I recently read two misleading items on Roth IRAs in back issues of the JofA: a tax brief, “Risky Roth IRAs” (Dec.98, page 123), and a letter, “More about the Elusive Roth IRA Advantage” (Jan.00, page 102). The first does not correctly state the total future value of the contributory Roth because it omits the principal amount. There is also a subtle methodological flaw in both items: The fundamental distinction between tax-sheltered growth vs. taxable growth was ignored in computing opportunity costs.

When a Roth IRA (either contributory or a conversion) is selected over a traditional IRA, a potential future tax bill generated by the traditional IRA can be preemptively paid using nonsheltered assets. Typically, these nonsheltered assets, if not otherwise paid as taxes, would remain invested in a taxable account. Thus the opportunity cost of the prepayment should be computed using the anticipated rate of return on taxable assets, which is, of course, almost invariably lower than the rate of return on sheltered assets (because of capital gains taxes). Thus, no comparative analysis of Roth vs. traditional IRAs that ignores capital gains taxes, and that uses a single interest rate to compute all present and future values, can be satisfactory.

For example, if the 10% rate of return used in “Risky Roth IRAs” is assumed to be the return on taxable assets, and long-term capital gains taxes are 20%, then the equivalent sheltered rate of return must be

10% .80 = 12.5%

At 12.5% growth, the projected future value of the Roth IRA after 25 years will be twice as large as the value claimed in the tax brief. Consequently, contrary to the conclusions drawn from that example (where income tax rates are the same before and after retirement), the Roth is superior to the traditional IRA.

The letter cited above also seems to assume that one interest rate alone can be used to analyze both Roth and traditional IRAs.

I find it disheartening that the same fundamental mistake of ignoring taxation could be repeated in the JofA. I hope the editors will be alert to its appearance in the future.

Ricardo Diaz
Professor of Mathematics
University of Northern Colorado
Greeley, Colorado

We expected to find a new strategic approach to budgeting in “Better Budgets” ( JofA, Feb.00, page 37). Instead, we found an article that might have been an advertisement for enterprise resource planning (ERP) software and systems consultants.

The article contains some useful information for management accountants but also material that may be misunderstood. We believe the following clarifications are needed to achieve better budgets.

ERP systems are massive, complex beasts designed to integrate information and processes that span many organizational units. They are usually expected to replace multiple systems, each of which was designed and managed for support of a much more discrete grouping of business functions. They are not simply big versions of an earlier system.

Theoretically, there is no reason why providing decision-makers with more efficient and effective access to better information would not result in significant improvements to the budgeting process. However, while the potential advantages of the ERP approach are obvious, in reality many issues arise that threaten their realization.

That more data can be made available to more people faster sounds good, but conversion from legacy systems to an ERP system requires managers and information-systems support staff to assume responsibilities for insuring data integrity and appropriateness of business processes. It is hard enough for business managers to understand the information systems and technology on which their units rely, but it is even harder for technologists to understand the entire corporate entity from a business perspective.

Effective project management is absolutely necessary for the success of any large systems-integration project, and changes in business processes resulting from reengineering and ERP system implementation make this a daunting challenge. Even ERP software manufacturers readily admit that few, if any, of their employees understand the entire system. In this context, the potential for trouble goes beyond the right hand’s not knowing what the left hand is doing. Most managers have had the experience of asking information technology people to modify a program and subsequently finding errors appearing in other modules. In a legacy system environment, the results of these errors are more likely to be confined to one area, identified and addressed before they spread throughout the entire organization.

This is not to say that ERP software should be avoided, but the responsibilities, knowledge, skill sets and diligence needed for maintaining the integrity of corporate information and computer-supported processes must be reevaluated.

ERP systems and “bolt-on” products for forecasting and analysis must be configured, programmed, fed (from data sources) and tested. They may contain sophisticated built-in models and features, but anyone who thinks of them as magical black boxes that just spit out great budgets will be disappointed. No matter how much you spend, the garbage-in, garbage-out rule still applies.

The strength of these new systems lies in their ability to access and process more information more quickly. The quality of the information and processing methods is a different question. This technology, when combined with poor information quality and inappropriate processes, guarantees more wrong answers faster and “prettier.” Giving a talented 12-year-old a new set of tools may enable him to build a better birdhouse, but getting even better and bigger tools won’t result in a skyscraper.

Marc Lynn, PhD
Associate Professor, Information Systems

Roland Madison, CPA
KPMG LLP Professor of Accountancy
John Carroll University
Cleveland

One point that needs to be made about “A Taxing Problem” ( JofA, May00, page 51) relates to the tax efficiency of index mutual funds.

Due to their extremely low distributions, index funds tend to function in a manner similar to tax-managed funds. Index funds also have lower expense ratios and an ongoing verifiable history of performance—both of which are obviously critical to the decision-making process.

Perhaps the only time a distribution might occur, other than in a dividend distribution, is when there is a change in the composition of the index. Nevertheless, current low dividend yields are a persuasive argument in favor of index funds.

I believe that with a little research, an investor can construct a highly tax-efficient portfolio using the variety of index funds currently available and, at the same time, maintain performance with a minimum of risk per unit of return.

I would like the JofA to address these points in future articles.

Mark S. Glochowsky
Senior Accountant
Gerber Plumbing Fixtures Corp.
Chicago

The article, “Start Your Own Firm,” ( JofA, May00, page 61) covered many good points. Specializing and the periodic fine-tuning of a practice are things many of us CPAs need to consider. However, I believe one of the most important aspects of maintaining a practice is billing. Learning how to bill separates the practitioners that survive from those who don’t.

Although I do not consider myself an expert, I would like to add some tips, especially for those CPAs who have the luxury of planning to go on their own.

• Learn how to bid work and how to invoice it: If you have the opportunity at your current job, bid work for clients. Learn to write invoices clients will pay. (If your car was repaired, would you sooner pay a bill that says “For mechanical services rendered” or one that details the work done?) When you give a price break, say so. If you saved the client money with your talent, tell them. (“This work saves you about $7,500 in federal income taxes.”) You will make the client feel better about paying you.
• Learn from the best: I once worked in a firm where the partner with the sloppiest work had the best billing record. Clients were happy to pay him. We laughed about it as we picked up our pay checks, but instead of laughing, we should have looked closer.
• Examine your side work: Many of you do tax returns or accounting on the side. I knew a man who prepared 350 tax returns outside of his regular job. His billing rates were significantly lower than the firm’s prices because he had minimal overhead. Unfortunately, his billing rates were so low that, if he ever went on his own, there was no way to raise them to support the overhead. Set your rates now as if they had to support rent, utilities, and insurance and give you a living wage.
• Treat your clients as you would want to be treated: Would you hire a painter to paint your house with no idea of what it would cost? Of course not. Give your clients the same consideration. It is much easier to bill and collect if your clients know up front what your charges will be.
• Strive for complaints: If no one complains, your rates are too low. Lose some work because your prices are too high. Knowing what your peers charge won’t necessarily help—they could be as clueless as you. Get enough price resistance to know you are in the ballpark of the correct rates.

John E. Ahern, CPA, JD
Chicago