What Enrolled Agents Can do vs. CPAs
I have never been a CPA, but I did major in accounting and I was taught Generally Accepted Accounting Principles (GAAP). In taking care of issues in the cannabis business, if you use GAAP, you can expense more items through cost of goods sold (COGS) than you can under any other method of preparing financial statements.
Obviously, I haven’t used GAAP since school, so not wanting to get sanctioned by the Florida State Board of Accountancy, I sent them a simple question.
I asked them, “As an EA can I prepare a financial statement under GAAP?” I’ve been in practice for 24 years, and I remember a time when I could call the statements that I prepared in Florida compilations. Somewhere along the way, CPAs hijacked the term compilation, and EAs were no longer allowed to use it in Florida. The answer I received from the State Board of Accountancy was that, as an EA, I wasn’t allowed to do financial statements, much less a GAAP statement.
Let’s hold up here for a second. First of all, I do tax planning for businesses. The only way to do tax planning, is to put the business’s records into the form of a financial statement. Meaning I have to produce a Balance Sheet and an Income Statement that clearly reflects taxable income. One could argue that a tax return itself for a business is a financial statement. Page one of the business return is the income statement, and Schedule L on Page 4 is the Balance Sheet. A GAAP statement is more or less a statement produced under the accrual method of accounting, with some adjustments.
So I called a CPA colleague of mine that I refer any client to that needs an audited, reviewed or compiled statement, and he told me that the term “financial statement” was what the State Board of Accountancy had a problem with. That’s because in reality the only people who can produce a financial statement in Florida was a CPA. So, we are basically back to splitting terms again.
A compilation used to mean that I took the source material that my client gave me, and compiled the records into a financial statement. Easy enough, right? However, a compilation morphed into the lowest level of assurance that a CPA can give on a company’s financial records. So, I include a disclaimer with the statements that I produce that states I prepared the financial statements on the Income Tax Method of Accounting. I go on to say that I am not a CPA and therefore cannot express an opinion on the statements that I have produced. The state shouldn’t have a problem with that.
The National Association of Enrolled Agents (NAEA), in their publication the EA Journal, published a very helpful article. Basically the article details the different statements that are prepared and then mentions Income Tax Basis Statements. The article goes on to say that since statements produced under this manner are not prepared under GAAP, the terms Balance Sheet and Income Statement should be exchanged with Statement of Assets, Liabilities, and Equity – Tax Basis for a Balance Sheet, and Statement of Revenues and Expenses – Tax Basis, should be substituted for Income Statement.
Simple enough, the article also goes on to say to check with your particular State Board of Accountancy. However, it shouldn’t really matter because I am not stating an opinion on the statements.
Further, a CPA will usually do an annual compilation, review, or audited statement and prepare a tax return based on the numbers of that statement, which is EXACTLY wrong. These statements are produced under GAAP. As I previously stated GAAP is basically the accrual method of accounting, but not the accrual method of accounting for tax.
For example, I have a client for tax consulting. The client does government contract work and needs to produce a reviewed statement every year. This reviewed statement is prepared under GAAP, which is not a recognized method of accounting for a tax return. So, I had to take the compilation that the CPA produced each month, and to do tax planning, I had to convert from GAAP to the accrual method of accounting for tax, which is not the same thing.
For example, under the accrual method for tax, I am allowed to accrue expenses that the company is contractually obligated to pay for the next three months, as long as the accrued expenses match income. Under the GAAP statement, the income is already accrued, so the accrual of the expenses are allowed, because they match income.
For tax, under the accrual method, income is considered income when you have a right to that income. For example, you have invoices in Accounts Receivable, which is a right to the income. I have simply matched the expenses to that income. So a CPA who often uses the numbers on a compiled, reviewed, or audited statement to produce a tax return isn’t preparing the return correctly. The client is overstating income and understating expenses.
That’s not to mention depreciation is different per book than per tax. Depreciation per books can be calculated a number of different ways, and the recovery periods are not the same as tax. For tax, the only way to depreciate something is using the Modified Accelerated Cost Reduction System (MACRS), which is basically 200 percent of the double declining balance, and each item being depreciated has a set recovery period.
In tax, you have IRC §179, special accelerated depreciation of 50 percent or 100 percent. I have literally seen a depreciation schedule that has recovery lives of 10 years on a tax return. Before 2013, you used to have to apply to the IRS to change the recovery period because it was considered a change in the method of accounting.
We then have the cash method and hybrid method of accounting for tax, which doesn’t exist on a GAAP prepared statement. Under the cash method, income and expenses are recognized when the income is received and the expenses are paid. The hybrid method of accounting is when the income and expenses are based on the cash method but inventory is counted under the accrual method of accounting.
The point I am making is that in 24 years of practice, unless a complied, reviewed, or audited statement is requested for some reason, most clients care about taxation. As a group, only about 10 percent to 20 percent of CPAs specialize in tax. They are mostly concerned with attest services, which they will use the results of to produce a tax return.
As I pointed out, this is 100 percent wrong. All EAs specialize in tax, so the statements we prepare are concerned with taxation. Which is better? It depends on what your goals are. Of the clients I deal with, 99.9 percent only care about taxes.
The question begs, "Who is better: an EA or a CPA?" The answer is it depends. If you need attestation services, you need a CPA. However, you can always use an EA to prepare the tax return and do tax planning for you.
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Craig W. Smalley, MST, EA, has been in practice since 1994. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as...