The document provides an overview of accounting concepts and financial statements for attorneys. It covers topics such as financial statements and tax returns, financial analysis, advisory functions, and client risks and opportunities that can be identified from statements and returns. The document defines accounting and discusses the accounting equation, balance sheet, income statement, statement of cash flows, and components of personal and business tax returns. It emphasizes how statements and returns can provide both obvious and not-so-obvious insights about clients' financial health, risks, opportunities, and more.

1. Accounting Musts
For Attorneys

2. Today’s Objectives
Cover Financial Statement and Tax Return concepts to educate you to better
serve yourself and clients by identifying and understanding financial risks and
opportunities and how they can be used to assist you in advising your clients.
 Financial Statements and Tax Returns
 Financial Analysis
 Advisory Functions found from Statement/Return Analysis
 Client Considerations (“Risks & Opportunities”)

3. Who here feels like they can read
their clients financial statements
and tax returns and provide
effective analysis to not only
complete the scope of your job, but
better serve your clients?

4. What can a Financial Statement / Tax
Return Tell us?
THE OBVIOUS
 Company or Individuals’ Financial Health,
 Assets and Liabilities, and
 How much money they are making….
THE NOT SO OBVIOUS
 Fundamental Business Errors,
 Potential Risks and Opportunities,
 Fraud, and
 Strategic Plan Risks and Opportunities…

5. What is Accounting?
Accounting is the process of measuring, interpreting, and
communicating financial information to support internal and
external business decision making.

6. Basic Rules
• Generally accepted accounting principles (GAAP) encompass the
conventions, rules, and procedures for determining acceptable
accounting practices at a particular time.
• Financial Accounting Standards Board (FASB) is primarily responsible
for evaluating, setting, or modifying GAAP in the U.S.
• Sarbanes-Oxley Act responded to cases of accounting fraud.
– Created the Public Accounting Oversight Board, which sets audit
standards and investigates and sanctions accounting firms that certify the
books of publicly traded firms.
– Senior executives must personally certify that the financial information
reported by the company is correct.
– Resulted in increase in demand for accountants.

7. Types of Accounting Reports
 Compilation - In a compilation engagement, the objective is to assist management
in presenting financial information in the form of financial statements without
undertaking to provide any assurance that there are no material modifications
that should be made to the financial statements so they will conform to the
acceptable financial reporting framework. Because of the even more limited scope
of compilation procedures, the CPA’s report will not express an opinion or provide
any assurance regarding the financial statements.
 Review - A review engagement is conducted to provide limited assurance that
there are no material modifications that should be made to the financial
statements for them to be in conformity with the financial reporting framework.
 Audit - An audit is the highest level of financial statement service a CPA can
provide. The purpose of having an audit is to provide financial statement users
with an opinion by the auditor on whether the financial statements are prepared
in accordance with the proper financial reporting framework. An audit enhances
the degree of confidence that intended users, such as lenders or investors, can
place in the financial statements.

8. The Accounting Cycle
Accounting process - set of activities involved in
converting information about transactions
into financial statements.

9. Financial Statement Overview
Income Statement
for the Twelve Month Period
Statement of Cash Flows
For the Twelve Month Period
Beginning
Balance Sheet
January 1
Ending
Balance Sheet
December 31

10. Accounting Equation
• Assets - anything of value owned or leased by a business.
• Liability - claim against a firm’s assets by a creditor.
• Owner’s equity - all claims of the proprietor, partners, or
stockholders against the assets of a firm, equal to the excess
of assets over liabilities.
• Basic accounting equation - relationship that states that
assets equal liabilities plus owners’ equity.
• Double-entry bookkeeping - process by which accounting
transactions are entered; each individual transaction always
has an offsetting transaction.

11. Balance Sheet
 Balance sheet - statement of a firm’s financial
position—what it owns and the claims against its
assets—at a particular point in time.
 Photograph of firm’s assets together with its
liabilities and owner’s equity
 Follows the accounting equation

12. Balance Sheet Example

13. Balance Sheet
Working Capital is the measure of cash or liquid assets essential for its day-to-
day operation. By calculating your working capital, you can find out the value
of your current assets and if you are able to meet your financial obligations. It
is simply the current assets in excess of current liabilities.
CURRENT ASSETS – CURRENT LIABILITIES = WORKING CAPITAL
Accounts Receivable
Inventory
Prepaid Expenses
Taxes
Wages
Accounts Payable

14. Income Statement
 Income Statement - financial record of a
company’s revenues and expenses, and profits over
a period of time
 Firm’s financial performance in terms of revenues,
expenses, and profits over a given time period
 Reports profit or loss
 Focus on revenues and costs associated with
revenues

15. Income Statement Example

16. Income Statement
Cost
of
Sales
Cost
of
Sales
Operating
Expenses Operating
Expenses
Net Profit
Net Loss
Sales
Sales
Sales
- Cost of Sales
= Gross Profit
- Operating Expenses
= Net Profit or (Loss)

17. Statement of Owner’s Equity
 Statement of Owner’s Equity - is designed to show
the components of the change in equity from the
end of one fiscal year to the end of the next
 Begins with the amount of equity shown on the
balance sheet
 Net income is added, and cash dividends paid to
owners are subtracted

18. Statement of Owner’s Equity Example

19. Statement of Cash Flows
 Statement of cash flows - a firm’s cash receipts and
cash payments that presents information on its
sources and uses of cash
 Accrual accounting - method that records revenue
and expenses when they occur, not necessarily when
cash actually changes hands

20. Statement of Cash Flows Example

21. Statement of Cash Flows
 Cash Provided or Used by
Operations
+ or –
 Cash Provided or Used by
Investing Activities
+ or –
 Cash Provided or Used by
Financing Activities
= Net Change in Cash
 Ending Cash
(at December 31)
 Beginning Cash
(at January 1)
= Net Change in Cash

22. Financial Statement Notes
Key Notes include:
 Description of the company
 Significant accounting policies
 Estimates, contingencies and
commitments
 Related party transactions
 Income taxes

24. Tax Return Components
1040 Personal Return
Wages & Salaries
Federal taxable wages are NOT total wages!
FICA/Medicare may be different
• Adjustment for 401-K deferrals, which are not deductible from FICA/Medicare Wages.
State wages may be different – no adjustment for certain elective deferrals.
May not reflect compensation based assets like stock options, deferred compensation.
•Potential source of additional assets
No Breakdown between base salary and bonuses!
Interest/dividend income
May not show non-taxable interest and dividends (i.e.
interest from mutual fund from municipalities)!
Must obtain Schedule B
•List all sources of interest and dividend income

25. Tax Return Components
1040 Personal Return
Capital gains
Page 1 only shows NET gains and losses (which are limited to $3,000 per year)!
Page 1 doesn’t show total proceeds or reinvestments
Unusual trading activity may be evidence of assets being dissipated or diverted!
Always get Schedule D and any supporting schedules!
Look for Capital Loss Carryovers!
Rental real estate/S-corps
Page I only shows net, taxable income or losses!
Schedule E shows detail, BUT…
Only shows pass-through (i.e. your portion) income/loss, NOT actual
distributions!
Must get K-1 form!
Look for Passive Loss Carryovers!

26. Tax Return Components
1040 Personal Return
Income v. Cash Flows
What is available for support?
Income Cash Flows
Taxable Wages Net Payroll
Pass-through Income Distributions
Capital Gains and Losses Proceeds from Sales
Remember: Income for tax purposes and Cash Flows available
for support are not necessarily the same thing!

27. Tax Return Components
1040 Personal Return
Recurring v. Non-Recurring Income
Even if an item appears on the tax return, is it something that is available on an ongoing
basis?
Retirement Plan Distributions
If under retirement age, need to consider if funds were rolled over or were one-
time distributions
Sale of Residence or other property
Proceeds from refinancing of investments (may show as distribution from pass-
through entities!)
Base Salary v. Bonuses

28. Tax Return Components
1040 Personal Return
Expenses and Deductions
Adjustments to Income
Retirement Plan Contributions
IRA’s
Self-employed Plans
•Generally Discretionary!

29. Itemized Deductions
May provide information regarding spending
Mortgage Interest
Evidence of Potential Debt
Can be deducted for more than one property!
Need to verify, ask for form 1098!
Real Estate Taxes
Can be deducted for more than one property!
Safe Deposit Box Rental
Potential hidden assets
Investment Interest/Expenses
Investment interest may be evidence of debt (i.e. margin loans against assets!)
Tax Return Components
1040 Personal Return

31. Tax Return Components
1120 Business Return
Corporation
•Taxed as a separate entity!
S-Corporation
•Tax attributes “pass-through” to the shareholder!
Partnership/Limited Liability Company/Partnership
•Tax attributes “pass-through” to the partner/member (for an LLC/LLP)
•Multiple member LLP’s can be taxed as partnerships
•Single member LLC’s can be taxed as Schedule C (for business entity ) or shown on
Schedule E (for real estate entity!)
Schedule C (Solo Proprietorship)
•No separate return!
•Income and expenses shown on Schedule C of form 1040!

32. Tax Return Components
1120 Business Return
The Income Statement
Gross income and other receipts
Cost of goods sold
Other deductions
Always make sure you get supporting schedules showing all expenses!
The Balance Sheet and Retained Earnings
Look for accumulated cash!
Schedule L and M1
Officer loans receivable/payable!
Changes in balances can impact calculation of cash flows!
Always make sure you have supporting schedules!
What are Retained Earnings?

33. Tax Return Components
1120 Business Return
Schedule K and form K-1
•Filed with Partnership Return detailing “share”
•Income vs. Distributions
Income represents taxable income or loss from business activities.
Distributions represents cash (or other assets) actually paid to the
owner/partner!
Need to look at underlying accounting records, since “distribution” amount is
a “net number!”
•Look for other entries on the K-1
Section 179 Expense (certain property costs)
•May artificially reduce income on Schedule E
Charitable Contributions
•May represent a “lifestyle” expense
Interest/Dividend/Capital Gain Income
•May represent accumulated assets in the business!

34. Tax Return Components
1120 Business Return
Cash v. Accrual
•Income – Earned v. Received
Many small businesses (especially personal service providers) report on cash
basis for tax purposes
Actual “income” may be understated, as receipts are deferred for tax planning
or other reasons
Consider looking at Account Receivable schedules
•Expenses – Incurred v. Paid
Expenses may be paid early to reduce income
Look for extraordinary expenditures at year end

35. Tax Return Components
1120 Business Return
Schedule C (Sole Proprietorship)
•Separate Return is NOT filed!
•Included with individual tax return.
•Balance Sheet is not presented!
•Must obtain underlying accounting records to identify assets and liabilities.
•Income is subject to both regular income tax and Self-Employment Tax.
•Because the Schedule C is not a separate entity in the same way as a regular corporation or
partnership, requirements for keeping business and personal financial operations apart are
not as strict!
•Potential for comingling of business and personal assets/transactions is greater!

36. Ratio Analysis (‘Exploratory Analytics’)
Audit Data Analytics (ADA) is the science and art of discovering and
analyzing patterns, identifying anomalies, and extracting other
useful information in data underlying or related to the subject
matter of an audit through analysis, modeling, and visualization
for the purpose of planning or performing the audit. ADA includes
methodologies for identifying and analyzing anomalous patterns
and outliers in data; mapping and visualizing financial
performance and other data across operating units, systems,
products, or other dimensions for the purpose of focusing the
audit on risks; building statistical (for example, regression) or
other models that explain the data in relation to other factors
and identify significant fluctuations from the model; and
combining information from disparate analyses and data sources
for the purpose of gaining additional insights.

37. Ratio Analysis
Ratio analysis - tool for measuring a firm’s liquidity, profitability,
and reliance on debt financing, as well as the effectiveness of
management’s resource utilization.

38. Activity Ratio
Inventory turnover
ratio indicates the
number of times
merchandise moves
through a business.
Net sales
Average of inventory
Total asset turnover
ratio indicates how much
in sales each dollar
invested in assets
generates.
Net sales
Average of total
assets

39. Profitability Ratios
Profitability ratios measure the organization’s overall financial
performance by evaluating its ability to generate revenues in excess of
operating costs and other expenses.

40. Leverage Ratios
• Leverage ratios measure the extent to which a firm relies on
debt financing.
• Total liabilities to total assets ratio > 50 percent indicates that
a firm is relying more on borrowed money than owners’ equity.

41. Client Considerations
 Are ratios and trends consistent with industry statistics and within their own
business? If not, why?
 What are areas that may allow for improvement?
 Revenue / Margin Enhancement
 Cost Cutting Analysis
 Are certain transactions present that rise to question their validity or their
purpose?
 Fraud
 Planning for Bankruptcy, Divorce
 Have transactions, relationships and/or agreements had a severe affect on
the person or entity?
 Is the client viable?
 Will they pay their bills? What can we do to help them achieve revenue,
profitability goals?

42. QUESTIONS?
josh@villelashilts.com
Cell: (904) 325-9006
www.villelashilts.com