Accurate recording of numerical values seems like such a routine matter to business managers until they learn that accounting actually entails conflict and debate. Making sure that all the right accounting procedures are followed is a significant benefit from having accountants who pass the exam for CPA credentials at management positions.
Most business executives understand the easier parts of accounting. But correct handling of unusual situations is the hallmark of study for CPA designation. Accounting errors are costly, particularly when the IRS attacks companies over the treatment of certain transactions. In those cases, the only defense is accurate knowledge of tax regulations and execution of corresponding accounting steps. Many instances arise in corporate finance where this is not an easy matter.
An example of tax rule complexity and the application of skills from CPA review class is the accounting treatment of construction interest expense. This is not just a subject to master for the CPA exam and then discard. As the accountants at Dominion Resources learned, this topic is relevant to work by CPAs in corporate accounting. The company had to rely upon the Court of Appeals for the Federal Circuit in May of 2012 to obtain relief that reversed an earlier unfavorable ruling by the Court of Federal Claims. The issue decided by the court was the seemingly basic matter of construction interest.
The tax regulation concerning construction interest typically applies to property not yet placed in service. That quite obviously is property under construction. The court ruling explained the facts like a CPA course by pointing out that interest is generally capitalized, rather than expensed, when incurred to improve real property. This is a common matter that CPAs frequently must explain to owners of small businesses.
But, the court case involved a large business and entails an unusual situation because the property was temporarily withdrawn from service. This presented some interpretation about whether some of the interest expense is currently deductible – as Dominion Resources claimed – or entirely allocable to the property – as the IRS contended.
While Dominion Resources replaced major components at two plants, operations were temporarily shut down at the facilities. Simultaneously, the company deducted some interest incurred on debt not directly related to those improvements. The IRS wanted all of the interest capitalized. The court decided that the tax statute is ambiguous regarding property temporarily removed from service. It then determined that the IRS was unreasonable in deciding none of the interest expense is deductible.
Two accounting lessons are emphasized in this court case. First, interest is capitalized when incurred while property is removed from service to construct improvements. Second, and most important, accountants must determine the amount of interest that could have been avoided if the construction had not occurred. Only that amount of interest is capitalized. This case also proves that study of key accounting issues is just as relevant to corporate finance as answering CPA exam questions.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.