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Accounting for unclaimed property.

The normal, everyday operation of a business results in the generation of obligations that can become abandoned and unclaimed property, which is then subject to compliance requirements pursuant to state law. Understanding unclaimed property requirements and risk factors can be invaluable for accounting professionals seeking to understand the potential impact on the financial statements. When not correctly managed and reported, a historic unclaimed property liability coupled with the risk of state audits--and subsequent fines and penalties for noncompliance--can become a material issue.

Given the fiscal situation of many state governments, unclaimed property audits are occurring more frequently than ever before. Unclaimed property has become one of the fastest growing sources of revenue in many states. Nationwide, the total value of unclaimed property in states' custody is approximately $35 billion--$40 billion. Less than half of these amounts will eventually be reunited with their rightful owners. It is important to note that states get the immediate and beneficial use of these funds.

The source of this revenue is a direct result of the lack of compliance by business and financial institutions. This is evident from the significant liabilities that states are assessing in this area. These assessments generally have a direct impact on companies' financial statements, as reserves are not usually established due to the fact that this property is typically regarded as a liability. It is for these reasons--and many more--that CPAs should learn the complex world of unclaimed property to ensure a proper understanding of the risk factors and incorporate the impact of this liability in reviews, findings, and opinions. This will enable management to recognize and appreciate the risk; implement the necessary policies and procedures required to achieve compliance; and, where necessary, have adequate reserves established to negate the impact on the financial statements if audited and assessed.

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What Is Unclaimed Property?

All U.S. states have abandoned or unclaimed property laws that require companies, both public and private, to report and remit all liabilities owed to third parties--such as vendors, employees, customers, clients, shareholders and bondholders, policyholders--on an annual basis once the prescribed statutory number of years, known as the "dormancy period," has expired. Generally speaking, three to five years is the trigger for dormancy (with the exception of payroll liabilities, which are generally one year), but dormancy periods vary by state and property type. Significant numbers of companies have failed to comply with these requirements and as a result have endured historic and existing practices of taking these liabilities to income. Unclaimed property laws require the states to audit, demand, and assess liabilities from all industries, and states are more aggressively fulfilling this statutory right. CPAs should recognize that outstanding obligations never become assets of the company but remain obligations, which are to be remitted to the fiduciary custody of the states. Examples of such liabilities include, but are not limited to, uncashed checks, escrow balances, accounts receivable credit balances, overpayments, unidentified remittances, unredeemed gift cards, rebates, health and welfare plans, self-insured plans, and third-party administered plans.

States have confirmed through audits that significant numbers of companies are not in compliance with the unclaimed property laws because they have never reported such amounts, they have reported but missed key property types given the industry, or they have never reported for historic periods that states are allowed to audit given the general lack of a statute of limitation. State audits can generally reach back to the earlier of a company's date of formation or incorporation or the effective date of the specific state's statute.

The other issue that significantly impacts the scope of state audits is management's failure to recognize and account for the impact of mergers and acquisitions on the potential exposure for unclaimed property. CPAs should appreciate that thorough due diligence and analysis must be done pertaining to the quantification of the successor's liability in an effort to determine the impact on the company's financial statement. In a stock acquisition or asset disposition, the unclaimed liability for the predecessor becomes the liability of the successor entity.

Who's Responsible?

The responsibility for reporting unclaimed property falls within the purview of different groups within an organization but generally resides within the tax department, even though unclaimed property is not a tax. Given this fact, the details necessary for accurate and timely compliance are not always provided to the tax department by the accounting or financial side of the organization, and, as a result, full and accurate compliance may not always be attained. CPAs can assist management in understanding the pitfalls that can arise in such scenarios and recommend that policies and processes be created, implemented, and monitored by internal audit staff to ensure communication and facilitate timely and accurate compliance. This process can begin within communication between the auditor and the company's tax department to ensure that both groups engage the necessary parties on these issues.

One of the most important aspect auditors must keep in mind with regard to unclaimed property is that noncompliance has a cumulative effect. Instead of having an impact for one year, it has an impact for 25 to 30 years, which changes the threshold for materiality, especially with interest and penalties factored in.

Unclaimed Property, SOX, and SFAS 5

The Sarbanes-Oxley Act of 2002 (SOX) provided much-needed structure around financial reporting and internal controls. As such, SOX compliance should directly improve auditors' unclaimed property management practices, and, in the process, reduce financial and reputational risk. SOX section 404 outlines the rigorous scrutiny that must be imposed on a company's financial operation both annually and quarterly. Two specific actions are required each year:

* An internal review of all financial controls, and

* An audit on the effectiveness of those financial controls.

This annual review is highly valuable for identifying and quantifying current and past-due unclaimed obligations. Under SOX, significant outstanding monetary obligations will typically constitute material conditions, which must be reported in financial disclosures. Enhanced requirements of accountability under SOX are forcing these types of disclosures to be made routinely. The section 404 rules demand a higher level of scrutiny and accountability at all levels to enable the required CFO and CEO certifications.

While SOX applies only to public companies, it provides excellent guidance that can benefit private entities as well.

SFAS 5, Accounting for Contingencies, requires that reserves be recorded to the extent they are material to the company's financial statements. Failure to accurately quantify the unclaimed property for all historic years, to accurately determine materiality and assess the likelihood of a state audit, could result in noncompliance with the requirements of SFAS 5. If a business consistently fails to report, excludes key property types from its reports, misses significant years in its reporting history, takes credit balances into income, nets overall outstanding debits against outstanding credits, voids outstanding checks simply to remove the obligation from the books, or fails to reconcile seemingly insignificant reconciliation issues, it creates audit risk and exposure to liability. The result of these practices over a prolonged period of time--with inadequate books and records to disprove a presumption of abandonment--can materially impact a company's financial statements.

Audit Red Flags

While there are no silver bullets in terms of avoiding an unclaimed property audit, there are many simple red flags that can be eliminated. Because states are becoming more aggressive in their efforts to audit for unclaimed property, the events that can trigger an audit have become more identifiable. Among the more common, and perhaps obvious, indicators are the following:

* Failure to file any unclaimed property reports

* Failure to report unclaimed property for several years

* Submitting reports indicating zero or negative amounts of unclaimed property

* Failing to report property types common to a company's industry

* Failing to report amounts consistent with industry benchmarks.

Noncompliance specific to the above issues may result from ignorance or negligence, but they are not the only events that can trigger an audit. There are also everyday events that can generate new unclaimed property types and concerns for companies that think they are in compliance. For example, mergers, acquisitions, and spin-offs are a huge audit nigger, especially for public companies with unexchanged shares of stock. If the owners of the acquired company do not respond to company solicitations to exchange their old shares for shares of the new company, then the unexchanged shares must be reported as unclaimed property. Auditors should review the books of the transfer agent to ensure compliance for security-related unclaimed property. Insurance companies that have completed a demutualization may also run afoul of unclaimed property laws. A demutualization can trigger unclaimed property as policyholders must claim shares of stock or cash for the first time. If unclaimed, they must be reported.

Where a company is incorporated also matters. For examples, Delaware is particularly aggressive in terms of unclaimed property audits. No matter how compliant an organization may be, the risk of an audit may still be greater in certain jurisdictions.

Unclaimed Property Best Practices

Using the SOX and SFAS 5 guidelines is a good starting point for minimizing the risk of overlooking factors that may affect materiality and the ultimate financial results. The following are some issues CPAs should take into consideration to improve management's compliance with unclaimed property laws and minimize the potential impact on financial statements.

Define the liabilities. Encourage management to assess and analyze the various sources within a business that may produce unclaimed property. Review existing policies, including unwritten practices, for how liabilities are resolved for each of these areas.

Understand why unclaimed property is being generated. Management should take time to understand why individuals or businesses have failed to take action with regard to the obligations the company owes them. Customers often relocate, get acquired, or their businesses simply fail. Recipients of health benefit checks can easily become confused by obligations owed to them versus providers. Duplicate or alternate modes of payment can go unidentified if not properly reconciled. The following questions should be asked: Are there miscellaneous income entries without adequate explanation? Are comprehensive and written unclaimed property policies and procedures in place? Are the policies followed consistently throughout the organization?

Preemptively resolve outstanding liabilities. The primary threat presented by past due obligations is a state-initiated (or multistate) audit. A majority of states now use third-party, generally contingent-fee auditors to perform unclaimed property audits. Discuss with management the need to undergo a rigorous self-audit or third-party evaluation to make sure that historical practices and reporting are sound.

If risks are identified in the process or compliance history, it's important for a business to take corrective action as soon as possible. There are still opportunities in most states to take advantage of amnesty and voluntary compliance programs that provide leniency with respect to delinquent reporting and, in some cases, waive interest and penalties.

Develop a corporate policy regarding due diligence. The best defense is a good offense. In the unclaimed property world, due diligence is the practice of mitigating unclaimed property liability at its source--by finding missing owners and helping them take action to reconcile their accounts. The best approach is to conduct due diligence efforts within 90 days of the original payment transaction. Rather than waiting until statutory due diligence is necessary, businesses should reach out to customers six to nine months after a check goes stale, to increase the chances of finding them. In addition, address the undeliverable mail population; the best way to reduce undeliverable mail is to stay on top of it.

Reconcile accounts to prevent overpayment. Management should review existing practices to identify areas of duplicate payments and other costly accounting errors. Reducing these factors can minimize risks.

Document an annual compliance road map. A company should formalize all its compliance goals and the expectations of individuals who play a role in unclaimed property compliance. It is critical to establish a working environment where compliant behaviors are standard and executives are committed to and encouraging transparency. Management should maintain electronic and hard copy documentation of all previous unclaimed property reports for at least 10 years so that they can quickly and easily demonstrate compliance in the event of an audit. This will help to facilitate internal audits, contribute to long-term compliance efforts, and serve as a strong exhibit of controls in the event of a state audit.

Stay up-to-speed on laws. Because states are auditing more aggressively for unclaimed as a source of revenue, laws and regulations are continually changing. States frequently add different types of property, alter dormancy periods, and change process requirements. A range of unclaimed property software systems and outsourcing options exists to help businesses with the planning and execution of a strategy. If efforts are coordinated in-house, the workflow, staff responsibilities, and informational needs should be documented at each step in the process.

Compliance Is Critical

It is very important for accounting professionals to remember that unclaimed property laws apply to all businesses, including public accounting firms. Processes and practices are important in ensuring that any business is in compliance with a state's abandoned and unclaimed property laws, especially in areas of escrow accounts that maintain funds on behalf of clients. Be knowledgeable and vigilant. Arming management with the tools need ed to attain accurate and timely compliance will help ensure that one's financial statements present fairly.

STATES' STANCES ON UNCLAIMED PROPERTY

New York

New York is fairly aggressive in terms of pursuing unclaimed property audits. It wants to see documentation to support positions and ensure that a business is following its compliance process with rigor. New York is very progressive with respect to unclaimed property. New York is one of the few states that has a process in place for just about every property type imaginable--and it's aggressive in enforcing compliance.

New Jersey

New Jersey is becoming more aggressive in its practices. For example, some states have enacted business-to-business (B2B) exemptions, whereby if a company has a liability that's owed to another business, it does not need to be reported to the state. In the past, Delaware was the most aggressive state in terms of demanding these types of exemptions as property owed to Delaware despite the provisions of the exempting state. (For example, if a company was incorporated in Delaware and had property due to Ohio, and Ohio had a B2B exemption, Delaware deemed the property to be reportable to Delaware.) Delaware's position is not statutory, but based on the state's interpretation of a Supreme Court opinion, New Jersey has since taken this approach to the next level: It has incorporated such provisions into its unclaimed property statute. This is a much more aggressive stance than any other state has taken on this issue to date.

Connecticut

Connecticut has always had its finger on the pulse of unclaimed property. Though historically easier to deal with from an audit perspective than other states, Connecticut has never been afraid to take on new issues. In fact, it was one of the first states that established case law with respect to unclaimed property.

Sonia Walwyn, CPA, is a vice president, unclaimed property services division, at Keane, New York, N.Y.
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Title Annotation:Sarbanes-Oxley Act of 2002; Financial Accounting Standards Board
Author:Walwyn, Sonia
Publication:The CPA Journal
Geographic Code:1USA
Date:Feb 1, 2011
Words:2505
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