In the world of accounting and auditing, there is a concept called materiality. The term materiality essentially means an amount that, if erroneously omitted or included, impacts the financials of a company to the point where they don’t tell the truth. One very basic example would be if a $1 million revenue small business made a mistake recording their accounts payable, and as a result, the business has $100,000 of expenses missing from their results. This would be material. If the same exact mistake happened in a multi-billion multinational company, it would not.

When it comes to materiality in accounting, there are many nuances that need to be considered when evaluating and determining what’s material and what’s not. One way to look at materiality from an accountant’s perspective is to determine how much a particular transaction (such as a purchase) or event (such as a lawsuit) will have on a company’s financial performance. Whether it’s an omission or a mistake in calculating and reporting such an event, the way an accountant evaluates and decides how to proceed with reporting the information (or not) can make a big difference in whether or not such information is material or immaterial.

Another way to look at whether information is material or immaterial is to determine if omitting (or through an accounting mistake) such information would mislead or change a person’s actions regarding the company (investing in, providing a loan to the company, etc.). If omitting the information would influence an outside party’s decision, it would be material. If including the mistake would not change an outside party’s decision regarding the company, it would be immaterial.

One consideration is the benchmark a company uses to determine if a transaction or event would trigger a materiality classification. For example, net profit, operating income, total assets/shareholder’s equity, gross profit, or gross revenue are commonly used. However, it’s important to keep in mind that operating income might not be the best metric if the business loses money, breaks even, or is modestly profitable.

When it comes to looking at net income and a loss, what matters is how big of a percentage the loss represents against the net income. If there’s a $10,000 loss of inventory (for example, due to a termite infestation of a special type of wood) at a furniture manufacturer that has annual sales of $100 million, it would be immaterial and not necessary to report it on the income statement. However, if this occurred at a start-up furniture factory with a net income of $50,000, it would be a 20 percent loss and would certainly make a material impact to investors, lenders, etc.

Documenting Decisions

The next step is for accountants to document their judgments and the reasons why they made each type of documentation. It’s a way for the internal financial managers or the auditor to determine what was done and why. One example looks at whether or not to depreciate or expense an item – for which the materiality depends on the item’s cost.

If an office desk costs $125, depreciating the office desk seems impractical and would likely be classified as a business expense during a company’s tax year. However, depending on the size of a business’ net income, a start-up may consider it material, but an established, publicly traded consumer staple corporation buying the same item would likely consider it immaterial.

Determining (im)materiality is often a judgment call by the financial experts within a company and the auditors who evaluate companies’ financial statements. With a consistent approach, businesses can make measured decisions for their internal and external audiences.

According to the Centers for Medicare & Medicaid Services’ report “Advancing Rural Health Equity,” the 2022 Consolidated Appropriations Act (CAA) maintained telehealth options due to the COVID-19 Public Health Emergency (PHE) order for 151 more days beyond the original expiration of the Covid-19 PHE. Medicare recipients will benefit from the extension of telehealth services. This legislation will also permit Medicare to pay for telehealth services provided by Federally Qualified Health Centers and Rural Health Clinics.

The 2023 Consolidated Appropriations Act extends, through 12/31/2024, the following telehealth flexibilities authorized during the COVID-19 public health emergency. Healthcare providers are permitted to bill Medicare for telehealth services regardless of Medicare patients’ residence. Examples of providers include audiologists, speech-language pathologists, physical therapists, and occupational therapists. Telehealth coverage will also remain available for mental health services through 2024.

During March 2020, the U.S. Centers for Medicare & Medicaid Services (CMS) lengthened the Covid-19 Accelerated and Advance Payments (CAAP) Program to more medical suppliers under Part A and Part B. Such accelerated and advanced payments are remittances to both Part A and Part B providers in the case of interruptions to submissions and processing of claims. This can happen during man-made or natural disasters as a means to speed up cash flow to healthcare suppliers and providers. The CARES Act (P.L. 116-136) offers greater flexibility via increased time lines and payment sums through the expanded CAAP program for providers.

Based on the Continuing Appropriations Act, 2021, and Other Extensions Act, while the CMS no longer accepts accelerated or advance payments, permitted providers will have repayment begin 12 months after each provider or supplier’s accelerated or advance payment is issued.

One important consideration when it comes to accounting for these types of transactions is party consideration. Primarily, these transactions involve more than simply the purchaser and merchant. When it comes to medical services, and especially Medicare and Medicaid, there’s the patient, the direct service provider (doctor, nurse, admin staff, etc.), the facility (in or out of network consideration), and the private or government-based administered entity. The point here is that when it comes to revenue recognition, there needs to be explicit delineation for which party delivers services to the patient (and when) and how each party recognizes revenue based on their arrangement(s) with the patient.  

As for recognizing revenue, the relationships between the patient and the different providers are important due to when the entities are able to recognize revenue — generally when the material/service/product is delivered/satisfied. This is where records are important to keep and analyze on the accounting end so there can be proper reconciliation as to when the product/service has been fulfilled and when it’s recognized by the appropriate entity for revenue recognition procedures.

While there’s no cut-and-dried method to account for the evolving way payments are made, it’s important to keep up with state and federal legislation. Always check with your accountant to stay current with the latest updates to these laws.

The first thing to define is what a lease itself is. It’s an agreement or contract where one party, the lessor, allows another individual or business, the lessee, to use their asset in return for payments or different assets. The next step is to define the following types of leases. The two types covered in this article are operating and finance (or capital) leases.

International Financial Reporting Standards (IFRS)

IFRS does not differentiate between operating and capital leases. However, depending on if the loan has certain characteristics of transferring generally accepted rewards and risks, it would resemble what’s otherwise considered a finance lease. When it comes to Canadian Accounting Standards for Private Enterprises (ASPE) and Generally Accepted Accounting Principles (GAAP), the terms capital lease and finance lease can be used interchangeably.

Operating Leases

Operating leases are used when the client wants to rent and not purchase. During and once the lease is up, the lessor is always in possession.

It can be cheaper to rent – and sometimes renting is the only option for small or medium-sized businesses that are unable to purchase assets. Another advantage for businesses is that they can stay competitive by being able to upgrade their assets since they don’t own it. Along with lessees generally only having to pay for asset maintenance costs, operating expenses for the leased assets are likely tax-deductible because they’re considered business costs. Agreements normally last three-quarters of an asset’s estimated economic life, and the present value of lease payments is usually less than 90 percent of an asset’s fair market value.

Finance (Capital) Leases

Once this agreement’s term is up, the lessee owns the formerly leased asset. Unlike an operating lease, it provides the lessee an opportunity to purchase the asset below fair market value through a bargain purchase option. It also differs in that the contract’s term spans a minimum of three-quarters of the asset’s estimated useful life. If the present value of the lease payments is at least 90 percent of the asset’s original cost, it qualifies as this type of loan.

Determining the Loan Type

Looking through the lens of IFRS, one way to decide what type of a lease to enter is to calculate the present value of the smallest lease financial obligations. Taking the following loan terms, we can determine what percentage of the minimum lease payments are of the asset’s fair value when the lease is signed. Here’s an example.

On the first day of the year, a business signed a lease agreement for five years for equipment that has a fair value of $150,000 and has an interest rate of 8.75 percent. A single installment of $33,750 will be paid at the start of each year. The equipment will be returned to the lessor at the end of the lease. The asset’s useful life is five years, with no residual value. The company chooses the straight-line depreciation method.

Since the equipment will be returned to the lessor, the bargain purchase option doesn’t apply. Also, since the economic life is five years and the lease term are the same length, it’s 100 percent, rendering the asset to have no alternative use once the lease is completed. Therefore, we can determine the present value as follows:

Number of Periods (NPER) = 5 annual payments over the loan’s life

Rate = 8.75 annual interest rate

FV = 0 (future value)

PMT = $33,750 (single payment per 12-month period)

Type 1 = (payment is made at the beginning of the year)

Calculated using Excel, the present value is $143,693. This present value divided by the initial cost means that the asset’s fair value when leased is 95.8% ($143,693/$150,000)

Based on this calculation, with the least lease payments’ net present value well above the 90 percent minimum threshold, it would be considered a finance or capital lease.

The term mark-to-market is an important phrase in corporate finance that has many nuances and industry-specific uses. Mark-to-market is a corporate finance term that provides businesses with a way to evaluate a holding’s fair value for both assets and liabilities. Since values can change over time, this gives a rational assessment of a business’ present fiscal circumstances based on the latest market climate.

When it comes to securities, an investment that is mark-to-market shows its current value. It’s a way to look at how much a business might get if it sells assets under current market conditions. This measurement is opposed to historical cost accounting, which keeps the asset’s value according to the asset’s price when first purchased.  

When a business prepares its balance sheet, some assets will be recorded at their historical cost or original purchase price, while others will need to reflect current market value. One type of asset that needs to be marked down is accounts receivable. If a business permits a 5 percent or 10 percent discount to collect on those to generate cash flow, it needs to reduce that item’s value via an adjustment for doubtful accounts or similar terms.   

One important consideration is how mark-to-market is different from impairment. Since retailers or manufacturers store most of their operation’s values in property, plant, and equipment (PPE), along with accounts receivable, such assets are documented at historical cost. If the assets lose value due to obsolescence, theft, damage in transit, a natural disaster, or uncollected accounts receivables, they would be impaired.

When it comes to derivatives that businesses use, mark-to-market assessment may be needed, according to ASC 815-30 for a cash flow hedge or ASC 815-35 for a net investment hedge of a foreign operation. Specifically, whatever is “excluded from the assessment of effectiveness” is attributed to earnings via a mark-to-market procedure or through amortization.

Dissecting Derivatives

A derivative, according to Accounting Standards Codification (ASC) 815-10-15-83, is a contract that derives its value based on the underlying variable. Examples of underlying variables include commodities, indexes, or the occurrence or nonoccurrence of an event (natural disaster). These types of contracts can be used to hedge or preserve the owner’s ability to buy the underlying at the agreed-upon price, especially if it increases in the future. Other uses include speculating on the movement of stock prices or engineering financing arrangements. 

A derivative is defined as a financial instrument or other contract that has all of the following characteristics:

1. The underlying, which is either the price of an individual or the index of a commodity, security, interest rate, exchange rate, etc., is one-half of how a derivative contract is settled.
2. The other half is a contract having either a notional amount (how much money it controls) or a payment provision. Notional amounts are characteristics of calls, futures contracts, and interest rate swap contracts. A payment provision may take the form of a payment being made in the case of a natural disaster breaching a financial damage threshold or if a commodity or interest rate index reaches or breaches a specified threshold.       
3. The next requirement to be considered a derivative is the contract for the underlying has “an initial net investment” of a nominal price compared to a near identical financial product that would obtain the same financial results due to the same market action. 
4. The final attribute necessary for a contract to be considered a derivative is that it’s subject to “net settlement.” This means that when the contract has matured, it’s able to be settled via cash, as opposed to physical delivery of the asset. As long as it can be settled through one of the following methods, it’s considered a derivative: 1. specified in the contract; 2. through a market mechanism; 3. an asset or derivative contract easily able to be transformed to cash.

Conclusion

It’s important to factor in periods of high volatility or when there are illiquid markets or few buyers and sellers of investments; what the market prices applicable to investments doesn’t always give a true reflection of an asset’s price. One recent example was when the market for mortgage-backed securities during the 2008-2009 crisis evaporated, the market gave an inaccurate value of the securities.

Businesses that navigate the intricacies of when and how to use mark-to-market assessments are using an important tool to help keep their books in order.

When it comes to determining if a business is eligible to claim a net operating loss (NOL), it depends on the financial situation. If a business’ taxable income is less than its allowable deductions in a set tax period, usually a year, then the business can utilize the NOL deduction on future tax obligations. Since some businesses’ profits and losses result from uneven cycles, the Internal Revenue Service (IRS) Code permits businesses to find a balance with their tax obligations.

How a Net Operating Loss Works

Here is an example showing a business’ situation with annual profit/loss summaries:

Year one: High profits and big tax payments due

Year two: Net operating loss incurred

Year three: High profits and big tax payments due

The way a NOL deduction works in the example above is that the losses from year two can be used to offset taxes due in year three.

Net Operating Loss (NOL) = Taxable Income – Allowable Tax Deductions

Referring to the income statement, if the company’s bottom line is a net loss, then the company might be eligible to take advantage of the NOL deduction.

It’s important to keep in mind there have been modifications to what and how businesses may use this. Until recently, the IRS let businesses utilize the carryback method to offset losses to prior years’ tax bills (up to 24 months of tax liabilities), resulting in an immediate refund. However, with the passage of the Tax Cuts and Jobs Act, NOLs were modified. Effective Jan. 1, 2018, or later, the two-year carryback provision was removed (except for select farming losses), but allowed for an indefinite carryforward period. The TCJA also limits carryforwards to 80 percent of each subsequent year’s net income. Additionally, if a business records a net operating loss in more than one tax year, they must be exhausted in the order that the losses occurred. 

The Coronavirus Aid, Relief and Economic Security (CARES) Act permitted NOLs occurring in tax years 2018, 2019, and 2020 to be carried back five years and carried forward indefinitely. However, the exemptions have now expired. Losses that occurred in pre-2018 tax years are still subject to former tax rules, with any remaining losses expiring after 20 years. Beginning with the 2021 tax year, when the Tax Cuts and Jobs Act (TCJA) passed in 2017, it permitted carryforwards of NOLS indefinitely. However, only 80 percent of taxable income can be “carried forward” during a single tax period.

2021 and Forward NOL Example

Year one: NOL $10 million

Year two: Taxable income of $3 million

Year three: Taxable income of $5 million

For year two, with the taxable income’s carryover limit (80 percent) of $3 million is $2.4 million. With the carryover limit subtracted ($3 million – $2.4 million = $600,000), the company’s taxable income will be $600,000 for year two. The remaining NOL of $7.6 million will be considered a “deferred tax asset.” Looking at year three, 80 percent of the year’s $5 million in taxable income equals $4,000,000 in a carryover limit. Subtracting $4 million from $5 million in year three’s taxable income, the business will have $1 million in taxable income, and $3.6 million will be the remaining NOL balance at the end of year three. 

With the tax code continuing to evolve, businesses that stay up-to-date with changes in the IRS Code will make the most of their ability to maximize deductions and reduce liabilities.