Escheat: Financial Statement Considerations

By Anthony J. Testa, Jr.

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Because of the potential relevance and applicability to financial statement engagements, CPAs should perform and document an escheat analysis. Escheat, in broad terms, refers to the devolution, or transfer, of property to the state. Because property rights are derived from state (not federal) law, each state defines what, when, where, and how property devolves to the state. Before performing an escheat analysis, one must properly identify states in which escheat laws apply and determine the applicable escheat laws and regulations. Three core elements comprise the basis for escheat, each of which forms an important component of the subject.

To analyze an escheat obligation or liability, one must examine the character of escheatable property, the identity of the parties, and the period of dormancy. Before an escheat obligation can arise, the state must articulate the specific property subject to escheat. While escheatable property can take any character, real or personal, or any form, tangible or intangible, the most vexing falls within the intangible personal property category. Intangible personal property includes unredeemed gift cards or certificates, uncashed checks to vendors, uncashed payroll checks, and mis- or unapplied cash receipts. Once the state-specific escheatable property is determined, the duty to remit the property depends upon a proper classification of the parties.

Most states label the party with the duty to remit escheatable property as the “holder.” Generally, a holder occupies the same position as a debtor (i.e., one party who owes to another party either payment or the transfer of goods). For example, a merchant who issues a gift card to a patron becomes a holder of the unclaimed goods owed to the patron. If a creditor fails to receive escheatable property from a holder after a statutory dormancy period—whether due to the creditor’s death, abandonment, or failure to claim—the property automatically escheats, by law, to the state. For example, after the date of sale, a beverage distributor that collects a security deposit of five cents for each bottle sold to a customer must remit, by law, each unclaimed nickel to the state after a statutory dormancy period. As with the definition of property, the period of dormancy varies considerably by state and property type.

Financial Statement Engagements

Because of the somewhat oblique nature (and relatively low enforcement) of escheat laws, a CPA might not think it necessary to perform an escheat analysis during a financial statement engagement. Nevertheless, CPAs should consider escheat during the planning, fieldwork, and reporting phases of each engagement.

During the planning phase of an engagement, CPAs should document the risks that the client, as a holder, must escheat certain property to the state. In the case of a multistate company, CPAs should consider the potential for multistate escheat obligations. Furthermore, engagement planning should consider whether the company has any systems or mechanisms in place to record, summarize, and classify such property as escheatable. During the planning phase, CPAs should also consider the need to mail legal letters to determine whether escheatable property exists, when escheat obligations arise, and which state laws are applicable.

CPAs should consider whether a company entered into or recorded transactions not addressed during the planning phase. During the fieldwork phase of an engagement, CPAs should carefully consider and evaluate any property that might need to be remitted to the state. Such obligations might arise in the form of contra assets; for example, as outstanding checks (vendor, payroll, or dividend), unapplied cash, or miscellaneous accounts-receivable credits. Such obligations might likewise arise during the analysis of liability accounts; for example, as unclaimed security deposits, miscellaneous suspense account credits, or as gift cards/certificates payable and not redeemed. If the fieldwork phase identifies potentially escheatable property not considered during engagement planning, the company should send out additional legal letters.

The fieldwork results should lead to several financial statement classification and reporting considerations. The balance sheet should distinguish property of the company (i.e., assets) from property held by the company but escheatable to the state (i.e., liabilities). The effect on a client’s statement of operations depends upon whether the client incurred any accuracy-related charges from the state. Accuracy-related charges generally result from the failure to file (or to timely file) escheat returns (for any periods open under the statute of limitations), or the failure to remit (or to timely remit) escheatable property to the state.

Fraudulent filings also create accuracy-related charges. Based upon the materiality of the escheat-related amounts recorded in the primary financial statements, or based upon legal advice, the company may need to disclose escheat matters in a footnote for commitments and contingencies.

As a final consideration before reporting on the financial statements, CPAs might draft appropriate language to include in the management representation letter. Management should affirm its assertions regarding the company’s escheat obligations and the propriety of the accounting and reporting thereof.