TREASURERS CLUB ACCOUNTING WORKSHOP

September 18, 2004


Presented by
NAIC
Minneapolis/St. Paul Chapter


Instructor:
Bruce Reed

Agenda

Welcome and Introductions

Treasurers Club Accounting Workshop

Instructor: Bruce Reed

How many of you have been to a Treasurer's workshop before?

Buddy system

This presentation is available at www.brucereed.com/InvestmentClubs/Presentations/index.htm

Welcome and Introductions - Expectations

What do you expect to get out of this class?

Welcome and Introductions - Disclaimer


Certain portions of this presentation are subject to NAIC and ICLUBcentral copyright, but the presentation itself is copyrighted by Bruce Reed.

Welcome and Introductions - Other Workshops

General Club Accounting Concepts

Club Organization

Cost Basis

General Club Accounting Concepts - Club Organization

The IRS considers most Investment Clubs to be partnerships.

Generally speaking, Investment Clubs ARE partnerships.  They should be operated like a partnership business.  

Members each own a percentage of the club.  They should each receive a portion of the income and expenses according to their percentage in the club.

General Club Accounting Concepts - Cost Basis

Everything in investing has a cost basis.  Cost basis is the money you put into something.  When you buy a stock for $1000, your cost basis is $1000.

When you sell the investment, you are taxed on the difference between the sale amount and your cost basis.   If you sold that stock for $1200, you have taxable gains of $200.

The same applies to your investment in the club.

NAIC Club Accounting Concepts

This class is based on NAIC club accounting software and methods.

Other software and methods should have similar concepts.

Current NAIC software is NAIC Club Accounting for Windows (NCA) version 2.5.11, and NAIC Online Club Accounting (NOCA).

The terminology in this presentation is from NOCA.  NCA is generally the same, but does have some differences.   For example, NCA has an Audit function for making corrections to units and unit values on existing transactions; NOCA handles this automatically.


Club Accounting concepts

NAIC Club Accounting Concepts - Custom Designed

NAIC Club Accounting Concepts - Transaction Specific

NAIC Club Accounting Concepts - Account Selection

The source and/or destination of the transaction determines the Account to enter transactions.

You can create new Accounts to tailor the accounting to your club specifics, in addition to or in place of the provided accounts - Bank, Broker, Suspense.  Examples are shown later in this presentation.

NAIC Club Accounting Concepts - Petty Cash Account

DO NOT USE PETTY CASH ACCOUNTS!

Any activity through the club checking account should be entered in the "Bank" account, or a cash account created for this purpose.  For example, you can create an account called "TCF Checking".

For non-investment monies, for example, club shirts:
   - Create a new Cash Account to work as an "accrual" account.
   - Enter deposited money as a Cash Transfer, from the Accrual account to Bank
   - Enter spent money as a Cash Transfer, from Bank to the Accrual account
Doing this avoids any effect on Member's units or value.

Some clubs hold a little money as cash for small expenses, such as stamps, copy charges, etc.  In this case a new Cash Account should be created.   Avoid using the title "Petty Cash" to prevent confusion; use a specific title, such as "Cash in Box" or "Cash in Joe's pocket".

NAIC Club Accounting Concepts - Record Deletion

Every entry represents the history of your investment club. Records of withdrawn partners and securities no longer held are permanent records and should not be deleted.

Club Accounting provides a means of marking inactive records.

Records should only be deleted if they are entered in error, for example a deposit entered twice.

NAIC Club Accounting Concepts - Allocation of Expenses

Allocation of Expenses can be "By ownership share" or "By member".   If no special collection is made from members to pay for an expense, then the choice of which method to use is subjective.

However, if a separate collection is made for an expense, and each member is chipping in equally, then Allocation of Expenses should be "By member".   Note that such a collection should be entered as Member Deposits and should buy units for each member (see the example later in the presentation).

Allocation of Expenses may be set by checking or not checking the "equal allocation" box.

Note that if your membership agreement dictates a method of expense allocation, that method should be followed.   Otherwise, the IRS takes the position that all expenses shall be allocated in proportion to ownership (see Publication 541).   To allocate any or all expenses "By member", your partnership agreement must spell it out.

Remember that an Investment Club is a business; all income and expenses arising from the Club's activities apply to the Club, not directly to each member.   At the end of the year, each member is allocated their share of income/expenses based on their share of ownership, just like a business.

NAIC Club Accounting Concepts - Unit Value Method

Club accounting is based on the Unit Value Method.

Things that may affect Units and or Unit Value

NAIC Club Accounting Concepts - Unit Value Method - Member Deposit transactions

Member Deposits buy units and add directly to the member's value in the club.

Member Deposits includes regular member investments as well as special assessments for expenses, if your club has any.

Some clubs try to keep expense money separate from investment money.  There is no need to do this.   If your club insists on collecting separate money for expenses, enter it the same way as regular member payments, and when entering the Expense, be sure to mark the Allocation as "By member".

Effect on Units and Unit Value


NAIC Club Accounting Concepts - Unit Value Method - Member Deposit transactions, cont.

When a Member Deposit is entered, units are calculated for the member by taking the payment amount and dividing by the Unit Value.

Member Deposits add to the member's cost basis in the club.

NAIC Club Accounting Concepts - Unit Value Method - Member Fee transactions

Member Fees don't buy units.

Member Fees do add to the club's total value, and increase the per unit value of the Club.

Member Fees do add to the member's cost basis in the club.

Member Fees can include things like late fees, and bank fees that apply to a specific member (such as a bounced check).

Member Fees should be treated like penalties.  They should not be used for something that applies to all members.

NAIC Club Accounting Concepts - Unit Value Method - Security Income

Security Income includes Cash Dividends and Reinvested Dividends.  Security Income can also include Return of Capital and awards from shareholder lawsuits.

Security Income should always be entered on the Securities menu.

Note that Reinvested Dividends are actually two transactions - Cash Dividend and Stock Purchase.  Broker statements usually show both transactions separately, sometimes on different days.   You can use the Securities, Reinvest entry to enter Reinvested Dividends, but do NOT also enter them as Cash Dividends.  Entering them using Reinvest from the menu handles both transactions in one entry.

NAIC Club Accounting Concepts - Unit Value Method - Non-security Income

Non-security income includes Interest, Money Market Dividend, and "Other".  

Interest also includes credit union dividends.  Most credit unions use the term "dividend", but the IRS classifies credit union dividends as normal Interest.

"Other" income is entered using the Cash Accounts, Income menu item.   "Other" includes any other kind of income not listed anywhere else on the NOCA or NCA menus.   For example, a shareholder lawsuit settlement received a year after a stock is sold might be entered as Income (follow the advice of your tax advisor or accountant).

NAIC Club Accounting Concepts - Unit Value Method - Expenses

Expenses includes all expenditures of the club, whether tax deductible or not.  Software is tax deductible.  IRS rules say Investment-related seminars are not deductible.   Most clubs consider Treasurer workshops to not be Investment-related, but rather are related to running the business aspects of the investment club, and therefore are deductible.

Sorry, Holiday parties are not deductible.

NAIC Club Accounting Concepts - Unit Value Method - Sale of securities

The sale of a stock or other security does not result in ordinary Income or Expense, but instead results in Capital Gain or Capital Loss.

Sometimes a Merger, Spinoff, or Stock Split results in fractional shares.  Usually these fractional shares are not issued as shares, but are issued as "cash-in-lieu-of" - money that gets deposited in your broker Money Market account.   It's important to know that this money is a sale, not a dividend.  If your broker reports this as dividend, contact them for a correction.

These fractional shares are a sale of securities, and result in a Capital Gain or a Capital Loss.

The software provides for "cash-in-lieu-of" for fractional shares on the entry screen for the Merge, Spinoff, or Stock Split.

NAIC Club Accounting Concepts - Unit Value Method - Current stock prices

Your club by-laws should have a provision for official Club Valuations, which are usually monthly.  An official Club Valuation is entered using the Securities, Create New Valuation menu item.  A 'Valuation' is just a record of the current stock price of all current holdings.

The value of a Club is the total of all cash accounts plus the current value (price) of all securities owned.

NAIC Club Accounting Concepts - Unit Value Method - Non-club transactions

Non-club transactions are payments that don't directly relate to the club or club activities.  For example, a club has a holiday party, and collects money from each member.   This money is not related to the member's investment in the club, and does not add to the member's cost basis.

Non-club transactions should never affect the units or unit value of a club.

When entering non-club transactions, they should not be directly associated with a member.   They should be entered as Cash transfers between a special "suspense" account and the "Bank" account.  The member's name can be entered in the comment area.   These are considered "pass-thru" transactions.

NAIC Club Accounting Concepts - Unit Value Method - Non-club transactions, cont.

"Pass-Thru" transactions:

NAIC Club Accounting Concepts - Unit Value Method - Summary

In relation to Units, there are three kinds of transactions:
  1. Deposits/Withdrawals, which add/subtract Units for Members, but do not affect Unit Value
  2. Income/Expenses, which don't change the total units, but do affect the Unit Value of the Club
  3. Cash Transfer, which have no effect on units or Unit Value

Unit Value, sometimes called per unit value, is simply total club value divided by total club units of all members.

Club Accounting Procedures

Club Accounting Procedures - Monthly Processes

Club Accounting Procedures - Monthly Processes - Enter monthly transactions

Club Accounting Procedures - Monthly Processes - Reconcile balances

Print a Valuation Statement for the end of the month.  If your club's monthly valuations are not done at the end of the month, you can still use a 'custom' date.   If you do use a 'custom' date, remember that this is not an official valuation, used only for reconciling cash balances and number of shares.  Do not use the 'Current Unit Value' or the 'Total value of portfolio' from this report.

For each cash account, compare the bank or broker statement balance against the balance on the valuation statement.  If there's a difference, print a Cash Journal for the month.   The starting balance, transactions, and ending balance should all match the bank or broker statement.  

For each security held, match the number of shares on the broker statement with the number of shares shown on the Valuation Statement.

Club Accounting Procedures - Monthly Processes - Backup data

This is done from the Accounting, Utilities menu.

You can use the Backup Manager, or you can Export a backup file to your computer.  Or you can do both.  I do.

Club Accounting Procedures - Monthly Processes - Send notices

Some clubs have each member print their own reports.  If your club does this, notices should be sent to the members when the information is ready for printing.

Club Accounting Procedures - Monthly Reports

It's up to each club and the treasurer to determine which reports to print.  When deciding which reports to print, keep in mind what kind of information the members need to see and also keep in mind what information would be needed for the annual audit.

Here are the reports I print for my club:

Club Accounting Procedures - Monthly Reports, cont.

If your members print their own reports, they can select any reports they like.  The most common member reports are:
If you print statements for the members, you'll need to print a copy of the Valuation for each member.   Also, you might want to print each member's Unit Ledger one at a time.  If you print them all at once, it won't put them on separate pages.

Club Accounting Procedures - Withdrawals

Entering member withdrawals is straight-forward.  The software will step you through it.  Use the Members, Withdrawal menu item.

Club Accounting Procedures - Verification of Club Books

Club Accounting Procedures - Verification of Club Books - Pre-filing verification

Verification (audit) of the Clubs records is not generally tied to the filing of the Club's tax returns.

However, many clubs may benefit from having some kind of verification by another member before closing the books for the year and filing tax returns.

Club Accounting Procedures - Verification of Club Books - Reports to print for Verification

print reports for 01/01 thru 12/31, or as-of 12/31

Club Accounting Procedures - Verification of Club Books - Other documents

Include the last statements from the prior year for beginning balance verification.

Club Accounting Procedures - Verification of Club Books - Procedures

Club Accounting Procedures - Verification of Club Books - NAIC Resources

Verification procedures
   - old.better-investing.org/clubs/verifying-books.html

Annual Verification Report
   - old.better-investing.org/clubs/audit-report.html

Club Accounting Procedures - Year End Duties

Some topics covered in the Treasurer's Year-End/Tax Workshop:
(this presentation will also be available on this web page)
(note - not all items apply to all accounting systems)

Club Accounting Procedures - Tax Information

Some topics covered in the Treasurer's Year-End/Tax Workshop:
(this presentation will also be available on this web page)

Club Accounting Tips

Club Accounting Tips - Entering Dividends

Dividends from stocks
Dividends from broker/bank

Club Accounting Tips - Dates on Transactions

For transactions that rely on unit value (Member Deposits, Withdrawals), avoid using the same date as any club valuations.  There are software issues related to this.  

Club Accounting Tips - Problems with Journals not matching

If your Cash Journal does not reconcile with other journals, first check that all journals are run for the same date (or range of dates).

The next thing to check for is withdrawals entered on the same date as a valuation.  There is a known bug in entering withdrawals on the same date as a valuation.   This only applies to official valuations that are created when you enter stock prices, not 'custom' dates used to print non-official valuation statements.

Club Accounting Tips - Total Return and Compound Annual Return

Ignore these columns (better yet don't print them).

Total Return is not a straight-forward calculation of current value vs. cost.  It is a complicated calculation based on Compound Annual Return.

Compund Annual Return is a complicated calculation based on the time of ownership of each "block" of shares of a stock.   Reinvested dividends and additional purchases are factored in, based on the date of purchase/reinvest.

Advanced Topics

Advanced Topics - Company-paid fees/commissions

The Club receives a quarterly Dividend Reinvestment Plan statement that shows the current dividend paid and also "Tax Reportable Company Paid Fees and/or Commissions".   How are these fees recorded?

Company-paid fees and commissions are treated as additional dividends.   They are reported as taxable dividend income on the 1099-DIV form that your Club receives at the end of the year.   Company-paid fees are added to the cost basis of the purchased stock.   In Club Accounting, Charges Paid by Company is listed under Securities, Enter New Transaction, Charges Paid by Company.

Advanced Topics - Can one member buy out another?

May a new member buy out a withdrawing member? May current members subdivide the withdrawing member’s shares among themselves? Are there fees involved?

No, No, No.

You can’t have one member buy out another member because it involves complex accounting and tax consequences.

Your Partnership Agreement can spell out how other members can make deposits which match a withdrawing partner's value.   This cash can be used to pay off the departing member.

If a withdrawal fee is charged, it works best of the new deposits are entered with a date before the withdrawal, because the withdrawal will change the unit value.

This should not be a problem if no fee is assessed.

Advanced Topics - Options for total withdrawals

What are the options for members making a total withdrawal?

  1. Club pays withdrawing member with cash on hand.  This may or may not require the sale of securities to make enough cash available.

  2. Club pays withdrawing member with less cash than the member's cost basis and the rest in stock.

  3. Club pays withdrawing member with more cash than the member's cost basis and the rest in stock.

Advanced Topics - Options for total withdrawals - Withdrawal paid with all cash

With cash payment, the Club may have enough cash on hand, or may have to sell stock.

Selling a stock, at a gain or loss, has the normal ramifications of a loss or gain, but has no other direct effect on a withdrawal.  Selecting stock to sell should follow your normal procedures for selling stocks.

Advanced Topics - Options for total withdrawals - Withdrawal paid with stock

If part of a withdrawal is paid with stock, the Club is able to defer gain or loss from the stock until each member withdraws or the Club disbands.   Since there is never a sale of the stock for the Club, all earnings are deferred until each member realizes a gain at withdrawal.

However, usually there is no good reason for a Club to defer a loss.


If the amount of cash received is less than the withdrawing member's cost basis in the Club, then all taxable gains are deferred until the sale of the stock, at the member's discretion.   The member's cost basis of the stock is their cost basis in the Club minus cash received.

If the amount of cash received is more than the member's cost basis in the Club, then the difference is taxable gain, and the stock has a cost basis of zero.

Advanced Topics - Options for total withdrawals - Other Considerations

Convenience of stock transfer - does the member also have an account at the Club's broker?

Does the Partnership Agreement allow payoffs with stock?

Advanced Topics - Equal partners?

Does everyone have to be an equal partner?  No!


Advanced Topics - Cash Accounts

The source and/or destination of the transaction determines the Cash Account to post transactions to.

You can create new Accounts to tailor the accounting to your Club specifics, in addition to or in place of the provided accounts - Bank, Broker, Suspense.

For example, if you are trying to make entries that accurately reflect the dates of collecting member's monthly payments and the dates of bank deposits, you could create a Cash Account called Member Collections.

Here are the transactions you would enter:
This way, your records will exactly match the bank statement.

Advanced Topics - Cash Accounts - Cash Accounts, cont.

Another advantage of creating your own Cash Accounts - if, for example, your broker is TD Waterhouse, you could create a Cash Account labeled 'TD Waterhouse'.  Then your Valuation Statement will clearly identify your broker.


Here's another use for custom Cash Accounts - non-investment monies, such as money for an investment pool contest.  Here's how.  First create a Cash Account labeled 'Investment Pool Contest'.

Then, on the date or dates money is collected, you enter a Cash Accounts, Transfer transaction, Source is 'Investment Pool Contest' and Destination is 'Bank'.  Use the Comments field to enter any details, such as the Members who are participating.

On the date a winner is declared, a check is written to the winner.  A transaction is entered in Cash Accounts, Transfer, with a Source of 'Bank' and a Destination of 'Investment Pool Contest'.  Use the Comments field to enter the name of the winner.  Continued...

Advanced Topics - Cash Accounts - Cash Accounts, cont.

Important Notes:

For this type of activity, the key thing is to only use Cash Accounts, Transfer for transactions, and to enter offsetting transactions.  When all is said and done, the 'Investment Pool Contest' account should have a zero balance.  This is called a 'wash' transaction.

This type of activity is not recorded using Members, Deposit or Members, Member Fee because this type of activity should not affect the Member's cost basis in the Club.

As a matter of principle, these types of transactions don't properly belong on the books of the Club, but if the Club thinks this is the best way to track something like this, it's important to follow the right process - see Note 1 about 'wash' transactions.

More important than the note above, if this type of money is deposited into the Club's Bank account, the Club's records should reflect that in the Cash Account for Bank.

Advanced Topics - Member Deposit vs. Member Fee

How can you tell when to enter Member money as Deposit and when to enter it as a Fee?

Before answering that, we should point out there's another way Member money could be entered.  If the money should have no impact on the Member's cost basis in the club, the transaction should be entered under Cash Accounts.  See the earlier example for an Investment Pool Contest.

Assuming the Member money collected does have something to do with the operation of the Club, then how do you determine whether to enter it as a Deposit or a Fee?

Simply put, a Member Fee doesn't buy units, therefore a Member Fee is a penalty against the member.  Anything collected from all members cannot be a penalty.  What would be the point of penalizing all members?

But what about sharing the cost of Club expenses, such as the annual NOCA fee?  That's an easy one.  Look back at the beginning of that question - it says 'Club expenses', not 'Member expenses'.  Continued...

Advanced Topics - Member Deposit vs. Member Fee - Member Deposit vs. Member Fee (cont.)

Here's an example.  This example may seem extreme, but picture a club such as mine (I have 94 units) with a new member joining (starting at 1 unit).  

Our example club called the Mostly Me Investment Club has two members - Mostly Me and Little You.

The next few screens compare the results of Equal Allocation vs Normal Allocation (proportional).

Advanced Topics - Member Deposit vs. Member Fee - Member Deposit vs. Member Fee (cont.)

Equal allocation method:

  1. NAIC Tax Printer expense is entered with equal allocation -- $24.50 for Me and for You.  That's an immediate decrease of 2.4 units each.
  2. Now Me has 91.6 units and You has -1.4 (negative!) units.  Unit Value is still $10.01, Total Value is $902.00, Total Units is 90.1.  You is now worth -$14.01!
  3. Dividends add to Club Value, Unit Value is now ($902+$98) / 90.1 = $11.10.  Me is now worth $1016.06 and You is worth -$16.06.  You lost money when the club had earnings!
  4. NOCA expense is entered which is equally allocated - $24.50 for Me and for You.  That's an immediate decrease of 2.2 units each.
  5. Me now has 89.3 units, and You now has -3.7 units, totalling 85.7 units in the Club.
  6. End of year distributions are normally time-based.  The March dividends would be allocated using the units owned after the January expense.  Since You owned -1.4 units out of 90.1, you have -1.61% ownership.  $98.00 times -1.61% is -$1.57, which is printed on the K1.
  7. Now You has to explain to the IRS how You had negative dividends!
  8. And Me has to explain to the IRS the 101.61% ownership in the club!

Advanced Topics - Member Deposit vs. Member Fee - Member Deposit vs. Member Fee (cont.)

Normal allocation method (proportional):

  1. NAIC Tax Printer expense is entered with normal allocation, decreasing Total Club Value to $902 ($951-$49).  Unit Value is now $902 / 95 = $9.49 (down from $10.01).
  2. No change in Units.  You still has 1 Unit.
  3. Dividends add to Club Value, increasing Total Club Value to $1000 ($902+$98).  Unit Value is now $1000 / 95 = $10.53.
  4. No change in Units.  You still has 1 Unit.
  5. NOCA expense is entered with normal allocation, decreasing Total Club Value to $951 ($1000-$49).  Unit Value is now $951 / 95 = $10.01 (back where we started!).
  6. During the year Me and You did not buy any more units, and their percent of ownership did not change.  Makes sense to me!
  7. The Club had $98 of earnings and $98 of expenses, resulting in no change in Total Club Value.  Me too!  And You too!
  8. End of year distributions -- You had 1.05% ownership throughout the year.  You are allocated $.52 for Tax Printer Expenses, $1.04 Dividend income, and $.52 for NOCA Expenses.  Net result - no gain or loss.

Advanced Topics - Member Deposit vs. Member Fee - Member Deposit vs. Member Fee (conclusion)

In our example for Equal Allocation, the Club had net gain/loss of zero, and nobody bought (or withdrew) units.  So how did You lose $50.57?  I don't care -- I gained $50.57!

In summary, think of it this way.  ALL income and expenses for the Club apply to the Club, not directly to Members.  Then when all is said and done (tax time!), each Member gets their share.

Resources

NAIC

ICLUBcentral

Yahoo

IRS

Resources - NAIC

Local

Minneapolis/St. Paul Chapter NAIC
P.O. Box 18264
West St. Paul, MN 55118
Voice Mailbox: 952-932-9686

National

www.better-investing.org Toll Free: 877-275-6242

Email Discussion Lists

lists.better-investing.org - click on Club Treasurers

Club Treasurer's Duties

old.better-investing.org/clubs/treasurer-duties.html

Other information

old.better-investing.org/clubs/clubs.html#corner

Resources - ICLUBcentral

Web Site

www.iclub.com

NCA

NAIC Club Accounting (NCA) for Windows V2.5.11 (current version)
Legislative changes will require an update for year-end
NCA $169
NCA Support (includes NOCA) $49/year
NAIC Club Tax Printer $49 (each year)

NOCA

NAIC Online Club Accounting
www.naic-club.com
NOCA with Support $49/year
NAIC Club Tax Printer $49 (each year)

Resources - Yahoo Stock Information

Stock Quotes

finance.yahoo.com

Historical Stock Quotes

chart.yahoo.com/t

Resources - IRS

Web site

www.irs.gov ( NOT www.irs.com !)

Publication 541 - Partnerships www.irs.gov/pub/irs-pdf/p541.pdf

Current year Form 1065 instructions www.irs.gov/pub/irs-pdf/i1065.pdf
Current year Schedule K-1 instructions www.irs.gov/pub/irs-pdf/i1065sk1.pdf

Questions?

eMail me

This presentation can be found at www.brucereed.com
Click on Investment Club & Treasurer Presentations.


Recap - expectations


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