers that securities prices should be priced at current market values. Or is it not that obvious?

I have become increasingly frustrated in recent years that financial information prepared and presented in strict accordance with the guidance detailed in the contemporary accounting literature can be so at odds with the economic reality it is supposed to represent.

CPAs are responsible to the public, and this responsibility transcends all others. AICPA’s Code of Professional Ethics states, "Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism." This does not mean CPAs cannot also be responsible to an employer, an associate, or a supplier, but it is the public that is the primary concern. CPAs are also responsible for being objective. Many perceive a CPA’s overriding responsibility to be conservative, however, it is objectivity that undergirds virtually everything that we do and every decision we make. We are advised, "Objectivity is a state of mind, a quality that lends value to a member’s services. It is a distinguishing feature of the profession. The principle of objectivity imposes the obligation to be impartial, intellectually honest."

The information that flows from a strict interpretation of FASB’s recent fair value pronouncements do not seem to follow through on those principles. It seems these pronouncements can lead to "conservative" valuations that are far from fair. The question then becomes, do we CPAs have a professional responsibility to ensure the public is aware of this? And if we believe information as presented could be subject to misinterpretation, do we have an ethical responsibility to draw attention to this potential for misuse?

For example, in the late 1990s, many financial analysts were gleefully proclaiming we were in a new economy and that earnings did not matter. CPAs knew that corporate losses consumed cash; therefore, earnings must have mattered. At the time, I often questioned whether CPAs should have spoken louder when the "new economy" comments were being made. Had we been more vocal, could the tech stocks debacle have been dampened?

Not too long ago, real estate prices in many regions were galloping along at growth rates of 20 percent or more. Hybrid and negative amortizing mortgages were becoming fashionable. Most CPAs that I spoke with expressed serious concerns about the wisdom of such mortgages and the sustainability of such gains. Should the CPA profession have spoken more loudly?

In some ways, the volatility of bank stock prices over the past few months and the recent government intervention on behalf of financial institutions are a direct result of accounting conventions. Specifically, I am referring to recent fair-value pronouncements that relate to the timing of recognizing impairment charges. Under current GAAP, relatively short-term asset market price depressions are leading to the recognition of impairment charges that may not be reversed when conditions improve. This is causing banks to write off assets in record amounts, perhaps unnecessarily. Attempts by Congress, SEC, and other governing bodies to mitigate the damage by relaxing those rules are taking place only after the damage has been done.

The very-short-run, short-run, and long-run planning horizons are extremely important for valuation issues. An asset temporarily impaired in the very short run due to market instability may be valued more realistically in a few weeks or months. To require a bank—or any firm—to write down assets in light of recent market turbulence seems to run counter to the public trust CPAs strive so hard to uphold.

Would anyone reasonably believe that the largest shareholders of many banks would be willing to sell their stakes for the prices listed today? While some may sell to avoid exposure to such turbulence, could the bank itself be sold for its imputed post-impairment value? Not likely. Yet, a CPA performing an audit, or a CFO, would be committing career suicide by deviating from "published" very-short-run market valuations. Imagine what an SEC counsel for a firm would tell his or her client if you refused to write down an asset temporarily impaired to current market values. "No one goes to jail for being too conservative" would likely be the response. Even with the relaxed rules, only time will tell if CFOs were being too aggressive with relaxed mark-to-market rules.

Pricing in the markets is difficult under the best of circumstances. CPAs should not be put in a position of valuing stocks, but we should, I believe, accept our responsibility to prevent financial reports from being misused, egregiously or inadvertently. To assume only the "worst case" in valuation assessments is a violation of our principles of objectivity and an impairment of our responsibility to the public. Shareholders who sell believing an asset to be "worthless" have, in fact, been harmed by accounting conventions.

The solution is straightforward: CPAs must fight to revise accounting practices that lead to short-sighted asset valuations during periods of market turbulence, such as we have today. We must be willing to defend valuations that we professionally believe to be impaired only temporarily, despite current market prices. We must strive to act objectively, and we must remember our responsibility to the public.

The CPA profession and government oversight bodies must acknowledge that temporarily unmarketable assets are still assets with value, and that the values framed under the current authoritative guidance, and relied upon as sacrosanct by the public, may be different than their economic values. Disclosure is best for assets that are only temporarily impaired in management’s professional judgment.

Financial statement accuracy is about professional judgment and professional skepticism. CPAs are paid to uphold these values, to be objective, and to remember our responsibility to the public.

Francis X. Ryan, CPA, is president of F. X. Ryan & Associates Ltd. in Lebanon. He can be reached at fryan1951@aol.com.

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Beyond the Client: Looking to Consumers’ Needs During Turbulent Times

By Maureen A. Renzi, APR, PICPA vice president of Communications

The recent events in the financial sector have hit businesses and households hard. Depleting balances in retirement and other savings funds, falling home prices, and reduced credit options underscore the importance of the CPA profession’s financial literacy message. Issues of debt and savings are no longer something to put off into the future. PICPA and AICPA resources make it easy for CPAs to respond to the public’s immediate need for sound financial guidance.

The CPA profession, through the AICPA’s financial literacy programs, has been working to heighten consumers’ understanding of basic financial planning principles for many years. In fact, in 2004, AICPA predicted that if consumers continued down a path of increased debt and decreased savings, it "would cause dire consequences in the national economy." In today’s volatile environment, many consumers are finally realizing they need to plan and budget; but many do not know how to make it happen. CPAs have the credibility and knowledge to help consumers take control of their finances.

Financial Education in the Workplace
PICPA’s Money & Life program is designed to offer a free financial education program in the workplace that includes information on basic financial planning topics, such as budgeting; good debt versus bad debt; renting, leasing, and buying; and establishing financial priorities.

Volunteer CPAs come into a company to offer education and resources, but not sell a product. CPAs in industry, such as Natalie Brown of First Energy Corporation, scheduled a program in her company after work hours. Those who attended were already individuals who were employing basic budgeting principles and were hungry for more information. Brown observed, "I find that the people who were never really concerned with their finances, and believed things would work their way out, are finding that was not such a good plan. Today, I think more people are looking for some basic guidance."

Laurie Peer of Reinsel Kuntz Lesher LLP mentioned the program to a client. The client recognized that this was something his employees needed, so he closed his factory for three hours and made it a mandatory program. According to studies conducted by the Federal Reserve, programs like these increase employee loyalty and decrease stress while increasing productivity.

Financial Education in the Community
Money & Life resources can be easily adapted for community presentations. State Reps. Mike Fleck and RoseMarie Swanger, for instance, have hosted town hall meetings with a Money & Life component. Virgil Kahl, of Spring Ridge Financial Group and one of the developers of the program, worked to have programs offered as adult education programs and at her local library. PICPA has also sent information to chambers of commerce and community organizations, and participated in programs with the Pennsylvania Office of Financial Education to create an awareness of resources available and to develop CPA partnerships with community groups. Members are encouraged to look for additional opportunities in their community to deliver the message of financial responsibility.

Financial Education in the Classroom
The Money & Life program was adapted for college students and presented at Moravian, Lycoming, Gannon, East Stroudsburg, University of Pittsburgh at Johnstown, and Point Park College. Students were invited to participate in interactive sessions to find out more about college loans, credit scores, car loans and insurance, and more.

PICPA’s Emerging CPAs committees are working to present financial literacy programs in high schools. Classroom resources are available for CPAs and faculty to provide students with guidance on how to develop important savings habits early that they can use throughout their lives.

For parents interested in offering programs on the elementary school level, AICPA, with the help of the Ad Council, developed a series of financial lessons for "tweens" - students in fourth to sixth grades. These resources are an extension of the "Feed the Pig" savings campaign, and can be found at www.feedthepig.org/tweens.

Consumers are looking for reliable and trusted professionals to help guide them through these confusing and upsetting economic times. Fortunately, many PICPA volunteers have worked to develop resources that any member can use. For CPAs who want to schedule a program, but not present it, PICPA has a list of members willing to present programs. Members can view PICPA’s resources at the Speakers Bureau section of www.picpa.org. To schedule a program or volunteer to help in this effort, contact the Communications Team at communications@picpa.org or call (888) 272-2001. By taking part in these efforts and increasing the profession’s outreach efforts in the community, you can build on the CPA’s already stellar reputation as a trusted financial professional.