Simply Use the Financial Statements and Tax Returns – n’est pas?
It is not unusual, as to various types of litigation related services, that we are presented with either tax returns and/or financial statements, and it is (allegedly) expected that such would be sufficient for us to proceed with our work. Typically, this might come about when it is necessary to determine the extent of income realized from a closely held business and/or the value of said business. It is our experience that most legal practitioners fully understand it is indeed a rare investigative or valuation job that can be done purely based on financial statements or tax returns. However, every once in a while, with what does appear to be some sense of sincerity, it is posed to us that using the tax returns (which, after all, are sworn to as being the truth, the whole truth and nothing but the truth) or the financial statements (which of course carry some accountant’s signature and therefore are tantamount to sacrosanct) is sufficient to enable us to render a report.
The reality is that, even where there is absolutely nothing improper (i.e. no personal expenses being paid and no unreported income being taken), it is still the exception to the rule to be able to use the unadjusted financial statements or tax returns without any form of accounting investigation or analysis. Even where all is above board, even where there is an audited (often referred to as certified audit) financial statement, we must delve into the books and records, and the underlying documentational support for same.
A brief explanation as to why. Financial statements, especially if they are compilation type, and often even if review and even if audit, will many times not deal with (that is, leave as is handled in the company’s books and records unchanged by the accountant) such matters as perquisites. Indeed, it is perquisites, or untaxed fringe benefit type of payments for or on behalf of business owners, which make operating a business so attractive to many people. There is of course the sense of independence and controlling your own financial destiny – but there is also the sense of being able to put it on the books, run it through the books, and have the business pay for it. Virtually no financial statements which one would normally receive would deal with these types of issues. That is, if one had a business doing $800,000 in revenues, with the owner showing a salary of $50,000, but taking an extra $20,000 in one form or another of fringe benefits (or expenses paid by the business), it is a virtual guarantee that no matter what level of financial statement you are presented with, there will be no information to lead the reader to understand that the owner’s true compensation is not $50,000 but really $70,000. This would be the same if you were looking at the tax returns of the company.
There will also be times when, with absolutely nothing improper having been done, merely the different needs of an accountant looking to appraise a business or to determine the level of income realized therefrom, will be such that certain analysis and adjustments to the reported figures will be necessary so as to put into context economic and financial reality (as contrasted with what is often a tax fiction). In addition, particularly as to tax returns, there are various tax rules that have to be met when filing tax returns that may impact (favorably or unfavorably) the numbers presented on the returns – which may have no sense of economic reality.
It must be clearly understood that it is only in the true exception to the rule that we can do our jobs as to investigating a business, determining income therefrom, and determining the value of same, using merely tax returns or financial statements.
~Kal Barson
