Wholesalers/retailers often provide display cases or other types of retail shelving to vendors as a means to showcase their products. These wholesalers/retailers incur the costs relating to the development and transfers of the display cases in the expectation that the cases will help increase the sale of their goods. They have no expectation that the display cases will be returned and expect the vendors to make use of the cases for several years.
Generally, wholesalers/retailers capitalize the costs related to the display cases. However, a tax deferral opportunity may exist for wholesalers/retailers to expense the costs as they are incurred.
On February 7, 2005, the SEC issued a letter citing that leasehold improvements made by a lessee that are funded by landlord incentives or allowances under an operating lease should be recorded by the lessee as leasehold improvement assets and amortized over the shorter of their economic lives or the lease term. The SEC further noted that the incentives should be recorded as deferred rent and amortized as reductions to lease expense over the lease term.
The release of this letter has caused a great deal of concern in the retail sector. Until this point, many retail companies recorded basis in the leasehold improvements net of the landlord incentives for financial accounting purposes. For federal income tax purposes, many companies follow the financial accounting treatment relying on section 110 of the Internal Revenue Code. Or, if the requirements of section 110 were not met, they argued that they did not have the benefits and burdens of ownership with respect to the property. With the issuance of the SEC letter, however, a number of retailers are now wondering whether they need to revisit the way in which incentives are being recorded for federal income tax purposes.
PricewaterhouseCoopers can help shed some light on this issue. For those retail companies who are able to utilize the provisions of section 110, the tax reporting should remain the same. For retail companies who do not qualify for the exclusion under section 110, however, they may face increased pressure to successfully demonstrate that (1) they do not have the benefits and burdens of ownership with respect to the property or (2) the tenant is not liable for tax on the tenant allowance. These latter companies may want to evaluate the strength of their current position and develop a suitable strategy.
Recently, there has been a lot of media attention on how companies with multi-store locations (e.g., hard and soft goods retailers and restaurant chains) are misinterpreting store location lease accounting requirements. For this reason, it may be advisable for similar type companies to take a closer look at their current accounting practices regarding leased space.
The first issue generally relates to the use of different periods to recognize straight-line rent expense and depreciation of leasehold improvements, not including "rent holiday" periods in the lease term and accounting for landlord incentives. The accounting for leases with fixed or indexed rent escalation clauses, requires the use of the same lease term assumptions in determining current rent expense as depreciation expense for leasehold improvements, provided the leasehold improvements do not have a shorter useful life. In many cases, companies are finding that they had incorrectly calculated their straight-line rent expense and depreciation expense for financial statement purposes.
In addition, some companies were not charging operations with rent expense during "rent holidays" as part of the calculation of their straight-line rent expense. A rent holiday is when a company is permitted to occupy leased space to prepare the space for its intended use, but may not be required to pay rent to the lessor.
Finally, some companies have been netting tenant allowances against leasehold improvements in their balance sheets. Generally, tenant allowances are considered lease incentives for accounting purposes and should be reported as deferred rent with amortization over the lease term.
Please note that, while these circumstances can and most often do impact the computation of deferred income taxes for financial statement purposes, they generally have no direct impact on current federal or state income tax filings since taxing jurisdictions recognize rent expense without reference to future rent increases. In addition, separate tax rules govern the treatment of landlord incentives which, in certain circumstances, can be excluded from income.
The actual accounting can vary lease-by-lease and requires careful application of financial reporting requirements. Since calculations are highly technical — based on each store location's lease terms, the useful service life of the leasehold improvements, and possibly other factors — we encourage companies to work closely with their advisors in reviewing these matters.
Retailers commonly receive economic benefits and incentives from merchandise/product suppliers that can take several forms. Supplier merchandising programs can include "up-front' advance cash payments that may or may not require performance by the retailer or funding of various retailer level programs, including advertising and training and volume buying allowances. Often retailers will economically realize these benefits and incentives by "charging back" vendors on open invoices or by receiving cash or credit.
Generally, accounting requirements dictate that the benefits and incentives received from suppliers directly reduce the cost of the products procured from the supplier (that is, deferred on the balance sheet as a reduction to inventory costs until the associated inventory is sold). However, significant controversy has occurred in the financial community over retailers recording these supplier economic benefits and incentives immediately to the retailers' income statement and not appropriately suspending them in the balance sheet as a direct reduction of the inventory purchased from that specific supplier. Amounts received in advance of product purchases (commonly referred to as slotting allowances) generally take the form of a deferred liability, amortized to earnings, as a reduction of cost of goods sold - often over the contractual supply term the retailer has agreed to with the vendor.
In limited circumstances that meet very specific accounting requirements, the benefits and incentives received from vendors may be offset directly against expenses (e.g., a reduction of advertising incurred). However, in general, the treatment for the Federal and State income tax reporting of vendor incentives is similar to the book treatment as described herein (although, in certain circumstances, these incentives may need to be reported as current income for tax purposes).
In the past year, many product prices have increased dramatically and economists are forecasting average inflation of 3-4% over the next few years. Not surprisingly, the most significant inflation increases are found in petroleum, metals, lumber and livestock products.
Any company with an inventory based on these items should look at the potential benefit of adopting Inventory Price Index Computation ("IPIC") LIFO in the current year. Such a switch may allow the company to reduce taxable income by deducting inflation included in its inventory. For some, this tax savings could be significant.
For those who might consider adopting the IPIC LIFO method, PwC has a LIFO calculator that can be used to estimate the potential first-year tax savings. Keep in mind that in order to use LIFO for tax purposes, it must be used for external financial statements as well. Therefore, the decision to adopt LIFO for calendar year 2004 must be made prior to the issuance of the company's 2004 financial statements.
In April 2000, Visa announced the launch of its Cardholder Information Security Program (CISP) initiative. Approved in October 1999 and mandated June 2001, CISP defines a standard of due care for securing Visa cardholder data. The CISP initiative requires all entities that are storing, processing, or transmitting Visa cardholder data to meet minimum security standards.
PricewaterhouseCoopers' security & privacy practice provides CISP assessments to assist merchants to comply with these standards and to enhance the security over processing online transactions. The following twelve security requirements are the focus areas for the CISP assessments:
1. Install and maintain a working firewall to protect data
2. Keep security patches up-to-date
3. Protect stored data
4. Encrypt data sent across public networks
5. Use and regularly update anti-virus software
6. Restrict access by "need to know"
7. Assign unique ID to each person with computer access
8. Don't use vendor-supplied defaults for passwords and security parameters
9. Track all access to data by unique ID
10. Regularly test security systems and processes
11. Implement and maintain an information security policy
12. Restrict physical access to data
Find out how our CISP assessment methodology can relate to your business needs. Contact
Jay Bolton or,
Powell Hamilton.
A recent FASB ruling, FIN 46R, mandates that many retail companies, including franchisors and franchisees, will need to consider whether to consolidate in the financial statements of the retailer, the financial statements of the related enterprises holding real estate used in the business – whether separately owned or controlled by the retailer's shareholders. These financial reporting changes also can extend to the need to consider whether franchising companies should consolidate the financial statements of its franchisees.
Retail companies have a relatively short timeframe to review these new developments and determine whether they have viable alternatives to these new financial statement requirements. PwC's audit and accounting professionals can assist you with evaluating the implications and determining which alternatives would benefit your company.
Benchmarking can be performed across three main levels: (1) within a firm against other units, (2) within a certain industry or (3) across industries. Comparing one firm or one industry against other industries helps one to identify issues and performance gaps that may not be apparent from a narrower perspective. At PwC, we help clients get the comparisons needed for success. For many years, we have provided retail & consumer companies with access to benchmarking data to make more informed management decisions.
Our transaction services practice, comprised of a select team of senior deal professionals, can assist you in identifying, evaluating and executing various strategic alternatives for increasing the value of your business. Our professionals have deep experience on both the buy-side and the sell-side of various types of transactions, including divestitures, mergers, strategic/corporate acquisitions, joint ventures, corporate restructurings and leveraged buyouts. As appropriate, they might also facilitate, as well as help prepare your company for, introductions to some of the nation's leading private investment firms. This function is tailored to your particular preference and can be used to provide informational feedback well in advance of a capital need, as well as formal introductions germane to a proposed investment request.
Our human resources services practice helps our clients increase the competitive and economic power of their most important resource — their staff. For example, we offer a range of human resources (HR) data tools and metrics designed to help quantify the predictable impact of your human capital investments on business performance. We also benchmark HR operational practices and performance to help reduce costs and enhance service quality. In addition, we provide effective delivery solutions around HR information systems, payroll and HR processes.
One of the most significant issues facing your industry is accounting for inventory. As the result of global competition and e-business, companies are undertaking record levels of mergers, acquisitions, reorganizations and technology-driven changes which, in turn, greatly impacts inventory calculations. Moreover, IRS scrutiny of inventory accounting issues has increased in recent years, with more companies experiencing audit activity in the inventory area. PwC can help you analyze your inventory accounting methods and calculations to improve cost-effectiveness and help mitigate the risks of an IRS audit.
At the same time, as your competitors introduce new products to the market, your current inventory may become obsolete at a level not reflected in recorded estimates of unsalable or obsolete inventory. Moreover, if you deal in rapidly changing technology, it is not uncommon to record significant book charges related to obsolete inventory. If you face shortened product life cycles and inventory obsolescence, PwC can recommend options to help you adjust inventory costs to their net realizable value at year end.
Effective cash flow management is crucial to competitiveness. A key value differentiator of PwC is our approach to this goal. Not only do we provide the tax, assurance and advisory services to meet your needs, but we also bring to your attention any cash flow opportunities that may be beneficial to you:
Overpayments can cost a company a significant portion of its annual profits, thus adversely affecting both financial statements and tax returns. Accounts payable technology is continuously enabling new and diverse payment methods that allow accounts payable systems to handle an increase in volume and scale. However, this same technology can also inadvertently establish operations practices that cause accounts payable system inefficiencies and overpayments.
Many retail & consumer businesses are not taking advantage of existing sales/use tax exemptions. As a result, they may be overpaying sales/use tax to state and local taxing authorities. In other circumstances, companies may not have proper procedures for determining the correct amount of sales/use tax to remit — resulting in state and local sales/use tax audit assessments.
Retail & consumer businesses often have assets that are currently under-depreciated for tax purposes. By reclassifying those assets, they may obtain improved cash flow through accelerated depreciation benefits in future years. Similarly, many retail & consumer companies report personal property taxes based on book or federal tax figures instead of fair market value. By re-evaluating the value of the assets within a jurisdiction, large over-assessments of property taxes may be avoided.
Satisfied customers/consumers play a crucial role in the profitability of retail & consumer companies. For this reason, PwC keeps up with the ways in which expectations are changing. We do so by regularly researching and recording industry best practices — not only through formal market research processes and analyzing the ways external trends or events may impact customer/consumer expectations, but also by leveraging our own clients' knowledge and successes. Our Global Best Practices Web site provides a common framework for defining our clients' key business processes mdash; regardless of industry, region, size or service.
