EXECUTIVE
SUMMARY |
WITH MORE STATES CONDUCTING
AUDITS, CPAs need to encourage
companies to pay greater attention to
their unclaimed property liability. This
includes both reporting unclaimed assets
to the right state and making sure the
company properly reflects the liability on
its balance sheet.
UNCLAIMED PROPERTY
HOLDERS MUST exhaust all
options to locate the property’s
rightful owner before determining to
which state they should report the
assets. Companies should have policies
and procedures in place to track
potential unclaimed property and comply
with the applicable state reporting
requirements.
WHEN COMPANIES HAVE
DISCARDED UNCLAIMED property
records, state auditors use estimation
techniques to determine the liability.
To prevent this from happening,
companies should adopt record-retention
policies compatible with unclaimed
property laws.
A COMPANY THAT FAILS TO
COMPLY WITH STATE unclaimed
property laws increases the likelihood
of an audit. States can assess interest
and penalties for failure to file
unclaimed property reports.
COMPANIES SHOULD USE FASB
STATEMENT NO. 5 to help them
account for unclaimed property liability
on their financial statements. It says
the treatment of a loss contingency on
the books depends on whether the
likelihood of the future event giving
rise to the loss is probable, reasonably
possible or remote. |
ANTHONY L. ANDREOLI, CPA,
is national director of the unclaimed
property services group at Deloitte &
Touche in Los Angeles. He previously acted
as a consultant to more than 40 states in
developing their unclaimed property
programs. He recently was a coauthor of
CCH’s multistate tax library volume on
unclaimed property law, compliance and
enforcement. His e-mail address is
aandreoli@deloitte.com . JOSIAH S.
OSIBODU, CPA, is a senior manager in
Deloitte & Touche’s unclaimed property
services group in Pittsburgh. His e-mail
address is josibodu@deloitte.com
. |
nclaimed property has become
increasingly important in the past few years as
more states conduct unclaimed property audits of
entities that hold such assets. In a period of
economic downturn, the states see unclaimed
property as a viable nontax revenue source. In
this environment CPAs should be aware of state
laws as well as some of the financial reporting
issues surrounding unclaimed property.
This article will be of particular interest to
CFOs, controllers and other CPAs with
responsibilities in either the accounting or
financial reporting areas because of the potential
impact unclaimed property has on a company’s
financial statements. In addition, in the current
regulatory climate there are increasing pitfalls
for companies with misleading financial
statements. This article is designed to acquaint
financial executives with the problems associated
with improperly classifying unclaimed property
liabilities and offers guidance to CPAs on how to
avoid them.
THE BASICS
Unclaimed property is generally
defined as a liability a company owes to an
individual or entity when a debt or obligation
remains outstanding after a specified period of
time. An uncashed payroll or dividend check is a
common type of unclaimed property. The value of
the negotiable instrument represents the debtor’s
obligation to the payee. When the payee does not
extinguish the debt by cashing the check, this
creates a property right protected by state
unclaimed property laws.
Example. At the
end of a pay period an employer accrues
its payroll costs by recording a debit to
payroll expenses and a credit to payroll
payable. On payday the employer debits
payroll payable, credits the payroll cash
account and issues a check to the
employee. When the employee presents the
check to his or her bank, this
extinguishes the debt and relieves the
employer of the liability. However, if the
employee fails to present the check, the
employer’s payroll liability remains
outstanding. The fact that the check goes
uncashed does not remove the employee’s
property right (as evidenced by the
payroll check) nor does it eliminate the
employer’s obligation to compensate the
employee. If the employer voids or writes
off the stale payroll check, it
understates its liability (wages payable).
The uncashed payroll check becomes
“unclaimed property” after it has remained
outstanding for a period of time (one year
or more as specified by state statute).
|
Internet Resources
Unclaimed
Property Holders Liaison
Council. Promotes the
rights of unclaimed property
holders,
www.uphlc.org .
National
Association of Unclaimed
Property Administrators.
Nonprofit
organization affiliated with
the National Association of
State Treasurers. Includes a
free link to help reunite
owners with their unclaimed
property,
www.unclaimed.org .
UnclaimedFunds.org.
Subscription Web site
that offers access to 55
searchable databases to locate
unclaimed property,
www.unclaimedfunds.org .
| |
Businesses or holders of unclaimed property
first must exhaust all options to locate the
property’s rightful owner through a process of due
diligence before determining in which state to
report the abandoned property. CPAs can help by
ensuring the company has policies and procedures
in place to track potential unclaimed property
amounts and comply with applicable reporting and
remittance requirements of the various states.
Here are some policies CPAs can recommend
companies implement:
Control all unclaimed property
through separate accounts that are subject to a
high level of internal control.
Require that all transactions in and
out of the accounts have supervisor review and
approval.
Capture and retain sufficient data on
the name, address and taxpayer identification
number of the property owner to enable the company
to properly report the unclaimed assets to the
state.
Follow up on outstanding checks and
credits after six months (not after two or three
years when the trail is cold). In addition
CPAs should remind companies to be attentive to
the potential unclaimed property exposure inherent
in any business acquisition and emphasize the
importance of due diligence efforts before a
company completes any significant merger or
acquisition.
MISSING RECORDS AND THE USE OF ESTIMATES
Given the long-term nature of
unclaimed property, CPAs continually encounter
problems with the availability of company records
or the lack of certain types of records. Because
of inadequate record-retention policies, most
unclaimed property holders do not maintain their
records intact beyond six or seven years. In many
cases companies discard supporting detail for
general ledger entries, such as journal vouchers,
journal sheets and the like after three to seven
years. When investigating a company, a
state unclaimed property examiner frequently faces
a similar lack of supporting detail and may be
forced to estimate the company’s
liability—potential to its disadvantage. State
examiners have used estimation techniques for
decades. Several areas of auditing use these
techniques as well—for example, when an entity
loses records due to fire, flood or other natural
disaster. Sales and use tax auditors also
regularly employ estimates to produce audit
findings. Section 30(e) of the 1981
Uniform Unclaimed Property Act specifically
permits the use of estimates where sufficient
records are not available to identify unclaimed
property amounts. When performing routine tests,
an unclaimed property examiner may discover the
holder has written off or otherwise removed
certain items from its books. Companies seeking to
anticipate their potential liability from a state
audit will find examiners use a variety of
estimation techniques depending on the factual
circumstances he or she encounters. This includes
standard statistical and mathematical tools and
models such as regression analysis, ratio analysis
and curve-fitting techniques. CPAs can
recommend a company take several proactive steps
to avoid having state auditors estimate its
unclaimed property liability.
All entities should adopt polices and
procedures relating to how long they keep certain
records, keeping in mind there is no statute of
limitations on unclaimed property.
Each organization should recognize
that state unclaimed property laws typically
require retention periods longer than tax
statutes, with 10 years being an average.
An entity should undertake a periodic
review to ensure it observes proper unclaimed
property procedures and identifies and reports
potential unclaimed property at the right time to
the proper jurisdiction.
ESTIMATING A POTENTIAL LIABILITY
Companies often mistakenly
believe the lack of historical books and records
translates to no unclaimed property liability and
that state unclaimed property auditors will be
unable to issue an assessment. As noted above,
when books and records are not available to
determine a holder’s actual unclaimed property
liability, auditors can estimate it. But CPAs
should emphasize to their employers and clients
that estimation techniques are not a substitute
for recognizing an actual liability. CPAs should
use these techniques to determine a company’s
liability only as a last resort. Unclaimed
property holders have unsuccessfully argued that
states should not use estimation and statistical
sampling to project liabilities. The courts have
held properly grounded statistical sampling and
estimation techniques to be a reliable way of
determining unclaimed property liability when
records are not available (as in State of New
Jersey v. Chubb ). When
its historical books and records are missing, a
company can estimate its unclaimed property
liability using a formula: P x X % = U. In this
formula P represents the population of accounting
transactions, X represents the unclaimed factor
expressed as a percentage and U represents the
unclaimed property liability based on the
assumption that in a specified population of
accounting transactions a certain percentage will
end up being unclaimed. The percentage varies
based on property type, unclaimed amount,
industry, size of company, internal control
structure and other relevant variables. To
estimate a client or employer’s liability, CPAs
first must establish the population of accounting
transactions. This may be the company’s annual
expenses, outstanding checks during a given period
of time or accounts-receivable credits at a
particular point in time. Frequently, a CPA’s
judgment is critical in determining the
“population technique” used in a given situation.
The CPA’s next step is to determine the unclaimed
factor by analyzing a sample to find the frequency
of unclaimed items. Then he or she can plug these
numbers into the equation to compute the
liability.
Where companies report unclaimed
property. For nearly half a
century, states have tussled with the complex
issue of which has the superior right to
escheat—or hold as a custodian for the
owner—unclaimed or abandoned property. In the
seminal case Texas v. New Jersey,
the U.S. Supreme Court held that using the
state of the creditor’s last known address was a
simple and factual way to address the problem. For
“ease” in administering the law, the Court decided
to use the state of the owner’s last known address
(as evidenced by the holder’s books and records)
as the state with the superior claim. According to
the Court, however, if this state is not
identified or does not have an unclaimed property
law, the state of the debtor’s incorporation may
claim the property.
NONCOMPLIANCE WITH UNCLAIMED PROPERTY LAWS
Failure to comply with state
unclaimed property laws can prove to be costly to
a holder. For example, an entity that fails to
file annual unclaimed property reports
significantly increases the likelihood of an
audit. States and their agents routinely audit
companies that do not file annual unclaimed
property reports or those that consistently file
negative reports certifying they have no unclaimed
property. The administrative and economic stake is
much higher once the state issues an audit
assessment; under the rules of most states, a
holder then has the burden of refuting the
presumption of abandonment and proving the
assessment is incorrect. States also can
statutorily assess interest and penalties, the
cumulative effect of which could be material to a
company’s financial reporting. For example, assume
a holder’s annual unclaimed property audit
liability is $50,000. Based on the average
reach-back (or look-back) period of 15 years for
holders that never have filed unclaimed property
reports, the assessment increases to $750,000. In
addition, the state can levy a failure-to-file
penalty of up to 25% of the assessment, which in
our example is $187,500. In most instances the
state also can impose compound interest, ranging
from 10% to 15% of the assessment. Depending on
the number of years under audit, the initial
unclaimed property audit liability could double
after penalties and interest. In addition to the
civil sanctions various states’ unclaimed property
laws impose, some states also file criminal
charges against companies that fail to comply with
reporting requirements. Based on the
hypothetical illustration above, the cost of not
complying with state unclaimed property laws could
be significant enough to have an adverse effect on
the company’s financial statements. This would
require it to make a full disclosure and force it
to restate earnings for prior years.
RECOGNITION AND DISCLOSURE ISSUES
In many instances companies do
not recognize and disclose their unclaimed
property liability on their financial statements
as GAAP requires. The remainder of this article
discusses issues related to recognizing and
disclosing unclaimed property liability under FASB
Statement no. 5, Accounting for Contingencies.
It defines a “contingency” in part as “an
existing condition, situation, or set of
circumstances involving uncertainty as to possible
gain (a ‘gain contingency’) or loss (a ‘loss
contingency’) to an enterprise that will
ultimately be resolved when one or more events
occur or fail to occur.” Statement no. 5
says the accounting treatment for a loss
contingency depends on whether the likelihood of
the future event giving rise to a loss, impairment
or liability is
Probable. A future event
or events that are likely to occur.
Reasonably possible. A
future event or events the probability of which is
more than remote but less than likely.
Remote. A future event or
events with only a slight chance of occurring.
According to Statement no. 5, an entity
should accrue a loss contingency by a charge to
income if it satisfies both of these criteria:
Prior to the issuance of the
financial statements, the available information
indicates it is probable the entity has incurred a
liability at the financial statement date.
The amount of the loss can be
reasonably estimated. To prevent the
financial statements from being misleading,
Statement no. 5 says it may be necessary for the
entity to disclose the loss contingency even if it
has not satisfied both of these accrual criteria.
The statement also says the entity should disclose
a loss contingency where there is a reasonable
possibility it may have incurred a loss or
liability. In the latter situation, the disclosure
must include the nature of the contingency and an
estimate of the possible loss or range of loss or
state that the company cannot make such an
estimate. Statement no. 5 doesn’t require
disclosure of a loss contingency involving an
unasserted claim or assessment unless the entity
considers it probable the claim will be asserted
and there is a reasonable possibility the outcome
will be unfavorable. The issue of
quantifying the liability is typically raised when
a state notifies a company of its selection for an
audit. The company can determine how much it needs
to disclose through either a self-assessment
process or an audit by an outside party.
THE POTENTIAL UNDISCLOSED LIABILITY
In general a loss contingency
could result when the holder of unclaimed property
determines a potential liability. For example, in
some situations a holder may need to estimate the
unclaimed property liability; in others, the
liability may be readily apparent without
resorting to estimation techniques. Companies have
sought to reclassify these obligations as
“miscellaneous income” or make some other
financial statement adjustment. This accounting
practice conflicts with state unclaimed property
laws, which are designed to preserve the property
rights of the “lost” owner and prevent unjust
enrichment of the company or holders of unclaimed
property. From the perspective of
Statement no. 5, companies should answer these
questions:
Is the existence or enforcement of
unclaimed property laws probable in their state of
incorporation or in the state of their customer’s
(vendor’s, shareholder’s, bondholder’s,
employee’s) last known address?
Can the company quantify or estimate
those liabilities outstanding for more than three
to five years?
If the answer is “yes” to one
or both questions, a company is obligated
to reflect an unclaimed property liability
on its financial statements and provide
additional disclosures in accordance with
Statement no. 5.
Example. An
employer knows a former employee has not
cashed a payroll check. The employer
should accrue an unclaimed property
liability to reflect the fact some state
is likely to seek to recover the unpaid
amount as unclaimed property. Applying
the standards of Statement no. 5, a
company must accrue a loss contingency
if information exists the liability is
probable at the date of the financial
statements and it can reasonably
estimate the value of the loss. Because
there is an outstanding payroll debt to
an employee and states have unclaimed
property laws, this satisfies the
“probable” element for accrual and the
company should accrue the uncashed
payroll check and reflect it on its
financial statements as an unclaimed
property liability. Customer
overpayments (accounts-receivable credit
balances) can also be a source of
unclaimed property. When customers
erroneously overpay, they are entitled
to a refund. If the company does not
properly classify the liability for the
customer overpayment as such, its assets
are overstated and its liabilities
understated. |
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PRACTICAL
TIPS TO REMEMBER
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CPAs can help
clients or employers avoid
problems with unclaimed
property by making sure the
company has policies and
procedures in place to track
such property and comply with
applicable state reporting and
remittance requirements.
Before a client
or employer merges with or
acquires a business, CPAs
should pay close attention to
the potential unclaimed
property exposure inherent in
any such transaction and make
sure due diligence efforts
cover this issue.
To avoid having
state auditors estimate a
company’s unclaimed property
liability, all entities should
adopt polices and procedures
concerning how long they keep
certain records. State
unclaimed property laws
generally require retention
periods averaging 10 years.
To prevent
financial statements from
being misleading, a company
may need to take the
precaution of disclosing a
loss contingency for unclaimed
property even if the company
has not satisfied the accrual
criteria in FASB Statement no.
5.
| |
Using the standards in Statement no. 5, a
holder should evaluate whether it must reflect the
outstanding customer overpayment as an unclaimed
property liability on its financial statements.
The first element for accrual is satisfied because
of the probability the company incurred a
liability and because the states actively enforce
unclaimed property laws. Second, a refund of the
overpayment is due to the customer in an amount
the company can reasonably estimate (the
difference between the original amount due and the
amount the customer paid). Therefore, the company
should recognize the unclaimed property liability
on its financial statements.
THE IMPORTANCE OF COMPLIANCE
The increasingly mobile nature of
our society and the increased attention states are
giving to unclaimed property make it likely this
area will continue to grow in importance for CPAs,
their clients and employers. It is incumbent upon
CPAs, therefore, to help companies proactively
develop an action plan to ensure compliance with
unclaimed property laws, as well as to give a high
priority to it within the organization. CPAs also
must help clients or employers assess the
financial statement impact of unclaimed property
to reduce or eliminate the possibility of
significant misstatements. |