A Primer on Rolling Equity

Overview

• Rolling Equity: A process where accountants ensure the ending balance in retained earnings from the previous year's tax return is properly reflected as the beginning balance in the current year's financial records.
• This process is crucial to avoid discrepancies and ensure that tax returns are accurate and balanced.

Key Concept

• Net Income: Closes to retained earnings each year.
• Balance Sheet: Ending balances on 12/31 become beginning balances on 01/01.

Common Issues

• Software Adjustments: Clients often use software like Quicken or QuickBooks to maintain records, which may require adjustments by accountants.
• Tax Software: Programs like Ultra Tax and Lacerte roll over balance sheet numbers but may not reflect accurate retained earnings if not properly adjusted.

Importance of Rolling Equity

• Ensures items are not recorded repeatedly year after year.
• Keeps the tax return in balance.

Examples

Example 1: Sally’s SeaShell Store

• Issue: Loan payments were recorded incorrectly, causing discrepancies in retained earnings.
• Solution: Adjusting journal entries (AJE) were made to correct this, emphasizing the importance of properly rolling equity.

Example 2: Lucy’s Pet Store

• Issue: New van was expensed rather than capitalized, leading to incorrect retained earnings.
• Solution: AJEs were necessary to capitalize the van and adjust retained earnings.

Methods of Rolling Equity

Method One

• Quick Method: Record current-year AJE accounting for prior-year balance sheet AJEs only.
• Plug to Retained Earnings: Ensures that the balance sheet is correct without duplicating prior-year P&L entries.

Example 3: Luke’s Pizza

• Correctly rolling equity involves recognizing discrepancies from unrecorded entries by clients.
• Outcome: Ensures that retained earnings align with tax returns.

Method Two

• Comprehensive Method: Useful for larger or altered financial records.
• Spreadsheet Approach: Compare updated client financials with prior-year records to identify necessary AJEs.

Example 4: Luke’s Pizza

• Highlighted alterations in financial records post-tax return preparation.
• Emphasizes importance of aligning client financials with prior tax returns.

Troubleshooting

• Adjustments to cash balances must reconcile and be reflected in P&L if cash discrepancies are noted post-tax return.

Strategies to Avoid Equity Issues

• Inform clients of any AJEs made and encourage recording them.
• Engage with clients to update their records, potentially saving time in future tax seasons.
• Lock financial records after year-end to prevent unauthorized changes.

Conclusion

Properly rolling equity is critical to maintaining balance and accuracy in tax returns. It requires diligence and careful bookkeeping practices to ensure discrepancies are resolved and do not carry into subsequent years.

Contact: Alyssa M. Reed, CPA, MAcc, teaches tax seminars and can be reached at [email protected].