The Difference Between Your CPA and a Controller: “M-1”
Posted on July 4th, 2016
Jack Kern
Owner/Pres.
Outsourced Accounting Department, Inc.
Most small business owners are conditioned from day one to understand the importance of engaging the services of a CPA or other tax professional. However, what they often do not understand is that they have hired someone to prepare their tax return at year-end, using accounting information they obtained from the client’s books, and then re-entered it into their own tax software for tax purposes.
A major factor in the focus on tax returns is that over the last couple of decades, with deregulation of the banking industry and the emergence of “mega-banks,” banks have moved away from requiring statements prepared in accordance with Generally Accepted Accounting Principles (“GAAP”), and toward requiring tax returns only for smaller commercial loan deals. In effect, these loans are now treated more like consumer loans, which was done mainly to minimize the amount of back-room financial analysis in order to operate more efficiently.
The underwriting justification for the above is that since tax returns are the numbers reported to the IRS and are (usually) prepared by a CPA, they are therefore “reliable.” But the truth is, the CPA firm is only compiling the information from the client’s books; they are not offering any assurances as to the accuracy of the underlying accounting, only that they have put it in the right “bucket” for tax purposes. So in the event of an audit, the burden of proof is still on the business owner, NOT the CPA.
The other potential problem here is threefold:
- The client’s books are often not adjusted so that they are consistent with the “book” income in the M-1 book to tax reconciliation[1] in the year-end tax return, which is where your internal “profit” is reflected in your business tax return.
- And when your books are adjusted by the CPA or tax professional, chances are they are often adjusted to “mirror” the tax return. And as I’ve discussed in previous articles, “Profit vs. Taxable Income,” and “The Difference Your Method of Accounting Can Make #2,” taxable income is not the same thing as profit.
- Further, as discussed in my recent article, “Larry’s Debt Repayment Strategies, Inc.,” “Profit” is what is necessary to pay back a loan.
So, the banking industry has not done small business owners any favors, as they are now under the impression that they must maintain their books for tax purposes. But this is not true. There is a major difference between the role of your outside CPA firm (see Google Review comments from a CPA firm with whom we do business), and how your books should be managed internally by a controller, bookkeeper, or outside bookkeeping firm, and the M-1 adjustment is what gives you the permission to “have it both ways.”
[1] Book to Tax Reconciliation
