Cost Accounting Analysis Term Paper

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H&R Block: Case Study

H&R Block has been a consistent performer since going public with solid earnings and cash flow. This paper will explore H&R Block's performance relative to other, similar industry players. It will explore whether H&R Block's leading image in the tax preparation industry will serve it well moving forward, particularly when competing with different kinds of businesses (including the IRS itself).

This paper will then analyze issues that could affect the company in the future, including competition, legal issues and future customer demand. There will also be an exposition and analysis of H&R Block's ethical problems related to its tax-return lending division, which is a major cash flow source, but also a source of significant regulatory and political scrutiny.

Origins and Growth

H&R Block began in the 1940's with a small tax-preparation office on Main Street in Kansas City (H&R Block, 2007). From its inception, the two Bloch brothers did the bookkeeping work for small-business clients in the area, like thousands of other such services at the time. In 1955, a pivotal event changed the company: at a client's suggestion, they placed an advertisement in the Kansas City Star advertising their tax preparation service. The high demand demonstrated that there was an untapped business opportunity, and they abandoned all their other businesses to focus on tax preparation and tax consulting.

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The U.S. accounting and tax preparation industry now employs 90,000 firms with annual combined revenue of $65 billion (NAMC, 2006). More specifically, the personal tax preparation area has grown in two ways: with innovation and through organic growth as more American consumers are comfortable with outsourced tax preparation. Tax preparation accounts for about a third, or $20 billion, of this total revenue for the industry.

The primary drivers for growth in this industry are strong consumer marketing, a growing and complex IRS codebook, and consumer lending tied to tax refunds (which will be discussed later in this paper).

Overview of the Industry, and H&R Block's Role

TOPIC: Term Paper on Cost Accounting Analysis Assignment

The industry is dominated by a few major players, of which H&R Block is by far the largest, with $4.021 billion in sales and a restructuring loss for the quarter of $109 million. The tax-preparation business continues to lose money, increasing from $153.1 million in 2007 Q1 to $172.3 million in 2008 Q1. This is on revenue of less than $70 million, which means that the company's core historical business is facing key competitive challenges as new types of competition come to the fore. H&R Block's gross profits of $1.377 billion last year make the company a very profitable venture with 25% gross margin and 42.9% operating margin, but continued write-offs in core businesses have led to losses last year and in the first quarter, totaling over $500 million in the past 5 quarters.

The primary competitors are the following:

Jackson-Hewitt, with revenues of $293 million, is about one-fifth the size of H&R Block. Its primary business, tax return preparation and software, provide the bulk of J-H's revenues. As such, they are about twice the size of H&R Block in the core tax preparation business, with 3.65 million tax returns prepared in 2007.

Intuit represents a different kind of competitor. Its approach in the past has been on tax self-preparation. Its growth in recent years has paralleled H&R Block's, but the stock has risen 395% since 1995, as compared to H&R Block's rise by only 115%. Despite its sales being only 1/2 of H&R Block's, Intuit's market capitalization is 50% higher, reflecting investor expectations that Intuit's cost structure and growth model are more compelling. Since Intuit is primarily online and software-oriented, its return on assets and equity are both higher than H&R Block's; a key reason might be that Intuit's gross profits, at $1.8 billion, are higher than H&R Block's.

The IRS is an emerging competitor. Its e-filing initiative, called Free File, has offered free services to individual tax preparers online, and has taken a significant share. Heavy lobbying by the tax preparation industry caused the IRS to impose income limitations, offering the free service only to people with incomes of less than $50,000 (White, 2006).

Challenges Facing H&R Block and the Industry

Over the past decade, H&R Block's significant growth has come on the back of the value of the information it collects from consumers when it prepares their tax returns. They have proven able to monetize this information in several ways:

Refund anticipation loans, which are directly tied to the tax returns done by the firm and its franchisees. Since H&R Block knows its customers' tax-refund status intimately, it has been able to build a substantial franchise in this area.

Mortgage loans: This has been an outgrowth of the above business, and a direct tie to the information and relationships that H&R Block has developed with its customers over time. This business has reached a significant level, and the company agreed earlier this year to sell the division to Cerberus Capital, a private equity firm (and the recent purchaser of Chrysler), which offered $2 billion for the company. The recent melt-down of sub-prime mortgage lending has caused Cerberus to ask to renegotiate the terms, which may mean that H&R Block will be required to maintain the business within its general umbrella of companies and services.

The greatest competition to H&R Block is coming from the Internet. With its network of franchised tax preparation offices, it is difficult for H&R Block to match either the flexibility or the cost structure of its online and software competitors. The biggest competition in this area is Intuit (covered above) and Microsoft. Both offer significant competitive threats to H&R Block in the future:

Their costs are significantly lower, with a gross margin percentage double that of H&R Block in this business.

They can copy the services offered by H&R Block, because those companies have rapid online access to customer financial information which allows them to offer similar services. Intuit is growing its own, in-house consumer lending and mortgage businesses, which it is advertising heavily.

They don't have the political and legal history that H&R Block has with consumer lending. That means that they can avoid some of the pitfalls encountered by H&R Block, particularly centering around the usurious interest rates requested by H&R Block from its customers for tax anticipation loans.

Microsoft and Intuit are both international companies, with tax preparation and consumer financial services around the world. Although neither is a significant factor outside of the English-speaking world, their low cost structures, low barriers to entry in new countries, and ability to do business without an expensive store- and franchise-based structure, makes it easier for these companies to expand.

Ethical Challenges Faced by H&R Block

H&R Block is, in some ways, an unwilling participant in consumer lending. Its tax-anticipation loans were a natural, consumer-led outgrowth of its tax preparation business. The problem has been that the interest rates charged for these short-term loans

The Company has been sued in a number of states, including California, for "predatory" practices and hounding consumers for debt repayment.

This has caused a consumer whiplash that has punished the stock and caused senior management to focus a good deal of its attention on public relations. A sense of the political ire caused by their practices can be sensed from the following quote from Consumer Affairs:

Also known as "instant" returns, quick-refund loans are a predatory sham of the highest order. The cost is astronomical -- 1700% or more -- and that's not including the extra fees that are tacked on by the most unscrupulous practitioners of this white-collar version of armed robbery (Hood, 2006).

H&R Block's consumer and political problems can be traced to a larger ethical debate within American society: how shall consumer financial data be used? Americans are hooked on credit, and particularly poorer Americans find consumer lending (including tax anticipation loans) a tempting offer when they are cash-strapped.

H&R Block's ability to monetize such consumer information means that the company can afford to give away its tax-preparation services (as it does now for clients with less than $50,000 in income), while making outsize profits on its other services.

Recommendations for H&R Block

The company is facing three key issues: (1) its growing ethical issues, (2) its competition from international, software, lower-cost competitors such as Microsoft and Intuit, and (3) its need to move away from mortgage lending, which is in a free-fall.

In order to face the changes needed, H&R Block will need to confront its current problems and find a solution to each:

High-cost franchise operations: H&R Block will not be able to step away from its franchise structure, but it needs to supplement the franchisees in a way that can reduce its overall cost of doing business. Block may consider either partnering with other, year-round financial product companies (such as investment firms, like Charles Schwab or Merrill Lynch).

Lower-cost delivery: Intuit's success is partly based on its lower cost structure. That means that Intuit is able to make 70 cents for each additional… [END OF PREVIEW] . . . READ MORE

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