domenica 21 agosto 2011

How to record ‘contributed labor’ on the company books.

Clients ask me this question from time to time and usually don’t like or understand the answer. The question is, “If I donate or contribute my labor to a charitable institution, can I record the cost, at my normal charge rate, as an expense on my financial statement?” The obvious result is that the client’s Net Profit will be lower leading to lower taxes.

It seems reasonable doesn’t it? After all, your time is worth money and you are giving it to a worthy cause. What’s the matter with that? First, read my October article titled, “The Historical Cost Concept Accounting Principle”. It explains that money must exchange hands, or a promise to pay money, before an amount can be recorded on the books because there needs to be an objective way to determine the value of a transaction. Was there any money or promise of money exchanged in the example? No, there was only a contribution of labor.

Second, from a debits and credits perspective, how would you record a contribution of labor? If you recorded a debit to an expense account called Contributions, what would be the credit entry? Not Cash. Not Payables. Maybe Equity? Let’s look at that. If you write a credit entry to increase Equity, then the expense entry lowers Net Profit as washes out the increase in Equity. Sound pretty good? Not really, because you just violated the accounting principle of Historical Cost. No money was actually paid, so there was no objective way to value the transaction.

What if you decided that your time was worth $1000 an hour? You worked eight hours so you recorded an expense of $8,000. That might be a big hit on the old Net Profit. Plus, it looks like you contributed a substantial amount to the business. More likely, someone who charged $75 an hour might be inclined to up it to $125 an hour if they felt they could. You can see why the Internal Revenue Service (IRS) would take a dim view of this. If left up to the discretion of millions of taxpayers the potential for abuse would be staggering.

Therefore, this practice is not allowed. The integrity of financial statement reporting must be protected, and the IRS doesn’t want to be cheated.

After explaining all this to clients, often they still don’t get it. Or, they don’t want to get it. They feel they gave up something so they should get something back, i.e., the write off. The IRS says that if you performed a service for someone then record that service as income on your books, then you can deduct it as a legitimate Contribution expense. I say, why bother, since they both wash each other out. It’s just extra accounting work.

I welcome your comments or questions on this sometimes confusing concept.


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