Quickbooks Transaction Transfer

I owe a big thanks to my friend and colleague, business manager Craig Shenkler, of Ceres Financial Management.  I had lunch with Craig today and he alerted me to a feature in QuickBooks about which I was not aware.  This feature is a HUGE (and I mean mega-HUGE) productivity tool.  I was under the mistaken assumption that only list data could be imported into QuickBooks via Excel.  I was familiar with some third-party QuickBooks Marketplace vendors who developed software that can transfer transactions between QuickBooks company files.  In fact, I used a program once to move data from one company to another.  But the process was clunky, user-un-friendly, time-consuming, finicky and wrought with many peculiarities that made the whole process unwieldy.

Enter the QuickBooks batch transactions application.  This feature, available in the Accountant’s Edition of QuickBooks Enterprise Solutions, is a tool whereby transactions in one QuickBooks company file may be transferred into a second QuickBooks company file via Excel.  The tool is invaluable for bill-back activity.  I tested the program today and it was remarkable.  The actual execution of the app is a breeze.  I set up a test run and successfully transferred over 100 transactions from Company A to Company B in under 5 minutes.  The application uses Excel as the intermediary buffer to hold the data.  Transactions (in this case I tested the app with credit card data) are exported from Company A into Excel.  This is accomplished via the standard CREATE EXCEL SPREADSHEET.  Then the data in the Excel spreadsheet is copied into a temporary spreadsheet within QuickBooks Company B – a simple cut and paste.  The date, vendor name and amount transfer without complication.  The account category may require editing, depending upon how mirrored the chart of accounts are between the two company files.  The transactions are then edited (primarily to revise account categories) and with one click all of the transactions are recorded in the new company.  The feature worked flawlessly.

This app will eliminate the duplication of effort associated with entering detailed transactional data twice: once in the primary company file and a second time in the secondary file.  It will save many labor hours of manual input each month.  The program is especially useful for entertainment industry clients – in moving expenditures from their personal books to their loan-out companies.  Kudos to Craig for his relentless pursuit of productivity in accounting.

FETCH

In our technology-driven world, almost every operational challenge inspires a digital-based solution.  There is no shortage of geeks searching for ways to improve the efficiency of the tasks that we accountants face on a daily basis. Such are the benefits of the hi-tech world in which we live.

At X6 Management, we seek to capitalize on technology.  The more that we can automate the tedious and repetitive components of our work, the more that we can focus on substantive issues, and that is good for our staff and great for our clients.  One significant side benefit to leveraging with technology is the material reduction in labor hours and concomitant drop in our internal costs.  We pass those cost savings to our clients in the form of fees that are substantially lower than those charged by our mainstream competitors.  It’s a win-win for everyone.

We are on a perpetual quest to build an accounting platform that pushes the limits of automation.  We’ve made progress on many fronts:  the archaic and cumbersome processing of paper checks has been replaced with the streamline and efficient application of ACH autopay and online banking.  Credit card transactions are no longer manually typed into the accounting system – instead, the data is instantaneously imported and auto-coded using the Quickbooks bank feed application.  With our user-friendly virtual filing system, all of our clients’ documents are converted to electronic files that are effortlessly managed and easily accessible 24/7.

One labor-intensive task that has, up until now, defied productivity enhancement is the retrieval of electronic documents from the various websites we access in order to manage our clients’ accounting.  Every month we face the task of downloading bank, investment and credit card statements as well as invoices for various payables including utilities, telephones, mortgages, auto loans, etc.  The ordeal of manually transferring dozens of statements from such websites is labor-intensive and time consuming.  Retrieving a single statement involves logging into the website, finding the location within the site where the documents are stored, selecting the relevant file, opening the document and then saving the file to the appropriate folder.  It’s tedious and time-consuming work.

Fortunately, the Geeks have come through with a neat fix.  Software currently on the market takes the drudgery out of file management.  The days of arduous document retrieval are over. The program we selected fetches documents from almost any website and transfers them into our document management system.  The program unobtrusively runs in the background while we attend to other more important tasks. After a couple of hours, Voila! – the files show up in the appropriate folders of our document management system.  Once implemented and properly configured, the program automates almost the entire process, saving many hours of labor every month.

Almost?  Well, one ensuing issue has to do with the naming of all of these files that have been downloaded into our virtual file room.  We have a very specific convention for how files are named.  Strict adherence to our format is necessary to standardize the indexing and recordkeeping.  Files downloaded by the fetching software must be renamed to conform to our internal standards.  This requirement leads to the next time-consuming task:  renaming the files.  Once again, we look to the geeks for help.  And, yet again, we are not let down.  We are currently evaluating a handful of programs that utilize rules and algorithms to rename the imported files to conform to our naming conventions.   We have no doubt that this is yet another task that will, in the near future, be fully automated.

ALL JOURNAL ENTRIES ARE NOT CREATED EQUAL

Transactional entries are the means by which financial data is logged into the accounting system and are recorded via checks, credit card charges, deposits, transfers and general journal entries.  The end result is that informative numerical data is organized within the general ledger through a balanced transaction wherein debits equal credits.  But for any given financial occurrence not all journal entries infuse the same volume of information into the system.  Consider the following example.

Andrew Andrews receives a gift of 1,000 shares of Pear, Inc. stock from his mother, Andrea Andrews.  Andrew’s Business Manager ascertains that Andrea purchased the stock on October 24, 2008 for $100,000.  She gifted the stock to Andrew on October 30, 2013 at which time the gift tax value of the transfer is $500,000, determined by using the volume weighted average price (VWAP) method.  Andrea reported the transfer on a 2013 gift tax return.  As Andrea had previously used up her lifetime unified credit, the entire value of the transfer was subject to gift tax.  The gift tax allocable to the appreciation on the stock was computed to be $160,000.  The value of Pear, Inc. on the date of the gift was $520,000, based on a closing price of $520 per share.

Under a legacy approach the 1,000 shares of Pear, Inc. stock are recorded on Andrew Andrews’ books via a debit to securities and a credit to gift income:

DR Securities          520.000          Gift of stock

CR Gift income        520,000         Gift of stock

Immediately after the journal entry is posted the financial statements are accurate.  Stock has been transferred to Andrew and his balance sheet is updated to include the fair market value of the newly acquired asset.  The balancing entry to the P&L reflects a like amount of gift income.  So Andrew’s balance sheet reflects and accurate value of his holding in Pear, Inc. but nothing more.

But can the journal entry be improved?  Although Andrew’s balance sheet is accurate, important information has been omitted from the financial database.  Under a proactive approach, the journal entry will be tweaked to take into consideration the future informational needs of those who utilize the GL.  In five years when the Pear, Inc. stock is sold the tax preparer will need the tax basis in order to prepare an accurate tax return.  The holding period of the stock will also need to be ascertained in order to properly classify the gain as short or long term.  Any adjustments to basis for gift taxes paid by the donor would augment basis.   Consider this alternative journal entry:

DR Securities – Cost basis     100,000

Cost basis in shares gifted from Andrea Andrews; Original purchase date: 10/24/08

DR Securities – Cost basis     160,000

Portion of 2013 gift tax  paid by Andrea allocable to appreciation of shares

DR Securities – Valuation Adjustment     240,000

Adjustment to mark shares to Andrea gift tax value (VWAP)

DR Securities – Valuation adjustment     20,000

Adjustment to mark shares to closing market value (@ $520/share)

CR Gift tax income     500.000

Value of gift on AA books based on VWAP method

CR Unrealized gain     20,000

Mark to market as of close

Both the shortcut and expanded journal entries succeed in rendering an accurate general ledger.  Both balance sheets correctly reflect a $520,000 increase in the value of Andrew Andrews’ net worth as of the date of the gift.  But the Proactive journal entry has introduced significantly more data that is relevant to future analysis.  The second entry has successfully captured the following information:

  • The carryover tax basis attributable to the original cost of the Pear, Inc. stock in the hands of Andrea Andrews ($100,000).
  • The portion of the gift tax paid by Andrea Andrews that is allocable to the appreciation on the stock and that therefore augments Andrew Andrew’s tax basis ($160,000).
  • The date on which the shares were originally purchased.  This information is included in the memo field.  Since the holding period of the donor carries to the beneficiary of the gift, the original purchase date of the shares by the donor determines the tax classification as long versus short term gain.
  • The gift tax value of the Pear, Inc. stock as of the date of the gift ($500,000).  This may or may not be relevant information to Andrew Andrews.  However, by valuing Andrew’s receipt of the stock at the same amount as Andrea’s gift of the stock, consistency is maintained between Andrew’s books and those of his mother.  And if a question ever arose as to the value of the stock as reported by Andrea on the gift tax return, the information is readily available in the GL.
  • The difference between the values of the Pear stock as determined for gift tax purposes and the fair market value of the Pear stock as of the close of the market on the day of the transfer ($20,000).  This difference arises from the fact that the valuation of the transfer for gift tax purposes is based upon the average of the high and low stock price as of the day of the transfer.  In this example the average price of the Pear, Inc. stock for gift tax purposes was $500 per share, determined by the VWAP method.    The closing price on Pear, Inc. shares on September 28, the date of the gift, is $520 per share.  The difference between the two valuations is $20 per share or $20.000.  A final journal entry marks the stock to market as of the close of trading.

Is this additional data helpful?  If it is October 12, 2017 and you are preparing Andrew Andrew’s tax 2016 return, the return for the year in which he sold the Pear Inc. stock, the information is not only helpful but critical.  Basis data is often a poorly tracked component of a high net worth individual’s financial history, particularly for privately held stock.  The omission of accurate basis tracking from the database can have material consequences.  In the example above, the gift tax allocable to the appreciation of a transferred asset is often overlooked in calculating tax basis.  Such an omission will result in the overpayment of income tax on the subsequent sale of the asset.  Depending on the magnitude of the asset’s appreciation, that tax overpayment can run in the tens or even hundreds of thousands of dollars.  In the example above, omission of the allocated gift tax would result in the overpayment of federal tax by about $72,000.

Enriching a journal entry with pertinent financial information is also helpful for routine transactions.  Consider the consequences when a donation is made to a qualified charity. 

Doris Dogooder donates $10,000 to the Snail Society.  The donation entitles Doris to attend the annual Snail Society Awards gala held at the local Burger King.  The gold embossed invitation includes fine print indicating that the goods and services value of attendance at the gala is $500.  This means that although Doris is donating $10,000 to the charity, the tax deductible value of the contribution is only $9,500. 

The donation may be booked as:

DR                  Charitable contributions         $9,500

DR                  Meals & entertainment            500

CR                  Cash                                        $10,000

The transaction listing for charitable contributions will show $9,500 as the donation for the Snail Society, along with other donations made during the year:

01/15/12          Snail Society                                        9,500

03/20/12         American Heart Association               1,000

08/30/12         Red Cross                                             5,000

The amounts reported in the charitable contributions section of the P&L are accurate.  The amount posted for Snail Society has properly taken into account the reduction for the non-deductible goods and services element.  But could the journal entry be improved?  If you are the tax manager reviewing charitable donations, one standard inquiry is whether the reduction for goods and services has been taken into account.  An expanded transactional entry will proactively answer the question before it is asked by bringing transparency to the accounting.  Consider the following alternative entry:

DR                  Charitable contributions         $10,000

CR                  Charitable contributions         $500

DR                  Meals & entertainment            $500 

Nondeductible goods & services (annual gala)

CR                   Cash                                        $10,000

The transaction report for charitable donations will now look like this:

01/15/12          Snail Society                                    10,000

01/15/12          Snail Society                                       ( 500)

Nondeductible Goods & services (annual gala)

03/20/12          American Heart Association               1,000

08/30/12          Red Cross                                           5,000

The alternative journal entry reveals the accounting underlying the net entry of $9,500 for deductible donations.  The tax preparer’s question has been answered before it even had to be asked.  The books have proactively documented the elimination of the nondeductible goods and services by revealing the components of the transaction.  Both journal entries result in an accurate donations account.  But the second journal entry conveys additional relevant information and assures the tax preparer that the amount reported on the tax return as a charitable donation has been adjusted for the nondeductible portion.  In this regard, the transactional entry has been proactive:  the entry has been recorded with the goal of taking into account the future informational needs of the users.  And this was all accomplished by merely adding a single line in the check split.

One more example will illustrate the advantages of comprehensive transactional entries.  As we have seen many accounting practices record transactions on a net basis.  Under this net-posting approach, courtesy discounts, adjustments and other accommodations on invoices are not accounted for in the general ledger.  Consider a legal invoice that includes a negotiated discount.  Lawrence Lawson’s Law firm billed Patty Petunia $180,000 in connection with their defense of a law suit that had been initiated against Patty.  Patty was horrified when the invoice crossed her desk and called Lawson to demand an adjustment.  Lawson agrees to a 20% discount.  The revised invoice shows the gross fee of $180,000, the $36,000 courtesy discount and the net amount due, $144,000.  Patty’s bookkeeper prepares a check.  Cash is credited for $144,000 and legal fees are debited for the same amount.  As in the previous examples, the transactional entry is fundamentally accurate but utilitarian information has been omitted.  The next time Patty pays Lawson she may ask “didn’t Lawson give us a discount on our last bill?”  Perusal of the financial statements will not answer Patty’s question because the underlying accounting trail is not incorporated into the GL.  On the other hand, had the check recorded the split between the gross legal fee and the discount, the books would have yielded information beneficial to Patty and her Business Manager.

A high net worth individual’s balance sheet and income statement may be numerically accurate in the sense that the assets and liabilities reconcile with external reporting.  Although accurate, the underlying general ledger may be deficient in information that is not only useful, but critical, to strategic analysis and decision making.  It is in this sense that all journal entries are not created equal.

 

TECHNOLOGY IS CHANGING THE WAY WE DO BUSINESS MANAGEMENT: A Q&A WITH BILL JAASKELA

This is a summary from a talk at a Business Management Bookkeeper’s forum from 2014 at which I was a panel member.

How has Business Management changed over the years?

The most significant change is that Business Management is a much less labor intensive profession than it had been in the past.  At one time the bookkeeping function absorbed a significant number of staff hours to get the work done: the technological tools with which to leverage the work were not available.  Think of an old fashioned accounting office filled with file cabinets and adding machines and stacks of paperwork.  I call that the analog approach.  Under that regime paper invoices would be delivered to the bookkeeper by snail mail.  The billing information would be manually entered into the accounting software and paper checks would be printed.  A cumbersome review and approval process would follow along with the pursuit of signatures. A signed check would eventually be snail-mailed back to the payee.  The process involved a lot of envelope-opening, paper-shuffling and stamp-licking.  The simple task of paying a utility bill could take up to 20 minutes of labor time.

With the advent of the Internet, online banking, electronic data import and digital document management, the bookkeeping element of Business Management is increasingly automated.  Most of the recurring monthly expenditures for utilities, mortgage payments, cable TV, club dues and other such payments are processed through ACH Autopay.  Other monthly invoices are paid out of the bank bill pay system.  Paper checks are all but eliminated.  Credit card and banking activity is imported seamlessly into the accounting database and a significant proportion of the transactions are automatically coded to the proper expense category.  The time it takes to prepare the monthly accounting for a client has been cut dramatically. In the analog days it could take 10-20 labor hours to complete the monthly bookkeeping and accounting for a client (paying bills, recording all banking and credit card transactions, reconciling the accounts, generating financial reports, etc.).  By leveraging with technology it might take only an 5-10 hours to complete the same volume of work.  That is at least a 50% reduction in the number of labor hours needed to manage an account.

All these technological advances are taking place behind the scenes.  The client sees only the end product. So does this automation really change their experience of Business Management?

Technology has a significant positive impact on the services provided.  Data import brings 100% accuracy to the arithmetic of accounting.  Transposition, decimal placement and other human errors are eliminated as is the time-consuming drudgery associated with manual input.  The accounting staff can focus on more substantive issues and that creates a better work experience and a better work product.  Instead of typing row after row of credit card charges on a keyboard, the staff review the output, focus on account classification and turn to more analytical issues and that is always a benefit to the client.

But the biggest impact of technology is the substantial drop in the fees that the clients pay for Business Management.  Instead of paying $3,000, $4,000 $5,000 or more per month, clients experience an expanded scope of service for half to a third of what they previously paid.  Technological innovation drives down operating costs big-time.  If it took 30 hours a month to service a client using old technology but only 10 hours using new technology, the operating costs to service the account will drop significantly.  Over the course of a lifetime these lowered fees can translate into hundreds of thousands of dollars. 

In addition, lower fees broaden the scope of clients who can benefit from Business Management.  When business management fees are in the $1,000 - $2,500 per month range a lot more people can afford the services.  The days of $50,000 per year business management fees are long gone.

Are bookkeepers being eliminated?

In embracing this new technology the traditional bookkeeper position is not being eliminated per se.  We are re-engineering what bookkeepers do.  The traditional bookkeeper role is being morphed into a position that might be more appropriately titled data flow manager.  A dataflow manager ultimately accomplishes the same workload as a bookkeeper but does so by leveraging with digital technology.  A dataflow manager can typically handle 3 to 4 times the volume of work as that of a traditional bookkeeper.  The technology can easily cut 10 – 15 hours or more of time out of a client’s monthly maintenance.

Are all business management firms adopting these new technologies?

Many Business Managers have been slow to embrace the new technology.  Inexpensive productivity-enhancing applications abound yet many firms fail to even explore their utilization.  Consider data import.  Quickbooks has a remarkable application called the bank feed that automates the entry of credit card and banking transactions into the general ledger.  The bank feed feature works almost flawlessly and hundreds of transactions can be recorded into the general ledger in, literally, a few seconds.  Bookkeepers under an analog approach spend hours manually entering row after row of credit card charges into the system.  This input method is pure drudgery and is prone to human error – transpositions, decimal placement errors, and so on.

Yet even with all this readily available, user-friendly technology many accountants and bookkeepers are reticent to abandon manual entry.  But these old-school firms will be eventually have no choice but to change.  Competition is forcing a rethinking of how Business Management firms handle their back office operations.  Clients see the technology that can bring them online banking, financial tracking applications like MINT, the ability to pay bills on their mobile devices they reasonably question why it would cost them $3,500 or more per month to manage their bookkeeping.

But doesn’t it take significant effort to move to this new technology?

There is an upfront investment of time in implementing these new technologies.  But the only way to realize the full benefits of the technology is to crawl into bed with it.  Consider the Quickbooks bank feed feature.  Accountants need to invest the time to learn the data import application inside and out – all of the features, configurations, nuances, shortcuts, quirks and tricks of the trade.  It is only then that one can truly reap the rewards associated with these productivity tools.  The good news is that the payback is fast and furious.  If you have a firm with 20 clients and you cut 15 hours of labor per month per client you are saving 300 hours per month of labor time.  That is the equivalent of almost 2 full time staff members.  And, again, that is why Business Management fees are dropping.  You can do the math and any way you slice it the fees that clients pay are dramatically lower than they were in the past.

But what about clients in the entertainment industry?  They have more complexity to deal with.  They have loan-out corporations and get residuals and royalties and so on.  There is a lot more to track and account for so it seems that fees in the industry would not be as elastic.

Accounting for entertainment clients is not rocket science.  Every professional has his or her own “complications” be it the manager of a private equity firm, the president of a hotel or the producer of a television show.  I think that Business Managers sometimes embellish the description of what they do in order to justify higher fees.  For example, a loan-out corporation is, in fact, an accounting non-event.  It is simply a carve-out of the client’s activity to isolate the business transactions from the personal.  There are tax and other advantages to a loan-out.  But Business Managers tend to inject a bit of drama into the analysis of a loan-out in order to rationalize their services.  In fact, the various tax and governmental compliance issues associated with a loan-out are routine.  I would argue that a loan-out actually enhances the productivity of the work and in that sense reduces the labor hours associated with a showbiz client.

Are there any other changes or trends in Business Management?

The reporting function is also undergoing a transformation.  There is a standard set of reports that Business Management firms have traditionally generated including a statement of income and expenses, a statement of net worth, a cash flow statement.    But clients want a concise, user-friendly summary of their monthly transactions so they can scan for fraud and to get a general idea of where their money is going.  The format of traditional reports often confuse clients and fail to address their core informational needs.  So Business Management firms are now more inclined to give clients the reports they really want rather than forcing upon them the reports that the business manager thinks they should have.

In addition, the traditional accounting-oriented reports are costly to produce.  It can take 5 hours to generate a set of monthly statements, and that can contribute $1,000 or more to a monthly invoice.  And these are for reports that the clients often don’t understand and toss in the wastepaper basket. The transaction-oriented reports are far less time consuming to create.  It’s a double win for the clients: they get the reporting they want and they get lower fees.   

You mentioned that clients can get an expanded scope of service at the same time that they pay lower fees.  How can it be that you give them more but charge them less?

Technology is now doing all of the heavy lifting.  Because the bookkeeping component of business management is on the cusp of being 100% automated, the entire definition of what business managers do is evolving.  Business Management is better conceived of as Information Management.  And that new thinking is driving the type of services provided.

Many business managers have expanded the scope of their work to include additional services.  In talking with our clients we found that they wanted their lives simplified, streamlined and de-cluttered.  We developed a service called “Life Organization”.  Our firm includes document management as a standard service.  We convert all of the paper of their life into digital files organized in a sophisticated yet simple virtual file organization system. We literally put our clients’ lives on a flash drive.

Many clients hoard paperwork.  They might have 5, 10 or 20 years or more worth of bills, receipts, bank and investment statements, escrow paperwork, tax returns and so on.  Even though they might have never once had to consult a single one of those documents they are reluctant to toss them.  With Life Organization clients transfer the hoarding function to the business manager.  But we are digital hoarders – the stuff we stockpile takes up no space, doesn’t smell bad and doesn’t carry airborne bacteria.  We scan every document no matter how inconsequential.  Every document is subject to optical character recognition, thereby making the document itself searchable.  And all of our client’s documents are organized in a stand-alone document management system where every document is electronically labeled and indexed and can be retrieved instantaneously. Unlike a paper document, a PDF never fades or deteriorates – the integrity of the document is permanent.  We get rid of clutter and turn chaos into order.  Clients love this service.  They can clear out their home and offices of banker’s boxes of filing yet know that any document is a mouse click away.  Clients start giving us everything from their kid’s grade reports to birthday cards to love letters.

But don’t these additional services increase the internal cost of business management?

To the contrary – like automated banking, digital document management cuts operating costs.  It is a misconception that scanning documents takes more time.  Study after study has shown that going paperless significantly increases productivity and efficiency.  With a digital approach you don’t have bookkeepers or file clerks searching for missing files.  You don’t have secretaries photocopying and faxing paperwork.  The additional time it takes to scan documents is no greater than the time it takes to file those same documents in manila folders and Pendaflex folders.  A dataflow manager can download or scan a month’s worth of documents (meaning bank and investment statements, invoices, ACH payment confirmations, all monthly bills, receipts, plus a shoebox full of whatever stuff the client wants us to scan) in an hour or two.  The internal costs of managing a paperless, digital office is significantly less than that of running an analog, paper-driven office.  We bring additional value to the client at a lower cost.  All of this technology, be it automated accounting or digital document management, is significantly driving down the cost to run a business management firm and it is the client who reaps the rewards with dramatically lower fees.

It is interesting to note that Business Managers are at the same time embracing technology as they are competing with technology.  With online banking, ACH auto-pay, Mint, and other applications, savvy clients reasonably ask why they would pay $3,500 a month for someone to cut checks when they themselves can easily do their own bookkeeping using the apps that are at their fingertips.  The key concept is that Business Management is Information Management.  It is less about crunching numbers than globally managing a client’s information.  Business Managers have no choice but to embrace the new technologies or they risk seeing a dwindling client base.

With all this technology isn’t their greater danger of fraud, identity theft and unauthorized access to client information?

Business Managers must be vigilant in protecting their client’s data.  But we need to go beyond the standard security measures like firewalls, encryption and antivirus software.  We also need to consider how to minimize the accessibility of a client’s information.  The fewer the number of individuals having access to sensitive information, the less the risk of a dissemination of that information.  To do our work we need social security numbers, dates of birth, user names, passwords, mother’s maiden names, security questions and answers.  The dilemma is how to give the staff access to the online accounts while limiting their access to the login credentials.  Fortunately, every problem brings a wave of IT geeks seeking to find a solution.  Sophisticated password management software has emerged that can provide the accounting staff access to a client’s online bank or credit card accounts without revealing the underlying user name, passwords and other credentials.  These programs provide an alias overlay that masks the client’s true profile information and grants access only under controlled conditions – such as at a specific time or at a specific workstation.  That means that the bookkeeping staff have controlled access without ever having knowledge of this sensitive identifying information.  A staff person could not access a client’s online accounts outside of the office as they never know the true login credentials.

These same programs also generate hyper-complex passwords to protect the various files (Quickbooks and others) that we work with.  The likelihood that a hacker can penetrate an account is significantly reduced when a password is randomly generated, long and complex.  These password management programs dramatically reduce the ability of a hacker to crack a password.  And, once again, the passwords are masked to the staff, thereby controlling their access to the data.

Clients justifiably worry about access to their information, especially when the information is in a digital format.  Yet those same clients are less likely to be concerned about the tax return with all of their social security numbers and personal information that is sitting on a desk in their home office.  There are security risks with any medium be it paper or a digital PDF.  I would argue that a client is more at risk of being “hacked” with a paper document than a digital document.  Every evolutionary step in the management of information has its risks.  But every step also has a new wave of innovation to minimize those risks.  We are constantly searching for and evaluating new ways to protect digital information.

QUICKBOOKS BANK FEED: THE NAMING ALGORITHM IS KEY

We continue our quest toward building a Business Management practice that is leveraged with automated accounting and bookkeeping. The more that we can automate the inner workings of the back office, the less that we will incur in labor costs and the lower will be our fees.  Since my last post we have fiddled with the vendor naming algorithm in the Quickbooks data feed application. We are learning a few tricks here and there with the naming rules. And with these tweaks we are seeing a substantial boost in the percentage of client transactions that require no editing when downloaded into QuickBooks. The percentage of transactions that are complete upon download (meaning that the bank feed name has been properly matched to the QuickBooks vendor name and then auto-coded to the proper expense category) is approaching 75%, especially for those clients having a routine and predictable monthly spending pattern (I.e., they tend to frequent the same restaurants, gas stations, doctors, department stores, etc.).

The new QuickBooks data feed program, introduced with QES 14, is a substantial improvement over the previous versions. The layout of the spreadsheet is user-friendly and provides useful statistics on the composition of the transactions, identifying the number that are deemed "complete" and those that require additional editing.  The overall graphical interface and color coding is quite helpful.  And the application provides the familiar customization that is a hallmark of Quickbooks including the ability to sort the bank feed data by any of a number of criteria.  We find that sorting the transactions by vendor name is particularly productive as you get an immediate snapshot of the overall composition of the data. In future blogs we will discuss some of the tricks that can further speed up the coding of transactions.

With the impressive speed and accuracy of the QB bank feed application, there is clearly no justification for the manual entry of banking or credit data into QuickBooks. The bank feed application drastically cuts the number of labor hours required to record financial activity. For clients with substantial credit card and banking activity (i.e., 400 transactions or more per month), the bank feed will turn a 4 - 8 hour project into a 30 - 60 minute project. And the program eliminates human error (transpositions, incorrect dates, decimal placement errors, etc.)

In the face of this user-friendly, time-saving, productivity-enhancing software, why do bookkeepers and accountants continue to endure the tedium and frustration of manual data entry?  When I ask around the universal response I get is: it just ends up being easier to manually enter the data. This is absurd and flies in the face of logic. It is not possible for manual data entry to be just as fast as electronic data import. We are saving dozens of hours a month by using the bank feed.  Habits are hard to break and manually entering data is, I suppose, a habit.  We all get stuck in a comfort zone and gravitate toward what is familiar.  There is a learning curve with any new application, but the Quickbooks data feed is about as user friendly as a program can be.  I am confident that anyone who uses the application for a couple of accounting cycles will realize the benefits and see the light.  Firms that continue to plod along with an archaic approach to data entry will eventually face a day of reckoning. They either adopt technology of the 21st century, or they see their profit margins shrink from wasting expensive labor hours on unnecessary and time consuming work. The Robo-bookkeepers are marching forward and are in no mood to turn back.

BUSINESS MANAGEMENT FEES: TIME FOR SOME COMPETITION?

Despite the widespread availability of inexpensive technologies that boost the efficiency of bookkeeping and back-office operations, Business Management fees have continued to rise over the last decade, as if the Internet doesn’t exist.  Some of the established firms have minimum fees of $2,500 or more per month.  And for those firms that charge a fee based on a percentage of the client’s revenue, the Business Manager can reap a six figure windfall in a year when the client has a big payday.  Firms that charge by the hour also have sky-high billing rates that defy logic.  Bookkeepers are billed out at as much as $100 per hour and accountants at up to $350 or more per hour.  Business Managers will argue that they provide sophisticated accounting and financial services including tax compliance (although many bill extra for the tax services), and that their rates reflect the complexity of their work. But ask yourself: does it make sense to pay $30,000 or more per year to have someone pay your bills, track your expenses and monitor your deposits?

The mainstream firms get away with charging high rates simply because they can:  There is little in the way of competition to drive down pricing in the profession.  Entertainment industry clients accept the 5% rate as a matter of convention.  Unfortunately for the clients, many business managers have agent, money manager, and attorney envy and that attitude is reflected in the fees. The writers, directors, producers and actors who break the $1 million threshold pay $50,000 or more for their bookkeeping and accounting.  No one seems to question those rates.  Well, we do.  We reject the income method of calculating fees. The percentage approach may be appropriate for agents and attorneys who have a strategic role in the generation of a client’s revenue.  But the Business Manager has no such role and we believe it is inappropriate to link the fee to a client’s income.  In addition, the time it takes to manage an account is about the same whether the client makes $100,000 a year or a million a year.  A client should not have to give up $50,000 of hard-earned money in a successful year just because an arbitrary formula dictates that result.  Those windfall fees can add up to hundreds of thousands of dollars over the course of a career.

One must keep in perspective what Business Managers do.  We are number crunchers.  We handle a client’s bookkeeping --- paying bills, tracking income, projecting cash flow, preparing budgets.  That’s not a bad thing.  But it should not be an expensive thing.  The core role of the Business Manager is to oversee the client’s general ledger.  Yet many Business Managers shun using the word bookkeeper when describing their work.  Why?  To justify their fees the significance of the bookkeeping function needs to be minimized when promoting their services.

It’s not Rocket Science

Business Managers tend to embellish the description of their services with language that conjures an air of importance and sophistication.  The websites of business management firms are predictable.  You will see references of the need for specialized financial analysis, high level tax planning, comprehensive insurance review and various other specialized, high-level and comprehensive services.  You will read a standard narrative about tax structures and strategies and the need for in-depth analyses to determine if a loan-out company or a pension plan is warranted.  Business Managers perpetuate the view that if you are in the entertainment industry (actor, producer, director, musician or writer) your finances are complex and require pricey professional services.  All of this discussion has an air of importance and mystery – that is not unintentional.  It is accounting drama to justify law firm level fees. The highfalutin semantics obscures the fact is that most of what Business Managers do is not particularly complicated.

Consider a loan-out company.  Accountants tout the importance of establishing and managing a separate legal entity (LLC or Corporation) through which all business activity is filtered.  A loan-out company generally will garner tax savings through the elimination of deduction limitations and the avoidance of the alternative minimum tax.  But the setup and administration of a loan-out is an accounting non-event.  It is one additional Quickbooks file within which accounting data is managed.  The marginal time associated with managing a loan-out is not material.  Business Managers may warn of the need to carefully administer the corporate or LLC filing requirements such as the preparation of annual minutes.  But the fact is that the annual minutes are nothing more than a template that needs to be updated.  One could argue that a loan-out company simplifies and streamlines the accounting by segregating the client’s business activity in a separate set of books.  When all is said and done, many Business Managers elevate the importance of the Loan-out as yet another justification to inflate their fees.

Behind the times

Pricey Business Management fees reflect a global failure by the profession to embrace technological advances that boost the productivity of back office operations.   Above-average fees are required to maintain an archaic platform that is heavily dependent on an underpinning of expensive labor.  The mainstream firms are built on a pyramid of managers, accountants, bookkeepers and clerks.  Otherwise simple tasks are distorted into complex productions through the introduction of layers of bureaucratic policies and procedures.  The intent is noble but the execution is clumsy.  Consider the basic task of paying a routine, recurring invoice such as a utility bill.  Even to this day a gas, electricity or water bill is managed in an arcane workflow involving the snail mail delivery of paper invoices, the preparation of hand-signed checks and a cumbersome review and approval sequence.  Start to finish the processing of a single payable could consume 15-20 minutes of labor.

Fast forward to the present.  With ACH Autopay an invoice is instantaneously checked off the to-do list in a process that essentially consumes no labor.  Paperwork that cluttered the process is eliminated.  The bottlenecks associated with the cumbersome review protocol disappear.  By deploying digital technology the labor hours required to handle the accounts payable function is a fraction of that under the old-school approach.

The accounting function is similarly leveraged with data import applications.  Under the analog approach bookkeepers manually enter row upon row of credit card and bank transactions into the respective accounting registers.  This is a slow and tedious process subject to human error.  The hours spent searching for transposition, transcription and other keypunch errors is time not well spent.  All of this inefficiency is eliminated when data is electronically transferred into the accounting system, literally at the speed of light.  The time to process information under a digital regime is a fraction of that using the outdated analog approach.  We are experts in the use of data import applications and our know-how is reflected in fees that are substantially lower than those charged by firms that plod along in an old-school paradigm.

Price competition might eventually bring the fees charged by the mainstream firms to a more reasonable level.  Potential clients at least now have some meaningful choice when it comes to pricing and product.  Newer firms come into the field with an arsenal of technology that changes the entire dynamic of the practice of Business Management.  We view our firm at the forefront of the new approach to business management and we fully embrace technology that will revolutionize the practice.

RECORDING INTEREST

I often think about the theoretical issues pertaining to Business Management accounting and bookkeeping.  I believe in a proactive approach to managing the accounting where one anticipates the future informational needs of those who rely on the financial database.  You then devise strategies for populating the database with the data needed to make sound strategic decisions. The greater the detail and transparency in the data, the better the analysis. All journal entries are not created equal and some convey far more information than others.  Consider the recording of interest expense on a debt.

There are two approaches to recording interest expense associated with a debt:  1) the expense payment method (otherwise known as, the wrong way) and 2) the balance sheet accrual method (aka, the right way).

  • Expense payment method:  Interest expense is recorded at the time a payment is made against the underlying debt.  Cash is credited and the offsetting debit is distributed between the portion of the payment representing interest and the piece representing the net reduction in principal.  The payment is therefore assigned to both a balance sheet liability account (the debt) and to a P&L expense account (interest expense).  The posting of interest expense is therefore inseparable from the execution of the check written to make a payment on the debt.
     
  • Liability accrual (amortization) method:  Interest is accrued independently of any payments against the debt.  A journal entry is posted as of the date on which the interest is payable or accruable, typically the last day of the month.  Interest expense is debited and the debt principal is credited for the computed accrued interest.  Any and all payments made on the debt are debited and allocated in full to a single account: debt principal.  The payments made on the debt instrument are therefore recorded independently of the accrual of interest.

Virtually all Business Management firms and Family Offices employ the former approach to account for interest expense on a debt.  A principal weakness with the expense payment method is that at least one of the elements of the transaction is likely to be inaccurate: the date on which interest effectively accrues.  By inextricably linking the posting of interest expense to the processing of a check, the timing of the accrual becomes subject to the vagaries of the work flow in an accounting office.  If interest on a mortgage is due and payable as of January 31 but the check is not cut until February 5, the date when the account manager returns from a bout with the flu, then interest expense will be recorded five days late.  On the other hand, the mortgage check may be cut two weeks early in anticipation of the bookkeeper’s upcoming vacation to Bora Bora.  Once again, the date on which interest expense is recorded is inaccurate.

The liability accrual method is consistent with a Proactive approach to accounting.  The primary advantage of this approach is that periodic interest is accrued and recorded independently of any payments made against the debt.  This methodology simplifies the accounting: 100% of any payment on the liability is allocated to principal, thereby eliminating the mathematical computations associated with the interest payment method.  When a bookkeeper cuts a check or otherwise records the mortgage payment the entire amount is posted to a single account.  The timing of the execution of the payment is generally irrelevant as long as it falls within the grace period.

As another advantage, the liability accrual method accurately replicates the loan amortization schedule within the general ledger.  Consistent with a standard payoff schedule, interest is accrued and added to principal within the debt register.  The register therefore tracks, as of any period in time, the beginning balance of the debt, the recurring accrual of interest, the level payment of principal and the ending balance.  The accrual method therefore generates a one-to-one correspondence between the amounts computed in the amortization spreadsheet and the numerical entries in the debt register.  Discrepancies are more easily detected and errors more effortlessly corrected.  In contrast, the expense payment method only records the net marginal reduction of principal in the debt register.  The amount of periodic interest accrued never shows up in the debt register.

The advantages of the amortization approach are magnified when debt servicing falls into arrears.  Under the legacy approach interest is recorded only when a payment is executed and that linkage will inevitably lead to an understated liability. The magnitude of the understatement steadily increases for each month that the obligation remains in default.

Informational deficiencies with the expense method

The expense method register records the marginal reduction in the balance of the loan as of the date a payment is executed.  For a typical calendar year the debt register shows twelve consecutive entries coinciding with the twelve checks written.  The information content associated with this approach is limited.  A manager reviewing the register or transaction report can confirm that the debt balance is steadily declining concurrent with the principal payments.  But neither the magnitude of the interest paid nor the mount of the monthly payment is revealed.  For a particular month is the $800 reduction in principal the net of a $10,900 payment and interest of $10,100 or is the net principal the difference between a $5,400 payment and interest of $4,600?  This information is absent.

In contrast, the accrual approach delivers an informative debt register revealing the two key items of data pertinent to analysis of the loan:  the amount of interest accrued for the month and the amount of the principal payment.  Periodic interest is recorded on the proper accrual date, independently of the execution of the payment on the debt.   The manager can glean the approximate interest rate by viewing the register, something impossible to estimate in the legacy debt register where there is insufficient data to provide a frame of reference.  The point is that the accrual method has delivered a balance sheet account that conveys significantly more information and data than the comparable account as reflected in the expense approach.  Furthermore, the entries in the accrual debt register can be ticked and tied to the entries in an amortization schedule.

The loan amortization method is superior to the interest payment method for yet another reason: error correction.  Loan invoices typically report both the interest recorded from the previous period and interest accrued and payable as of the current period.  Under the expense payment method if a bookkeeper inadvertently assigns the interest for a previous period to the current period, correction of the error requires that each check be reposted to redistribute the debit between interest expense and the principal reduction.  Using the amortization approach, the entire amount of the check is debited to principal thereby eliminating a requirement to redistribute the payment between accounts.

Late payment fees

If the monthly payment on a trust deed or mortgage is paid outside of the grace period (typically the fifteen day period beginning with the due date of the payment), a late fee is assessed.  The penalty will be shown as an additional charge on the subsequent monthly statement.  How is a late payment penalty recorded?  The late payment should be accrued to the debt liability register via a journal entry:

            Dr.       Interest expense          Fee on 09/10 late payment

            Cr.       Trust deed                    Fee on 09/10 late payment

The check to make the monthly payment would be increased by the amount of the assessment.  The account should be split into two records, both of which are posted to the debt liability account:

            Dr.       Trust deed                   Standard level payment

            Dr.       Trust deed                   Fee on 09/10 late payment

Why split the payment into two components when both records post to the same balance sheet account?  The payment split conveys information:  the register will have an entry for the standard level payment.  The additional “principal” directly offsets the late fee accrued to the debt balance.  This facilitates review.  An outlier in the middle of a string of level monthly payments conveys information – the larger than standard payment means that something out of the ordinary has occurred.  Splitting the payment aids in analysis because the reviewer can see the accrued late fee offset directly by an additional principal payment in equal value.

Payments of Additional Principal

The debt holder may elect to pay additional principal on the debt.  The additional payment does not alter the contractual requirement to continue making a set level payment.  After additional principal is remitted the amortization schedule is adjusted.  Any additional payments of principal should be recorded in a second record or account split.

FINE ART

Hanging in the dining room of the East Hampton beach house, the Jeff Koons painting conveys significant aesthetic joy to the family fortunate enough to afford such an asset.  The vibrant canvas also brings considerable accounting, insurance, tax and other financial consequences for a Business Manager as well as a wealth of information to be processed in the financial database.  Fine art may represent a significant component of a client’s net worth, particularly if one or more members are serious collectors.  An art collection could be valued at tens or even hundreds of millions of dollars and large enough to merit the full-time employment of an in-house art curator and related staff.  At least two families in Los Angeles are reputed to have collections each valued in excess of $1 billion.  With art, as with any asset, the Business Manager is responsible for ensuring that the acquisition transactions are accurately recorded and that the ongoing accounting and financial management is properly executed.

JEFF KOONS, Waterfall Couple (Dots) Blue Swish With Red Stroke, 2009, Oil on canvas

JEFF KOONS, Waterfall Couple (Dots) Blue Swish With Red Stroke, 2009, Oil on canvas

Setup On the Chart of Accounts

All transactions in connection with the acquisition of works of art are accounted for through a category level account, Fine Arts, established on the Chart of Accounts and coded in Quickbooks as a Fixed Asset.  For a client with a modest collection, a dedicated subaccount may be established for each piece.  Large collections, however, demand a dedicated subsidiary ledger to provide the scale necessary to organize a comprehensive and detailed relational database.  Before discussing the organization of fine art assets within the general ledger, an understanding of the transactions associated with the purchase of art is in order.

The Six Elements

The accounting for the purchase of a work of art encompasses the six elements of a financial transaction:

  • Reporting entity:  The entity acquiring the work of art.  The entity could be a family member or it could be a foundation or other legal entity such as an LLC or a revocable or irrevocable trust.
     
  • Date:  The date the acquisition is legally consummated.  This may be the date on which a $6,000 Hockney lithograph is charged to the Amex card.  Or it could be the date that funds to procure a $15 million Ruscha oil painting are transferred to the seller upon close of escrow.  The purchase of a significant piece of art may have an escrow that is no less substantive than one associated with the purchase of a home.  A noteworthy work of art may, after all, cost more than the residence in which it will hang.
     
  • Amount:  The purchase price or other value assigned to the piece.  This may be readily ascertainable:  it could simply be the price paid for the work.  If the work is acquired via a gift from another family member, the value would be determined through an appraisal, an estimate or other means.
     
  • Name of transacting party:  The gallery, individual or entity from whom the work was acquired.
     
  • Account to debit:  An asset category, fine arts.  As will be seen, to preserve the carryover tax basis attached to a gift, the acquisition value may be split between two balance sheet accounts: the purchase price subaccount and the valuation adjustment subaccount.
     
  • Account to credit:  The account or accounts out of which funds were drawn and/or borrowed to purchase the work.  If the piece is acquired as a gift, the Gift income account would be credited.

There is a proactive way and a reactive way to account for any financial transaction and accounting for fine art is no different in this regard.  A responsive database anticipates the informational needs of the users and that means infusing the system with content relevant to the financial management of fine art.  When Roberta Roberts contemplates the purchase of her twentieth Warhol, a large canvas titled Campbell’s Tomato Soup No. 5, her decision may be influenced by factors unique to the fine arts asset class.   She may ask: how many Soup Can paintings do I already have?  Is my Warhol collection too heavily weighted with pieces from the early and mid 1970s?  Should I sell a Warhol in inventory to fund the new purchase?  The financial database should capture sufficient data to facilitate Roberta’s decision making including:  the name of the piece, the date of the composition, the condition, the purchase price, the fair market value.  The data should be organized in a format that is clear, understandable and easily extracted.  That requires a general awareness of those characteristics and nuances unique to art.  No pun intended, there is an art to accounting for fine arts.

Supplementary Data

In addition to the financial data embodied in the six financial elements, a work of fine art carries ample supplementary information pertinent to identifying and cataloging the asset such as:

  • Name of the artist (i.e., John Baldessari)
  • Name of the piece  (i.e., Two men at Stonehenge)
  • Medium of the work (i.e., painting, screenprint, sculpture, woodcut, lithograph, etc.)
  • Date of the work
  • Edition number and edition size (i.e.: 46/200)
  •  Dimensions (i.e., 62” x 132”)
  • Signature data (i.e., signed in pencil on the verso)
  • Condition of the work (i.e., museum quality, minor fading, some soiling at that margins, crease in left corner)
  • Parties involved in the transaction (the art consultant who brokered the deal; the appraiser who valued the art, etc.)

Content indexing is critical.  When the principal considers donating the sculpture Tuna Wearing a Sombrero to his alma mater, the information pertaining to the granite composition must be efficiently retrieved from an inventory of potentially hundreds of works within the financial database.  How can the accountant zero-in on the relevant data from thousands of records of information?  Supplementary data serves to identify and index the individual works of art within a collection and is generally manifested as keywords in a memo entry or in the description field of the account setup window.  The financial data for Tuna Wearing a Sombrero may be located using the Quickbooks Find tool or by the Google Desktop Search icon.

Alternatively, Tuna Wearing a Sombrero may be the title of a dedicated account in the Fine Arts subsidiary ledger.  The financial data for the sculpture may found by scanning the chart of accounts in search of the account name.  In either scenario, the accounting system is populated with data that facilitates targeting and extracting the information utilized in decision making.

Subsidiary Ledger for Large Collections

A substantial art collection demands a subsidiary ledger.  A subsidiary ledger limited to fine art affords the accountant the scale necessary to set up a dedicated account for each work of art.  A collection may be comprised of hundreds of pieces – establishing a separate account for each piece in the general ledger would be impractical and bog down efficiency.  A subsidiary ledger provides the Business Manager with the flexibility to structure and organize a true fine arts database and replaces the Excel schedules that less efficiently accumulate the same data in a legacy accounting office.

The name for each dedicated account on the Chart of Accounts corresponds to the title of the composition.  Three subaccounts would capture, respectively, the purchase price, ancillary costs and a valuation adjustment (discussed later).  Category levels may also be established for each artist and possibly each medium.  Financial transactions relating to the Richard Serra screenprint Path & Edges #2 would be accounted for in an account named Path & Edges #2.  Path & Edges #2 would, in turn, be subordinate to a category-level account titled Richard Serra. The media (painting, print, sculpture, etc.) may be positioned as the highest category level with the artist a subordinate category as in the following hierarchical tree:

Fine Arts

                   Paintings

                                    Warhol, Andy

                                                Mao

                                                Marilyn No. 3

                                                Tomato Soup

                                    Lichtenstein, Roy

                                                Shipboard Girl

                                                Living Room No. 4

                    Screenprints

                                    Warhol, Andy

                                                Flower #10

                                                Kachina Dolls

                                    Lichtenstein

                                                Cow Going Abstract

Alternatively, the hierarchy may be arranged with the artist in a superior ranking and the media in a subordinate category:          

Fine Arts

                        Warhol, Andy

                                    Paintings

                                                Mao

                                                Marilyn No. 3

                                                Tomato Soup

                                  Screenprints

                                                Flower #10

                                                Kachina Dolls

                        Lichtenstein, Roy

                                    Paintings

                                                Shipboard Girl

                                                Living Room No. 4

                                    Screenprints

                                               Cow Going Abstract

Either approach is acceptable, but the latter is probably more practical since any search is typically driven by the artist name.

Three Subaccount Structure

Three subaccounts are assigned to each work of art:

Purchase price
Ancillary costs
Valuation adjustment

The Purchase price subaccount isolates the amount paid for a work of art exclusive of extraneous costs not associated with the creation of the work itself.  For acquisitions via gift or inheritance, the purchase price subaccount generally records the donor’s carryover tax basis in the asset.  The Ancillary costs subaccount captures any expenditure made in connection with the purchase but not directly linked to the creative process.  Items posted to the ancillary cost subaccount would include:  the cost of framing or mounting the piece; amounts paid in connection with transporting the work from the gallery to a residence; fees paid for authentication, research and legal fees associated with the acquisition and other related costs.  The third subaccount, Valuation Adjustment, is used to record the journal entry required to mark the work of art to fair market value.  A comprehensive discussion of each of the three subaccounts will follow.

The goal in proactive accounting is to organize information in a format that facilitates analytic review of the financial data.  The three subaccount structure for fine arts achieves this goal and brings transparency to the books in a concise and logical scheme.  A quick perusal of the balance sheet report concisely summarizes the most pertinent information to analysis and decision making:  purchase price, ancillary costs, and valuation adjustment.  Assuming the accounting is current, the valuation adjustment gives a good approximation of the realized taxable gain should the work be sold.                                                                          

In the legacy office an art inventory would typically be maintained on an Excel spreadsheet.  Columns in the spreadsheet would delineate index items (artist name, piece, date, etc.).  Each row would contain the data pertaining to a particular work of art.  But as we know, Excel produces a static spreadsheet and not a dynamic database.  Maintaining the information in the GL standardizes the data in the same accounting system and utilizes the database capabilities inherent in accounting packages.

Purchase Price Subaccount

The purchase price sub-account captures the contracted sales price for a work of art.  The price paid for the piece may be greater or less than the retail list price and any adjustments to arrive at the bottom line should be recorded.  If the seller grants a discount, both the gross sales price and the markdown are posted to this account.  For example, Patty Patterson purchases a Pollack print from the Paul Paulson gallery in Peoria.  The list price for the print is $35,000.  Paulson agrees to give his favorite client a 10% discount and sells the piece for $31,500.  Both components of the transaction are recorded in the purchase price sub-account:

Paul Paulson Gallery  Dr    35,000     Gross sales price
Paul Paulson Gallery  Cr     (3,500)   10% discount offered by Paul Paulson

Why post the discount?  Why not simply enter the cost at $31,500?  That is, after all, the amount charged on the Citbank card.  Price concessions are recorded because Proactive Accounting anticipates the prospective informational needs of management.  The discount represents a record of information with material future utility.  In three years when Patty Patterson wanders into Peoria she may call the CFO and ask, Hey Preston, how much of a discount did Paul Paulson give me on that Pollock print?  Patterson’s CFO can answer the question on the spot:  the data is in the database and no one needs to embark on a fishing expedition to locate a three year old invoice.  The Proactive approach eliminates the let me get back to you in half an hour syndrome.

At the time a journal entry is recorded every effort should be made to accumulate supplemental detail conveying informational value.  In this example, the memo associated with the discount specifically identifies Paul Paulson as the individual offering the markdown.  The Paulson gallery may be owned by two or more partners and employ several sales consultants.  Specifying the name of the individual offering the discount may or may not be of any consequence.  Incorporating that secondary information into the database is a preemptive action.

If the work of art is acquired via a gift from a relative or friend, the purchase price account would record the donor’s cost, thereby preserving the carryover tax basis.  The purchase price account should always be maintained with the intention that this is the primary account out of which taxable gain or loss is computed.  Ancillary costs may also augment basis for measuring taxable gain or loss but those amounts are captured in a separate subaccount.  The acquisition of art by inheritance may yield a step-up in basis of the asset.  The accounting for artwork transferred via a gift or inheritance is discussed later.

A marital dissolution may call for the division of an art collection.  In theory, each spouse had a preexisting interest in the community property or marital estate.  The collection items awarded to each party therefore represent distributions from the previously jointly owned property.  As with a gift, each item so distributed will retain a carryover basis that would be preserved when transferred to the separate property GL.  The agreed upon fair market value of assets per the judgment would also be recorded in the ledger.

Ancillary Costs Subaccount

The ancillary costs subaccount accumulates supplemental costs proximate to the purchase of a work of art.  Sales tax, VAT, shipping, inspection, framing, transfer insurance, restoration, commissions or consulting fees (if paid by the buyer), appraisal and temporary storage are examples of such ancillary outlays. These overhead expenses may be sizeable, particularly when in connection with the purchase of a significant work of art.

After much thought and debate Aaron and Ann Aarons decide to add a noteworthy painting to their quarter-billion dollar collection of Pop Art.  They purchase a $22 million Roy Lichtenstein triptych from the ultra exclusive Galleriè Gââjââjèè in Beverly Hills.  Their due diligence leading up to the closing included utilizing the services of a prominent art historian and expert on Pop Art who authenticated the piece; a restoration expert who cleaned a smudge on one corner of the canvas; an art consultant who brokered the deal; an attorney who reviewed the purchase and sale contract and a professional installer specializing in hanging large pieces of art.  Other costs included a nail-to-nail policy insuring the painting from the point the painting left the gallery to the point that it was successfully mounted on the wall of the Aaron’s den; a custom designed cleat for hanging the piece and the armed delivery service to transport the piece from the Rodeo Drive gallery to the Bellagio Road estate.

Ancillary costs on a significant acquisition can alone add up to more than the cost of a mansion in some parts of the country.  The sales tax alone on a $20 million painting could be close to $2 million.  The time to shove all of this information into the database is when the transaction is fresh in everyone’s mind and the purchase documentation is readily at hand.  It also means maintaining open communication channels among the staff and keeping everyone informed of the status of the transaction.  Some ancillary costs may miss being capitalized to the work of art if the bookkeeper is unaware of their link to the piece. 

The out of pocket price paid for of a work of art may exceed the “list” price.  If the art is acquired at auction, a buyer’s premium is generally added to the hammer price of the lot.  The buyer’s premium may range from 10% – 20% and represents the administrative overhead to the auction house.  The buyer’s premium is posted to the ancillary cost sub-account.  Some might argue that, as on a discount, this premium should be posted to the purchase price sub-account.  However, a discount represents an arms-length adjustment to the price and is therefore distinct from a premium charged as a fixed percentage of the strike price.  In this regard, the premium is more akin to a tax and represents a cost of doing business rather than a negotiated price concession based on market conditions.

The cost of a frame may be included in the purchase price of a work of art.  When the purchase is recorded in the ledger the price should be allocated between the composition and the frame.  An estimate of the value of the frame is required to complete the journal entry.  The cost of the frame can generally easily be determined by calling the gallery and requesting the value.  For an unframed piece the cost of the framing will be readily apparent and included in the invoice.

The purchase price of a work of art and all of the capitalized costs could be accounted for out of a single account.  However, segregating the ancillary costs isolates the pure cost of the painting itself in a single reference account.  Isolating the purchase price facilitates the computation necessary to mark the piece to market via a valuation adjustment.  The ancillary cost account also accumulates any costs that augment the tax basis for purposes of computing gain or loss on the disposition of the art.

Restoration & Repair Costs

Restoration and repair costs are recorded in the ancillary costs sub-account.  These costs may not be insignificant.  In 2006 Las Vegas resort and casino magnate Steve Wynn accidentally planted his elbow through the oil painting Le Rêve, a Picasso he had only days before agreed to sell to hedge fund mogul Steven Cohen for $139 million.  The accident left a two inch puncture in the canvas.  The prized painting subsequently underwent a painstaking eight week rehabilitation by a world renowned restoration expert.  The cost for the repair: $90,493.  This expenditure is capitalized directly to the painting and debited to the linked ancillary cost subaccount.  When a work of art is damaged an insurance claim is sure to follow.  The recovery of any insurance proceeds to reimburse for the repair costs would be recorded as a credit to the ancillary cost account (and a debit to cash).  Insurance proceeds in excess of the actual repair costs may result in taxable income, in which case the accounting should be adjusted accordingly.

Valuation Adjustment Subaccount

The third sub-account for a given work of art captures the adjustment necessary to mark the asset to fair market value.  This account is identical in theory to its counterpart for financial securities.  Unlike publicly traded stock, however, the value of artwork generally is not readily determined – there is no public exchange reporting bids and asks on oil paintings.  The valuation of art is typically established in an appraisal by a qualified appraiser.  The appraisal report identifies each work of art and assigns a fair market value.  The appraiser determines the piece’s worth based on research of auction results, pricing surveys, gallery inquiries and other means.  The difference between the net amount paid for the piece, exclusive of ancillary costs (as reflected in the purchase price sub-account), and the valuation per the appraisal, is the amount that is debited or credited to the adjustment account to mark the piece to market.  An example will illustrate the relationship between these three sub-accounts.

Wendy Wendell purchased a Warhol soup can print, New England Clam Chowder, in 1999 from the William Walters Gallery for $4,500.  She also paid $425 in sales tax and $575 for framing.  The GL initially reports the total value of the print as $5,500 ($4,500 + $425 + $575).   In January 2010 Wendy makes a New Year’s resolution to have her single-piece art collection appraised and to finally secure the proper insurance.  She calls upon Wallace Wolcott, a renowned art appraiser.  Wolcott issues his report and Wendy is thrilled:  her collection is currently worth $23,500.  Wendy’s GL will now show a valuation adjustment on her art in the amount of $19,000, the difference between the current fair market value ($23,500) and the purchase price ($4,500).  As with stock held in a brokerage account, the debit to the valuation adjustment is offset by a credit to unrealized gain.  Wendy’s GL shows the following activity in her fine arts section:

            Dr        Purchase Price                           4,500 Cost

            Dr        Ancillary costs                            425 Sales tax

            Dr        Ancillary costs                             575 Framing

            Dr        Valuation Adjustment                19,000                               

The $19,000 adjustment is posted as of the appraisal date.  The associated memo should reference the name of the appraiser and the date of the appraisal:  Per Wallace Wolcott Valuation Services report dated 01/11/10.  In reality, the value of Wendy’s Warhol appreciated gradually over a period of 11 years.  The one-time adjustment in the year of the appraisal represents a compression of the true time frame for the increase in value.  In theory, the accountant could amortize the adjustment over several years but, for practical purposes, the single-year adjustment is a reasonable compromise.

Although the art market has consistently escalated in recent years, events or circumstances may trigger depreciation in the value of a work of art.  Steve Wynn purchased Le Rêve in 2001 for $60 million.  Steven Cohen’s consent to pay Wynn $139 million for the Picasso established a new fair market value in an arm’s length transaction.  A $79 million debit to valuation adjustment marked the painting to this new value on Steve Wynn’s books.  After Wynn elbowed the painting, an appraisal revalued the work at $85 million, a $54 million decline.  On the date of the calamity the valuation adjustment account would be credited for $54 million and unrealized loss would be debited for the same amount. The roller coaster ride in the value of Le Rêve highlights the magnitude that fluctuations in the value of art may have on a family’s wealth.  Subsequent to the reappraisal, Steve Wynn filed a $54 million claim with Lloyds of London followed by a lawsuit for the same amount. Wynn and Lloyds eventually settled out of court.

 

 

The value of Picasso’s masterpiece, Le Rêve, has been on a roller coaster ride since 2001 when Steve Wynn purchased the piece and then accidentally poked a hole through the canvas.

Consistent with the proactive approach, any change in the valuation of a work of art should be referenced with an explanation for the adjustment.  The $79 million valuation adjustment on Le Rêve would include a notation such as:  Adjust to FMV per executed contract to sell to Steven Cohen for $139 million.  The subsequent downward revision would be likewise described with appropriate keywords:  Adjustment to valuation due to damage to painting (elbow incident).

The recovery of insurance proceeds on a claim may or may not be taxable and such analysis is beyond the scope of this discussion.  However, in some instances, as in the earlier discussion regarding the repair costs for Le Rêve, the proceeds may be posted as a credit to the ancillary cost account.

An appraisal to properly value an art collection may be costly and some clients may balk at the expenditure.  One can always ballpark the valuation adjustment based on in-house research.  The staff could scrutinize auction results at Artnet.com and call galleries to survey pricing.  However, a qualified independent appraisal is required for insurance purposes and with the continuing escalation in the value of fine arts the Business Manager must ensure that adequate coverage is bound.  At the least, the accountant must inform the client of the risks associated with an underinsured collection.  If the client chooses to forgo an appraisal and stick with insurance coverage that is out of date, the Business Manager better have that decision memorialized in a memorandum or email with a documented response.

Maintenance costs

Costs for maintaining an art collection fall into two categories: 1) general non-allocable costs that relate to the collection as a whole and that cannot be linked to a specific work of art and 2) directly allocable costs that are capitalized to a particular piece.  For tax purposes the costs associated with maintaining an art collection, such as insurance, curator and staff salaries, security, preservation systems, appraisals and so on are either nondeductible or possibly categorized as tSection 212 expenses and subject to the various associated deduction limitations.  As we saw with the Le Rêve fiasco, specific costs may be capitalized to a particular work of art.  Repair and restoration costs would be debited to the ancillary cost subaccount for the particular piece having sustained the damage.  Insurance proceeds, if any, to reimburse for such costs would be credited to the ancillary cost subaccount.

There are conflicting positions on whether the cost of a curator and art staff may be allocable to the cost of a painting.  Let’s say that the cost for the art staff is $200,000 per year.  Some practitioners take the position that staffing costs should be capitalized to the tax basis of the collection.  When a painting is sold, a portion of those capitalized costs are allocated on a prorata to basis (and posted to the ancillary cost subaccount) and reduce the taxable gain.  It is beyond the scope of this handbook to debate this issue.  It should be noted that if an aggressive position is taken, a methodology should be in place to compute the allocation of such costs.  One proposed method is to multiply the net cumulative capitalized staff costs by a ratio of the proceeds from the particular piece that is sold divided by the total value of the collection.

Computation of Gain or Loss On the Sale of Fine Art

The taxable gain on the sale of a work of art is computed in the same manner as the gain or loss on any financial asset.  The gross proceeds from the sale are posted to short or long term capital gain.  The purchase price (tax basis) subaccount and ancillary cost subaccount are credited in the amounts necessary to zero them out.  The offsetting debits are posted to the realized gain account and net against the gross proceeds.  Any selling costs, such as commissions, are likewise posted as debits against the gain.

Assume Wendy Wendall decides she’d rather have a new BMW than a Warhol soup can.  She sells the Clam Chowder print at Sotheby’s for $24,000 and incurs a $2,400 commission.  Wendy’s net taxable capital gain is $16,100 computed as follows:

The net cash proceeds are posted to the capital gain account via a journal entry that includes a credit to gains equal to the gross sales price ($24,000) and a debit to capital gain for the commission ($2,400).  The tax basis is removed via a journal entry that clears out all of the subaccounts linked to New England Clam Chowder.

The valuation adjustment is credited in the amount of $19,000 to bring the balance to zero and unrealized gain is debited for $19,000.  The $19,000 debit to the unrealized gain account may more accurately be conceptualized as the reversal of the credit that had been posted in a prior year when the unrealized gain was initially established.  Wendy’s P&L for the year of the sale will report a taxable capital gain of $16,100 and an unrealized loss of $19,000.  Her overall economic loss on the transaction is $2,900 ($16,100 realized gain less $19,000 unrealized loss).   Ancillary costs and selling commissions eroded Wendy’s realization of the full fair market value of the print.  Wendy ends up buying a Hyundai.

Accounting for Art Acquired by Gift, Inheritance or Divorce

When a work of art is acquired by gift, two components of value are recorded in the GL:  the carryover tax basis of the work in the hands of the donor and a component representing the mark-to-market as of the date of the gift.  The donor of the gift posts both components of value to their own GL and gift tax expense will be similarly recorded at the fair market value.  The donee’s books should mirror the accounting of that of the donor.  The concepts can best be illustrated by an example.

In October 2009 Brent Brock bestows his prized Braque oil painting to his daughter Brenda Brock Brickman.  Brock paid only $50,000 for the Braque in 1960.  At the time of the gift to Brenda, the value of the Braque was $600,000 and Brenda’s net worth increases by accordingly. Brock’s books show gift expense of $600,000 and Brenda’s books show gift income of the same amount.  However, if Brenda ever sells the painting her tax basis for computing gain is her father’s $50,000 cost.  To preserve the carryover basis the initial value should be split with the carryover basis ($50,000) posted to the purchase price account and the mark-to-market component ($550,000) posted to the valuation adjustment account.  This methodology preserves the purity of the tax basis in the purchase price account so that there can be no error in the computation of gain upon a future sale.

Only two months after Brenda takes possession of the Braque, the value soars when the Corcoran Gallery announces a major exhibition of the French master’s work.  Brenda Brock Brickman jumps on the news and sells the painting for $750,000, using her new found cash to invest in a biofuels compost heap. The accounts are settled as follows:

  • The checking account is debited for the proceeds received, $750,000
  • The long term capital gain account is credited for $750,000 for the gross sales price
  • The purchase price subaccount is credited for $50,000 to eliminate the cost basis
  • The long term capital gain account is debited for $50,000 to offset the gain by the donor’s carryover cost basis
  • The valuation adjustment account is credited for $550,000 to eliminate this adjustment

Brenda’s taxable gain is $700,000: the net of the gross proceeds of $750,000 and the carryover basis of $50,000.  But the accounting is not complete:  one debit remains to set the journal entry to zero:  the $550,000 debit to offset the credit to the valuation adjustment.  To what account is this debit posted?  The true economic gain to Brenda Brock is $150,000, the accretion in the value of the Braque during two month period that she held the asset.  The $550,000 is debited to unrealized gain.  This is not so much a true loss as it is an offset to the $700,000 realized gain.  The $700,000 realized gain is offset by a $550,000 unrealized gain leaving a $150,000 net economic gain. The $550,000 credit prevents the double counting of income.

The value of a work of fine art in the hands of the donor of the gift may have been massaged to reduce the value for gift tax purposes.  For any given work of art, the fair market value for purposes of an insurance appraisal may be different from the fair market value for purposes of a gift tax appraisal.  For gift tax purposes the goal is to minimize value whereas for an insurance appraisal the goal may be to maximize value.  The true value from an arms-length sale to an unrelated third party may fall in between the two amounts. 

Document Management for Fine Arts

A hefty volume of documentation may be generated in connection with the acquisition of a work of fine art.  The underlying paperwork associated with the purchase will be reviewed by the staff in connection with recording the journal entry. The documentation may include invoices, emails between the family member and the seller, the Certificate of Authenticity, condition report, appraisal report, a Purchase and sale Contract, promotional information, documentation regarding provenance including letters and photos and other miscellaneous documents.  All of this paperwork should be scanned to and appropriately indexed in the DMS.  Original documentation to establish provenance, such as photos or letters, should be scanned in high resolution color.

The DMS folder structure for the fine arts documentation should parallel the chart of account structure for the fine art category of the subsidiary GL.  In that regard, a separate folder is set up for each piece and titled to match the name utilized in the subsidiary ledger.  If the subsidiary ledger has a subaccount titled:  Warhol: Paintings: Ambulance Scene # 4, the DMS should have a folder for Warhol, a subfolder for Warhol paintings and a sub-sub folder for Ambulance Scene #4.  All documents pertaining to the acquisition of the painting would be scanned and deposited into the folder.  The original documents would be safely stored in a vault or file drawer. 

If the previous accounting was not orderly, the recording of the art will be a good opportunity not only to actually record the transactions, but to coherently organize the underlying documentation.  In this regard, a folder for artwork should be set up in the document management system.  Subfolders for each distinct piece, or each artist will be set up.  All of the documentation associated with a piece should be scanned and filed in the appropriate folder.

A BREAKTHROUGH: A 100% AUTO CODED DATA IMPORT

On July 5 we celebrated a breakthrough at X6 Management.  Using the Quickbooks bank feed to download the monthly activity for one of our client’s credit cards, 100% of the transactions were automatically assigned to the appropriate expense category and required no further editing.  All we had to do to complete the processing was to click the batch entry button and the transactions were instantaneously recorded in Quickbooks.  The online balance per the credit card website matched the balance per the books so our reconciliation was a slam-dunk.  All in all it took less than 5 minutes, start to finish, to complete the monthly accounting for this credit card.  In the interest of full disclosure I will concede that this particular card had relatively few transactions for the month of June:  27 charges to be exact.  Nevertheless the outcome represented a milestone in our quest to implement fully automated bookkeeping.  We are finding that the proportion of imported transactions requiring no editing has modestly increased each month.  For all clients at least 50% of the bank fed transactions are auto-coded and require no further attention.  For some clients, up to 75% of credit card charges are fully coded – and these results are achieved for clients with up to 400 credit card charges per month.

The Quickbooks bank feed application significantly improved with the release of QES 14.  The layout of the intermediate buffer, the color coding, the ease with which to edit the vendor naming algorithm: these upgrades have all contributed to a marked improvement in the user friendliness of the program and the accuracy of the results.  Data import is one of the most fruitful applications available to enhance productivity in a Business Management practice.  The bank feed application can easily transform a daunting project that would otherwise take many hours of manual data entry to complete into a routine task that might consume half an hour of labor time.  The robo-bookkeepers are on the move!

ELECTRONIC BOOKKEEPERS

A powerful and user-friendly tool, the Quickbooks Bank Feed ramps up productivity by automating the entry of banking and credit card data into the accounting system.  When properly used, this feature can save hours upon hours of bookkeeping time.  The robust application also brings a new level of accuracy to the data entry process by eliminating human error. Surprisingly bookkeepers continue to cling to the clearly inferior and outdated method of manual data entry.  Change does not come easy. 

Remember when checks were prepared by hand using pre-printed stock and a typewriter?  It’s hard to image how bookkeepers could get all their work done when limited to what in retrospect is an archaic approach to paying bills.  By the same token it is astonishing that so many accountants and bookkeepers continue to manually enter credit card and banking data when a superior alternative is readily available.  When I ask bookkeepers why they endure the drudgery of manually typing row upon row of transactions, they tell me that it just ends up being easier or that it takes the same amount of time to manually enter transactional data.  This response flies in the face of both logic and common sense as well as my own hands-on experience with the tool.  When used consistently, the bank feed application works almost flawlessly. 

Many of my clients routinely incur 300 to 400 credit card transactions per month and another 100 or more bank transactions.  It could easily take a day or two to manually enter all that data.  By contrast the Quickbooks bank feed imports all of those transactions into the credit card register in a matter of seconds.  A user-friendly, color coded interface serves as a link between the financial institution website and the Quickbooks company file.  This buffer is essentially a spreadsheet that temporarily holds the data for editing prior to the final feed into Quickbooks.  The editing can typically be completed in less than half an hour.  Labor time is reduced by 80% - 90% or more.  Just as important as the speed of entry, data import improves accuracy by eliminating human error – transposition, transcription and other keypunch errors vanish as does the frustration of hunting for these mistakes. 

At its best, the bank feed tool can accomplish not only the import of the numerical components of a transaction, but also the assignment of the transaction to the proper account category based on auto-recall.  When used consistently, Quickbooks learns to link a specific vendor to a particular account on the Chart of Accounts.  With time a greater proportion of the monthly transactions are so linked and therefore fully recorded.  I recently imported the monthly credit card activity for my client’s Citibank MasterCard.  Of the 221 downloaded transactions, 172 were fully coded and required no further editing.  Think of it: 172 transactions were recorded at the speed of light!

The QB Bank Feed program is essentially an electronic bookkeeper and does all of the heavy lifting.  That paradigm truly revolutionizes the field of Business Management.  By automating almost 100% of the data entry, the time it takes to manage a client is cut dramatically.  We no longer employ bookkeepers in our practice.  We employ dataflow managers who can accomplish three to four times the workload of that of a traditional bookkeeper. 

Is the Bank Feed program perfect?  No, but it’s near perfect.  After the data for a given account has been imported into Quickbooks, the program compares the balance per the financial institution and the balance in the accounting register.  These two figures match almost, but not quite, 100% of the time.  Once in a while there may be a mismatch.  Typically the discrepancy is easily found and is often a single transaction that, for whatever reason, was excluded from the import feed.  These minor glitches are generally resolved in a relatively short period of time. 

To understand the data import process, let’s look at the anatomy of a journal entry. Every financial transaction has four components:

  • The date of the transaction
  • The name of the vendor
  • The amount of the transaction
  • The account from the Chart of Accounts to which the transaction is assigned

The Bank Feed downloads two of these components with 100% accuracy: the transaction date and the transaction amount.  That is the easiest part of the import process.  Yet with manual data entry those two components are the most susceptible to human error (keypunch type errors).  The other two components: the vendor name and account classification, may require additional editing.

Let’s now turn to those other two components.  The name that is fed from the bank into the buffer register may have extraneous identifying information that is of no value.  For example, a credit card charge at Starbucks may be identified in the buffer as:  Starbucks Inc. LA08567A-099.  That bank-feed name needs to be linked to the stripped-down vendor name Starbucks.   Quickbooks utilizes a naming algorithm to convert the bank feed name to the vendor center name.  That way you don’t end up with 25 variations of a single vendor in the database.  The naming rules may be edited to further refine the process and improve the outcome.

Once the bank feed vendor name is linked and converted to the Quickbooks vendor name, the transaction will be automatically assigned to the same expense category as that associated with the particular vendor.  Over time a greater proportion of the bank feed transactions are fully coded and require no further editing.  The percentage of transactions that are auto-coded are a function of the consumer behavior of the client.  For clients having a more routine and repetitive transaction profile (i.e., they tend to go to the same restaurants and the same department stores and the same gas stations) upwards of 75% of bank feed transactions are fully coded.

We are in an era where, like it or not, bookkeepers are obsolete.  The traditional model of bookkeeping and accounting, which is labor intensive and data-entry centric, is a thing of the past.  Data flow managers can process four times the volume of work as that of a traditional bookkeeper and can turn their focus to more substantive and challenging accounting issues.  This is revolutionary stuff and will drive down the cost of Business Management and the associated fees that are charged to clients.  Business Managers who fail to embrace this remarkable technology are at a competitive disadvantage and will soon fall by the wayside as the robo-bookkeepers take over.