Field of Study: Management Services Digital transformation is one of the top trends in 2021 and the pandemic helped accelerate the process. Several enterprises adopted ERPs in the cloud or next-gen ERPs, enabling them to access data remotely, others adopted robotic process automation, establishing rules and structured data to automate business processes, and others are somewhere in between. The COVID-19 crisis has triggered an acceleration in the adoption of finance technologies. Nilly Essaides, senior research director of finance, EPM and FinOps and Bill Marchionni, senior director, finance advisor at The Hackett Group, continue our segment on 2021 Key Issues identified in their survey and give us their insights on aggressive growth projections for several tools and solutions, the top growth areas for finance digital transformation and more.

Field of Study: Accounting Convertible bonds are always a discussion item as companies are often concerned with proper classification. FASB simplified issuer’s accounting for convertible instruments and contracts on an entity’s own equity with issuance of ASU 2020-06, in an effort to reduce unnecessary complexity currently in U.S GAAP. Josh Schaeffer, director at Equity Methods, discusses the sexy side of debt and why convertible bonds are gaining more and more popularity, especially in times of financial crisis.

Field of Study: Auditing The AICPA has issued guidance in 2021 on a number of issues that impact the auditor’s work. In February, an Exposure Draft was issued dealing with Non-Compliance with Laws and Regulations (NOCLAR). In June, new guidance was issued on the use of specialists and pricing information. Ahava Goldman, associate director with the AICPA, reviews the standards in detail and explains the implications of the new rules.

Field of Study: Taxes Even though the temporary measures established during the pandemic to help businesses and employees are coming to an end, the guidance isn't ending. Barbara Weltman, president at Big Ideas for Small Business, discusses guidance on affording paid sick leave and paid family leave under Notice 2021-53. She also covers potential tax implications with respect to demolitions, foreclosures and debt cancellation, provides tax updates on marijuana businesses and discusses deductibility of expenses and the new Form 7203 for figuring basis for S corporation shareholders.

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1. 2021 Emerging Enterprise Themes – Part II

2. What Makes Convertible Bonds Popular?

3. Auditing Standards Update: NOCLAR, Management Specialists and Pricing Services

4. Corporate & Individual Tax Updates (November 2021)

CPA REPORT SUBSCRIBER GUIDE

NOVEMBER 2021 Summary Page i [p. 1]

CPE Requirements iii [pp. 3–5]

Segment One 1–1 [pp. 7–37]

Segment Twl 2–1 [pp. 39–70]

Segment Three 3–1 [pp. 71–101]

Segment Four 4–1 [pp. 103–130]

Sememt Five 5–1 [pp. 131–164]

Evaluation Form A–1 [pp. 165–166]

Index B–1 [pp. 167–170]

Group Live Attendance Form C–1 [p.171]

68]

CPA Report is a product of www.kaplanfinancial.com

Note: CPA Report now includes one Government/Not-for-Profit segment.

Information regarding COVID-19 changes rapidly; further updates will be in upcoming segments.

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Field of Study: Auditing The AICPA’s 2021 Not-for-Profit Entities Audit Risk Alert reviews what auditors need to know with regards to current business environment issues, accounting and audit challenges, and changes on the horizon for not-for-profits. Kaplan Financial Education discussion leader Allen Fetterman reviews the key elements contained within the Alert, in particular the impact of the pandemic on both clients and auditors.

5. The AICPA’s 2021 Not-for-Profit Entities Audit Risk Alert: An Overview

Summary Page (continued)

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1. Select discussion leaders who have the appropriate education and/or experience both to teach the segment subject and conduct the subsequent group discussion.

2. Have each discussion leader review the video segment and the written materials in the Subscriber Guide prior to the presentation of the segment.

3. Make sure that each discussion leader certifies the attendance at his/her discussion group by signing and dating the Group Live Attendance Form.

4. (Individuals) View the video segment (30 to 35 minutes).

5. (Individuals) Discuss the segment materials as they relate to his/her own work and/or organization (20 to 25 minutes).

6. (Individuals) Evaluate the instructor using the criteria listed on the Evaluation Form.

7. Check with your State Board of Accountancy for specific details, including group live sponsorship registration requirements.

Group Live Format

When taking a CPA Report segment on a group live basis, individuals earn CPE credits when they (or their organization) do the following:

CPE RequirementsWhen properly administered, the CPA Report educational program meets the requirements for group live and self-study participation as defined in the Statement for Standards in CPE Reporting.

Please note:

l You cannot earn additional credits by taking the same course in group live format and online self-study format.

l CPE requirements vary from state to state. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. CPAs should contact their state board regarding specific CPE requirements.

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e The following information will help you plan and implement the CPA Report program within your firm:

How to Implement the CPA Report

1. Each quarter, you may receive by email a CPA Report Summary Page in advance of the video segment notifying you of the upcoming Continuing Professional Education topics that will be covered.

2. The CPAR DVD is expected to arrive the month following the end of the quarter. If you do not have a standard day and time each quarter designated as CPE day, issue a memo with the date of your upcoming seminar. (If attendance is not required, please provide plenty of advance notice for optimum participation).

3. Select the topic(s) you wish to cover in your session when the CPAR Summary Page or the actual program arrives.

4. It is best for an organization to have its CPE classes on a regular and consistent basis, so it is easy for the staff to remember when scheduling clients.

5. You may wish to provide each group live attendee a “Certificate of Completion” noting the hours earned and the topic areas.

6. Always check with your State Board of Accountancy for specific details, including group live sponsorship registration requirements.

If you need more information or have any questions, please contact Customer Service at CPESupport@kaplan.com or 914-517-1177.

Note: CPE requirements vary from state to state. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. CPAs should contact their state board regarding specific CPE requirements.

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Please note: This issue of CPA Report Online Self-Study is scheduled to go live online on December 1, 2021.

If you need more information or have any questions, please contact Customer Service at CPESupport@kaplan.com or 914-517-1177.

Online Self-Study

Kaplan Financial Education, powered by Smartpros is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: www.nasbaregistry.org.

Self-Study Format

Participants can gain self-study credit by enrolling in the CPA Report Online Self-Study library of courses. All components of the program will be hosted online, including the video, interactive review questions, required reading, and final exam.

In order to ensure adherence to NASBA guidelines regarding self-study, the CPA Report and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers are no longer available. Customers should contact their company administrators for information on taking course exams and receiving CPE credit for the courses.

Customers may contact Kaplan Financial Education at cpesupport@kaplan.com to obtain certificates previously earned through the CPA Report Self-Study and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers.

Customers interested in the self-study format of the CPA Report can find information on Kaplan Financial Education’s self-study libraries at Online Accounting CPE Courses.

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1. 2021 Emerging Enterprise Themes – Part II

Learning Objectives:

Segment Overview:

Recommended Accreditation:

Reading (Optional for Group Study):

Running Time:

Video Transcript:

Course Level:

Course Prerequisites:

Advance Preparation:

Expiration Date: January 13, 2023

Work experience in a corporate staff environment, or an introductory course in management.

None

1 hour group live 2 hours self-study online

Update

“The CFO Agenda: 2021 Key Issues”

See page 1–12.

See page 1–21.

32 minutes

Digital transformation is one of the top trends in 2021 and the pandemic helped accelerate the process. Several enterprises adopted ERPs in the cloud or next-gen ERPs, enabling them to access data remotely, others adopted robotic process automation, establishing rules and structured data to automate business processes, and others are somewhere in between. The COVID-19 crisis has triggered an acceleration in the adoption of finance technologies. Nilly Essaides, senior research director of finance, EPM and FinOps and Bill Marchionni, senior director, finance advisor at The Hackett Group, continue our segment on 2021 Key Issues identified in their survey and give us their insights on aggressive growth projections for several tools and solutions, the top growth areas for finance digital transformation and more.

Upon successful completion of this segment, you should be able to: l Understand the meaning of a service delivery model and how

it supports a business, l Identify the main concerns of moving the finance function

into the cloud, l Recognize the importance of talent management and how it

has transitioned, and l Understand the mentality of forward-thinking organizations.

Field of Study: Management Services

A. Digital Transformation Processes

i. ERP in the cloud l Enabling remote data access

ii. Robotic process automation l Establishing rules & structured

data

iii. Somewhere in between

B. Digital Transformation Projects

i. On the rise due to: l Reduced workforce l Doing more with less l Expectations to increase

productivity

C. Process Technologies

i. 30% acceleration l ERP, finance suites, ERP in the

cloud l Accessing data remotely l Reducing costs l Doing more with less

ii. 32% acceleration l Robotic process automation

D. Benefit of RPA

i. Automation of repetitive tasks

E. Point Solutions Benefits

i. Plug functionality gaps within an enterprise system

ii. Easy integration with cloud-based ERPs

F. Service Delivery Model

i. In support of a business l Ensure finance supports that

business l Understand complexities

b Controllable b Non-controllable

l Imperative to understand strategy l Ensure modern finance

technology architecture o Aligns with information chain

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I. Digital Transformation in Finance

A. Remote Working Environment

i. Decentralized model

ii. Enables security concerns l Privacy issues & concerns

iii. Might be an ongoing recurring thing

iv. Long-term investments may need to be made

B. Cybersecurity Ranked In

i. Top 3 risks

ii. Top 5 objectives for finance l Protection of sensitive

information o It’s proprietary

l Potential of fraud

C. Finance Functions in the Cloud

i. Finance executives concerns l Transition l Cyber security risks

ii. Vendors allow & enable security protocols

iii. Noticeable benefits l Distributed work l Greater functionality l User friendliness

D. Change in EPM Solutions Ownership

i. In 2016 l IT department

ii. In 2020 l Finance team

II. Remote Working & Cybersecurity Risks

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A. Talent Management

i. Identifying high potential employees

ii. Transitioning from people who l Know where to look in the

system l Understand the business

b Have sophistication & presence

b Identify & understand risk

iii. CFOs are recognizing they may have a blind eye l 40% intend to launch a talent

management program

B. Automation Poses Serious Questions

i. What skill set would be needed

ii. How long will it take to get it

iii. Evaluating our own skill set & if upskilling is necessary

iv. Ability to upskill our team

C. Questions on Skills

i. What are the skills you have today?

ii. What are the skills you need in the future?

iii. Where are the biggest gaps?

iv. Where do you need to focus your development?

III. Managing Talent and Skills

A. Finance Performance Areas & Struggles

i. High performance in traditional areas l Cost control l Working capital l Sales support

ii. Struggles in becoming l Business advisors l Analytics experts

B. Considerations for Improvement

i. Business advisory l Communicate l Bring insight l Influence without owning l Service delivery model l Business interaction and

engagement

C. Customer-Centric Approach

i. Refers to an internal stakeholder l From a finance standpoint

D. Going Beyond Standardization

i. Customize or create more bespoke solutions for the end stakeholder

ii. Ensure there is a user friendly way to look at & understand data

IV. Challenges of Meeting Business Needs

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V. Maximizing Technology & Talent

A. Talk Points with Clients

i. Efficiency

ii. Effectiveness

iii. Experience

B. Employer Considerations on Experience

i. Evaluate the experience you provide to l Attract talent l Develop talent l Retain talent

ii. Be an employer of choice l Find ways to achieve that

C. Mentality of Forward-Thinking Organizations

i. Transformation journey and investments in technology are a must

ii. Understand the financial impact l Without the traditional ROI

iii. Leadership at the CFO & decision makers level

D. Customer & Internal Experience

i. Agility

ii. Scalability

iii. Planning

VI. Final Thoughts Looking Forward

A. Bill Marchionni’s Final Thoughts

i. Speed to realization l Agile project transformation

methodology

ii. Changing the l Use of estimates l Number of approvals

iii. Decision making & uncertainty l Leave comfort zones

iv. Focus on the service delivery model

“We have to leave our comfort zones.…That's a muscle that we need to embrace and use.”

— Bill Marchionni

B. Nilly Essaides’s Final Thoughts

i. 2020 shocked the system of many organizations

l Stress test on finance l Wake up call to leaders

ii. 2021 and beyond, changes are to be made

l Operationalized l Sustainable

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Discussion Questions

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1. 2021 Emerging Enterprise Themes – Part II

l As the Discussion Leader, you should introduce this video segment with words similar to the following:

“In this segment, Nilly Essaides and Bill Marchionni continue our segment on 2021 key finance issues and give us their insights on aggressive growth projections for several tools and solutions, the top growth areas for finance digital transformation and more.”

l Show Segment 1. The transcript of this video starts on page 1–21 of this guide.

l After playing the video, use the questions provided or ones you have developed to generate discussion. The answers to our discussion questions are on pages 1–7 to 1-9. Additional objective questions are on pages 1–10 and 1–11.

l After the discussion, complete the evaluation form on page A–1.

1. The 2020 pandemic helped to accelerate the process of digital transformation for many organizations. What steps did organizations take as part of this transformation? How did your organization transform?

2. The most recent Hackett Study identified the top growth areas for finance digital transformation in 2021. What were some of the growth areas identified by the study? In which areas would your organization like to experience growth?

3. Cybersecurity is an often-overlooked risk associated with implementation of technology. What are some of the issues companies should consider when it comes to cybersecurity? How does your organization protect itself from such risk?

4. Finance executives are finally recognizing the importance of developing new skills. How has the finance function sought to address the issue of talent? How has your organization addressed this issue?

You may want to assign these discussion questions to individual participants before viewing the video segment.

Instructions for Segment

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5. According to the Hackett Group study, the majority of finance organizations are struggling to meet business expectations for some of their most important objectives. What actions can finance executives take to better meet business needs? Do you agree with the speaker’s assessment of how the finance function can improve in this area? Why or why not?

6. Technology is a key factor in attracting talent to an institution. How can organizations use technology to attract talent? What technology experience does your organization provide?

7. The speakers shared their thoughts on how the pandemic has forced finance functions to change. How was your organization and finance function been impacted by the pandemic? Do you agree with the speakers’ recommendations for change? Why or why not?

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s1. The 2020 pandemic helped to accelerate

the process of digital transformation for many organizations. What steps did organizations take as part of this transformation? How did your organization transform? l As part of their digital

transformation process organizations adopted b ERPs in the cloud or next-gen

ERPs enabling them to access data remotely

b Robotic process automation establishing rules and structured data to automate business processes

b Other organizations are somewhere in between

l Declining revenues in many companies have increased pressure to reduce costs but digital transformation projects are on the rise instead of being put on hold

l A few of the reasons enterprises move toward data automation and a technology driven infrastructure include: b Reduced workforce b Doing more with less, and b Expectations to increase

productivity b Remaining efficient

l Participant response based on personal/organizational experience

2. The most recent Hackett Study identified the top growth areas for finance digital transformation in 2021. What were some of the growth areas identified by the study? In which areas would your organization like to experience growth? l The Hackett Group study revealed

that, notwithstanding increased scrutiny on discretionary spending and on new or existing projects, most finance transformation efforts either continued or were accelerated.

l The study found a 30% acceleration in the adoption of ERP and finance suites b ERP in the cloud

v Allows for remote access of data

v Reduction of costs v Doing more with less

l 32% acceleration in the adoption of robotic process automation (RPA) b Benefits of RPA include

automation of repetitive tasks l Significant growth in point solutions,

which are designed to plug functionality gaps within an enterprise system b Point Solutions Benefits

v Plug functionality gaps within an enterprise system

v Easy integration with cloud-based ERPs.

l Participant response based on personal/organizational experience.

3. Cybersecurity is an often-overlooked risk associated with implementation of technology. What are some of the issues companies should consider when it comes to cybersecurity? How does your organization protect itself from such risk? l The pandemic forced many

companies into a remote working environment: b Decentralized model is more

susceptible to security and privacy issues & concerns

b Potential to be ongoing and recurring

b Long-term investments may need to be made

l Per Nilly Essaides, cybersecurity was one of the top three risks this year that was cited by senior executives across G&A functions.

l Objectives for finance related to cybersecurity:

Suggested Answers to Discussion Questions

1. 2021 Emerging Enterprise Themes – Part II

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sb Protection of sensitive information b Potential of fraud

l Finance Functions in the Cloud b Finance executives concerns

include: v Transition v Cyber security risks

b Vendors allow & enable security protocols

b Noticeable benefits v Distributed work v Greater functionality v User friendliness

l Participant response based on personal/organizational experience

4. Finance executives are finally recognizing the importance of developing new skills. How has the finance function sought to address the issue of talent? How has your organization addressed this issue? l Questions regarding talent raised by

automation b What skill set would be needed? b How long will it take to get it? b Evaluating the skill set and

determining if upskilling is necessary

b Ability to upskill the team l Talent management

b Identifying high potential employees v Transitioning from people who

know where to look in the system

v To people who understand the business k Have sophistication &

presence k Identify & understand risk

b CFOs are recognizing they may have a blind eye v 40% intend to launch a talent

management program in 2021 l Participant response based on

personal/organizational experience

5. According to the Hackett Group study, the majority of finance organizations are struggling to meet business expectations for some of their most important objectives. What actions can finance executives take to better meet business needs? Do you agree with the speaker’s assessment of how the finance function can improve in this area? Why or why not? l Finance performance areas &

struggles b High performance in traditional

areas v Cost control v Working capital v Sales support

b Struggles in becoming v Business advisors v Analytics experts

l Considerations for improvement of the finance function b Business advisory b Communicate b Bring insight b Influence without owning b Service delivery model b Business interaction and

engagement l Take a customer-centric approach

with respect l Going beyond standardization

b Customize or create more bespoke solutions for the end stakeholder

b Ensure there is a user-friendly way to look at & understand data.

l Participant response based on personal/organizational experience

6. Technology is a key factor in attracting talent to an institution. How can organizations use technology to attract talent? What technology experience does your organization provide? l Try to appeal to employees who are

early in their career who are used to a specific digital experience

Suggested Answers to Discussion Questions (continued)

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sl Accounting and finance organizations

that use humans for manual and/or transactional work, cannot focus on the value-add work b These organizations risk losing

new talent b The experience will be not be

something new employees expect l Employer considerations on

experience b Evaluate the experience provided

to v Attract talent v Develop talent v Retain talent

b Be an employer of choice. l Participant response based on

personal/organizational experience.

7. The speakers shared their thoughts on how the pandemic has forced finance functions to change. How was your organization and finance function been impacted by the pandemic? Do you agree with the speakers’ recommendations for change? Why or why not? l Changes to be addressed per Bill

Marchionni: b Speed to realization

v Agile project transformation methodology

b Changing the v Use of estimates v Number of approvals

b Decision making & uncertainty v Leave comfort zones

b Focus on the service delivery model.

l Per Nilly Essaides: b 2020 shocked the system of many

organizations v Stress test on finance v Wake up call to leaders

b 2021 and beyond, changes are to be made: v Operationalized and v Sustainable

l Participant response based on personal/organizational experience.

Suggested Answers to Discussion Questions (continued)

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1. Corporate digital transformation projects:

a) are on the rise

b) are increasingly being put on hold

c) have been eliminated

d) are no longer required because of the pandemic

2. According to the 2021 study conducted by the Hackett Group, as a result of the COVID-19 pandemic many companies:

a) accelerated their use of process technologies but decreased their use of robotic process automation

b) decreased their use of process technologies but accelerated robotic process automation

c) accelerated their use of process technologies and robotic process automation

d) decreased their use of process technologies and robotic process automation

3. When it comes to working in a remote environment:

a) most companies have actually faced decreased security issues

b) many companies expect it to be a short-term issue

c) this is considered to be a decentralized model for security purposes

d) all of the above

4. According to the Hackett Group, in 2020, the majority of EPM solutions were owned by the organization's:

a) IT department

b) finance team

c) legal department

d) senior management

5. Modern talent management focuses on looking for employees who can do all of the following EXCEPT:

a) know where to look in the company's ERP systems

b) understand the business

c) have sophistication and presence

d) identify and understand risk

6. Modern finance functions tend to struggle with:

a) cost controls

b) working capital

c) sales support

d) being business advisors to the enterprise

7. According to Mr. Marchionni, forward thinking organizations:

a) don't necessarily feel the need to invest in technologies

b) understand the financial impacts of investments in technology but are not bound by them

c) are always looking out for the ROI on any investment, no matter the department or function

d) do NOT require leaders

You may want to use these objective questions to test knowledge and/or to generate further discussion; these questions are only for group live purposes. Most of these questions are based on the video segment; a few may be based on the reading that starts on page 1–12.

Objective Questions

1. 2021 Emerging Enterprise Themes – Part II

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8. When it comes to costs, a finance department must:

a) manage only its own operating costs

b) not be concerned with its own operating costs as long as enterprise costs are appropriately managed

c) manage both its own operating costs and support broader enterprise cost management initiatives

d) should not concern itself with cost

9. _____________ is the number one initiative on the finance transformation agenda in 2021.

a) Improvement of cost efficiency

b) Improving finance analytics and modeling capabilities

c) Securing finance data and systems

d) Modernizing finance application platforms

10. Which of the following applications is projected to experience negative growth in 2021 and beyond?

a) business process management tools

b) cloud based core finance application suites

c) cloud based best of breed solutions

d) legacy finance applications

Objective Questions (continued)

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Complimentary research December 2020 Source: www.thehackettgroup.com

2021 Key Issues By Nilly Essaides, Tom Willman and Jim O’Connor

Facing an unknowable period of continued disruption, finance must play a critical role in helping companies chart their course forward. While the pandemic-driven recession will make spend reduction an important focus, becoming a strategic advisor to the business is the No. 1 objective on the finance agenda for 2021 (see page 4). Business leaders need the function to provide better, faster and predictive insight so they can make smart choices about where to invest, where to cut, and how to enable necessary changes to continue to drive enterprise growth. In order to execute on this mandate, finance organizations will have to boost their analytics and modeling capabilities by

leveraging new technologies and upskilling talent.

This year, we also see the introduction of three new items to the list of key finance objectives: improving finance agility, aligning skills and talent to changing business needs, and optimizing working capital management. These reflect the COVID-19 reality. Finance must be able to adapt more quickly as conditions change, prepare staff for the skills of the future, and extract as much internal cash as possible to build a liquidity buffer and protect earnings.

The 2020 crisis is shaping the 2021 finance agenda

Unprecedented business disruption forced finance organizations to delay many 2020 plans and operate instead in a reactive mode. Respondents to the 2021 Key Issues Study expect stability may remain elusive: 41% believe conditions will stabilize by the second half of 2021, but 36% predict it will

1–12

Self-Study Option

Reading (Optional for Group Study)

THE CFO AGENDA

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l In order to ensure adherence to NASBA guidelines regarding self-study, the CPA Report and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers are no longer available. Customers should contact their company administrators for information on taking course exams and receiving CPE credit for the courses.

l Customers may contact Kaplan Financial Education at cpesupport@kaplan.com to obtain certificates previously earned through the CPA Report Self-Study and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers.

l Customers interested in the self-study format of the CPA Report can find information on Kaplan Financial Education's self-study libraries at Online Accounting CPE Courses.

CPA Report Update

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take longer. Only 23% expect stability sooner. Therefore, the crisis and its fallout will continue to shape finance priorities in 2021 and beyond. The dramatic shift in virtual work is a case in point. Before the crisis, 4% of general and administrative (G&A) staff worked primarily from home, and 13% had hybrid arrangements, working between home and the office. Post-crisis, these percentages will rise to 25% and 33%, respectively. Four emerging enterprise themes will influence the 2021 finance transformation agenda:

People: The shift to virtual work will require significant reskilling and innovation of management techniques. Companies will tap into an increasingly global talent pool. Performance management will evolve from measuring activity- and task-based productivity to business outcomes based on teamwork and collaboration. Further, diversity and inclusion has become a top priority.

Risk: Our 2021 Key Issues Study highlights a major increase in business risks across the board – from supply chain disruption to cybersecurity to regulatory change to the economic implications of prolonged pandemic-related restrictions. All parts of the organization, including finance, will feel the effects of this high-risk business environment and need to factor this into their 2021 transformation agenda.

Cost: Under the prevailing crisis recovery conditions, cost takes center stage. Finance must manage both its own operating cost and support broader enterprise cost management initiatives. The combination of significant 2020 cost cuts and increased workloads is straining many finance organizations, and this will continue into 2021.

Digital acceleration: Digital maturity was a major factor in the ability of companies to respond to the crisis, creating competitive differentiation. Most companies have taken the lessons to heart and plan to accelerate enterprise digital transformation. Finance must support the enterprise digital agenda, while shifting its own digital transformation into overdrive. In particular, cloud-based computing, collaboration technologies, and digitization of processes, assets, and content

will be major areas of focus throughout the enterprise.

2021 finance key issues

1. ACT AS A STRATEGIC ADVISOR TO THE BUSINESS The enterprise is increasingly reliant on finance for providing indispensable advice to drive strategic decisions. Top organizations will leverage advanced analytics solutions to provide greater insight into setting targets and deploying resources.

2. IMPROVE COST-EFFICIENCY The pandemic has intensified finance leaders’ focus on reducing process cost. Cost reduction through automation is the No.1 initiative on the finance transformation agenda in 2021.

3. IMPROVE FINANCE ANALYTICS AND MODELING CAPABILITIES Analytics surged from No.10 in 2020, reflecting an uncertain economic outlook and higher management demand for predictive insight. To fulfill its role as a strategic advisor, finance also needs to reinvent its data discovery process.

4. SECURE FINANCE DATA AND SYSTEMS Companies cited cyber risk as their chief business risk in 2021. As finance goes digital, it is more broadly exposed to these risks. Finance must shut down new entry ports to its sensitive data and tighten controls to prevent fraud.

5. IMPROVE FINANCE AGILITY* Facing extreme uncertainty and fast-paced change, finance must enhance its ability to sense changes in market conditions, and speed up its insight and execution capabilities.

6. ALIGN SKILLS AND TALENT WITH CHANGING BUSINESS NEEDS* Finance organizations recognize the importance of people to transformation success. This means leading talent programs in partnership with human resources to prepare staff with the digital skills of the future.

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7. MODERNIZE FINANCE APPLICATION PLATFORM(S) It’s concerning this objective is near the bottom of the list. So much depends on establishing a robust digital architecture, which requires system consolidation, upgrades and migration to next-generation platforms such as cloud enterprise resource planning (ERP) solutions.

8. IMPROVE INTEGRATION OF PLANNING PROCESSES Most organizations run multiple planning events in different parts of the company and with a different cadence. Financial planning and analysis should coordinate siloed planning activities to ensure everyone has access to the latest information.

9. TAKE ADVANTAGE OF NEW FINANCE TECHNOLOGIES Even before the pandemic, finance was on a rising trajectory in the adoption of smart automation solutions such as robotic process automation (RPA) and cognitive tools. As the function prepares for a digital future, it must accelerate its adoption levels to reduce cost and create new capabilities.

10. OPTIMIZE WORKING CAPITAL* During times of turmoil, liquidity comes at a premium. Finance is focused on areas such as optimizing working capital through targeted collections, enabling faster and easier payments, and monitoring the accounts receivable portfolio more frequently

1. Act as a strategic advisor to the business

COVID-19 has intensified demand for greater finance involvement in setting the company’s strategic course. Finance staff increasingly work closely with business leaders, as they make difficult choices about how to allocate scarce resources, execute their strategies and drive financial performance. Finance also plays a critical role in making enterprise decisions about investments in areas such as digital transformation by assessing potential use cases and comparing the relative value of

projects in terms of return on investment and time-to-benefit. The latter has become an imperative because the pandemic is forcing finance to fast-track digitization to take out cost and build new capabilities. Supporting digital transformation is the enterprise’s top “ask” of the finance organization for 2021 (see sidebar, “Finance alignment with enterprise priorities,” on page 13).

2. Improve cost-efficiency.

The crisis wrought havoc in the global economy, and unprecedented demand shocks led to steep declines in revenue for many industries. Even organizations in industries that were not hard hit and those that experienced an uptick in sales must brace for ongoing instability in the business environment. Finance plays a dual role in this regard. It is integral to identifying opportunities to eliminate or decrease costs across the enterprise. In addition, it must also enhance its own functional efficiency. Executives project a 3.4% contraction in the 2020-2021 finance operating budget and a 4.4% decrease in staffing levels. Because workload is projected to increase by 3.9%, this implies finance must improve productivity by 8.3% and efficiency by 7.3% in 2021. That is why we see significant projected increases in the adoption of process automation solutions such as business process management, best-of-breed cloud solutions and RPA tools.

3. Improve finance analytics and modeling capabilities.

The crisis was a wake-up call for many organizations, as they struggled to keep up with the pace of change and address demands for more forward-looking insights. These deficiencies reflect the lack of easy access to consistent data, hindering finance’s ability to see changes in real time, visualize their impact, and feed predictive models. More than ever, companies need visibility into what is ahead, for example, by running what-if scenario analysis to determine outcomes based on different circumstances and the actions to take to address most likely scenarios. Not surprisingly, the 2021 study projects a 24%

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year-on-year increase in the adoption of advanced analytics and data visualization tools (Fig. 1). 3. Improve finance analytics and modeling capabilities.

4. Secure finance data and systems

Cybersecurity held the top spot in the list of business risks for 2021. Finance is not immune; on the contrary, the rapid transition to remote work has increased the number of entry points for hackers and fraudsters. Finance executives predict the percentage of staff working from home to increase twofold compared to pre-crisis levels. Finance data is extremely sensitive. It contains the organization’s financial information, as well as links to financial institutions. On the upside, our research1 shows that finance executives are significantly less concerned about the security of modern cloud solutions compared to four years ago. Vendors in the finance space have tightened their security protocols significantly, as they reached new maturity levels.

5. Improve finance agility

New to the top 10 list is improving the function’s agility, which we define as the ability to sense oncoming change, make quick decisions and expedite their execution. To become more agile, The Hackett Group envisions a future finance organization that is much more enterprise aligned, as some of finance’s traditional activities migrate into digital operations hubs that support all functions and businesses. Finance will likely manage new

enterprise capability centers such as analytics and risk management.

6. Align skills and talent with changing business needs.

Finance organizations have been woefully deficient in their talent development efforts. Last year, talent didn’t even make the list of top finance issues. Yet, without an emphasis on reskilling, finance transformation is bound to fail. Our study revealed that finance leaders are now realizing just how important people are to the transformation process: 41% have a talent development program to prepare staff for the skills of the future, including core skills such as leadership, business acumen, storytelling and collaboration. Technical expertise is a given. However, as the function reinvents its operating model, professionals will have to become “finance athletes,” able to adapt to not only changing business requirements but a redesigned operating model.

7. Modernize finance application platform(s).

Our study shows an appreciable retraction from the use of legacy applications, coupled with a rise in the adoption of cloud-based core finance applications (Fig. 2). Respondents projected a 25% increase in cloud ERP adoption, making it the fastest-growing digital solution. We see many information technology (IT) organizations embracing a cloud-first approach, which cascades to all functions.

FIG. 1 Projected growth in finance adoption of data-related technologies

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Plus, the big vendors have already transitioned to cloud platforms. These new solutions enable finance to integrate different source systems with greater ease and build a single data repository without having to completely dismantle the legacy architecture.

8. Improve integration of planning processes

COVID-19 was primarily a planning crisis for finance. According to our research, inflexible planning was a major obstacle for an effective crisis response. At any given time, there are multiple planning events happening within the company. While related, these activities are typically disconnected. To prepare for an increasingly volatile environment, planning activities must work in sync. It is finance’s role to coordinate planning events and tighten the

information value chain, so planners can align their specific activities to the most recent.

9. Take advantage of new finance technologies

The successful transformation into the finance function of the future depends in large part on broader implementation RPA, artificial intelligence (AI) and cognitive tools. While finance has experimented with some of these before, it must now scale up by applying technologies to more and new uses and expanding adoption throughout the function. AI-enabled and cognitive tools can support analysts and allow machines to learn from experience, so they can provide better answers more quickly. Executives forecast a 13% increase in their adoption (Fig. 3 on page 10). Chatbots, which reduce the friction in the human/machine interface,

FIG. 2 Projected growth in finance adoption of cloud-based core and other solutions

FIG. 3 Projected growth in finance adoption of emerging technologies

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will also see increased adoption. More broadly, we anticipate a rise in deployment of RPA and advanced analytics. Combined, these new technologies can take finance beyond shaving process cost and into improving process effectiveness and end-user experience.

10. Optimize working capital.

The coronavirus outbreak put a squeeze on corporate liquidity, and continued economic threats loom on the horizon. Our research shows that finance intends to strengthen its working capital management discipline by improving credit risk assessments, using AI tools upstream to better target collection efforts downstream to secure receivable portfolios and negotiating longer payment terms.

Understanding the hurdles to finance transformation

The finance agenda for 2021 includes aggressive goals that will require a holistic transformation of the function so it can emerge stronger and better in the next normal. According to our research, the biggest obstacle to success is process and technology complexity. This impedes achievement of the entire top 10 objectives list. Chief financial officers (CFOs) and their teams must simplify their IT architecture and standardize processes as much as possible. We see evidence of this in finance’s 2021 transformation initiatives. For example, 57% of organizations have projects designed to improve integration of the planning process. Over one-half intend to expand end-to-end process ownership and standardize processes on the back end, while providing more stakeholders with friendly front-end interfaces. The second biggest impediment is lack of skills and talent. This is an area of great concern because finance has a history of overlooking the importance of people to successful transformation. It is encouraging that executives identify talent as a major issue, but only 41% plan to launch a talent development program. Upskilling is also integral to diffusing organizational

resistance to change, as staff becomes more comfortable with new ways of doing work.

Digital acceleration and realization of business objectives

Effectiveness of digital technology adoption is a factor that can increase the likelihood of achieving business and function goals. In this year’s study, technology leaders – those organizations that attained greater success overall in implementing core human capital management, data and analytics, and emerging technologies – were able to address top enterprise and finance function objectives far better than their peers (Fig. 4). This not only reflects how technology leaders are better able to improve their service delivery capabilities. It also points to their ability to redirect resources and

build new capabilities that increase business contribution.

Finance alignment with enterprise priorities

The year ahead will bring the most dramatic shift in enterprise priorities since the inception of our annual Key Issues Study. Enterprise digital transformation rose five spots to become the top enterprise initiative. After going through an accelerated digital learning curve during the crisis, companies plan to capitalize on the lessons learned. Diversity and inclusion rose seven spots on the enterprise agenda. Cost optimization is always among the primary initiatives, but this year it dropped from the top of the list to third place. The crisis triggered virtualization of work, elevating it into the top five initiatives for 2021. This will be an enduring characteristic into the next normal. Finally, data management and analytics continue to be an important focus for both the enterprise and finance.

The call to digital action

Regardless of finance’s plans and priorities for the coming year, CFOs will ultimately be judged on what they accomplished. When we look back a year from now, to what extent will finance have been able to

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2021 transformation progress hurdle importance ranking

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meet the aggressive agenda outlined in this paper? Digital acceleration will be key – so here is our perspective on the six steps finance must take to fast-track digital transformation and, thus, its ability to deliver on enterprise expectations.

1. Don’t wait. Many organizations have been stymied by the notion that they must take a linear approach to digitization. But this mindset can perpetually delay the implementation of new technologies. Most finance

functions have found that a single-source, single-system nirvana is unattainable. With the help of cloud-based technologies and modern data management solutions, finance can overcome these hurdles and lead its own efforts (with IT as a partner), while simultaneously working on digitizing and cleaning up data.

2. Take a cross-functional approach. Digital success cannot be achieved solely within the finance function; it

FIG. 4 Technology effectiveness improves realization of objectives

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should be a cross-functional effort involving all G&A functions. Organizations at the forefront of digital transformation see this cross-functional digital capability as a machine for creating value by infusing technology-powered change across the back office to generate greater value, faster.

3. Establish a dedicated transformation capability. Digital transformation cannot be a part-time assignment. It requires specific skills and formal project management. Establish a team with dedicated skills, for example, in a center of excellence or global business services (GBS) environment. Such a permanent digital transformation capability will allow finance to coordinate different aspects of the process such as generating and capturing innovation ideas through agile implementation and value realization.

4. Start small and scale up. Adopt best practices for developing a digital strategy in order to build a portfolio of initiatives. Then leverage the data generated through these small-scale implementations to scale up – to get the most out of the investment and speed up the propagation of digital tools across G&A functions.

5. Manage initiatives on a portfolio basis. By understanding the value profile of different initiatives (e.g., cost, impact, duration), organizations can review their relative merits and combine longer-term projects (e.g., cloud migration) with bursts of quicker initiatives such as RPA.

6. Utilize a rigorous, value-based methodology to prioritize projects. Companies are under pressure to reduce cost while at the same time making improvements to their operating model for the future. Management’s demand for robust use cases before allocating digital dollars means that digital initiatives must be understood in terms of the planned or realized value delivered within a defined time frame.

Are you ready to transform your finance operations?

Backed by our unparalleled benchmarking data and best practices repository, as well as experience across the full transformation life cycle, The Hackett Group is ready to support:

l Performance benchmarking and best practices

l Sales, general and administrative (SG&A) cost optimization

l Working capital and cash acceleration

l Finance and GBS service delivery model design, implementation, and optimization

l Talent management, skills and competencies, role definition, and career pathing

l Digital transformation strategy, tool selection and support

l Enterprise performance management and analytics

l Technology road map, cloud migration and modern architecture

l Master data management and architecture

l Transformation management office, change management and communications implementation

AUTHORS

Nilly Essaides Senior Research Director

Tom Willman Associate Principal and Global Practice Leader, Finance Executive Advisory Program

Jim O’Connor Global Practice Leader, Global Business Services and Finance Advisory Programs

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The Hackett Group 1000 Abernathy Road NE Suite 1400 Atlanta, GA 30328 T. +1 770 225 3600 T. 1 866 614 6901 (toll-free) W. www.thehackettgroup.com London Cannon Green 27 Bush Lane London, EC4R 0AN, UK T. +44 20 7398 9100

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SURRAN: Digital transformation is one of the top trends in 2021 and the pandemic helped accelerate the process. Several enterprises adopted ERPs in the cloud or next-gen ERPs, enabling them to access data remotely, others adopted robotic process automation establishing rules and structured data to automate business processes and others are somewhere in between.

A steep decline in revenues in many companies has intensified the pressure to reduce costs, yet, even during the aftermath of the coronavirus outbreak, digital transformation projects are on the rise instead of being put on hold. Reduced workforce, doing more with less, and expectations to increase productivity while remaining efficient are a few of the reasons enterprises move towards data automation and a technology driven infrastructure.

FOSTER: The COVID-19 crisis has triggered an acceleration in the adoption of finance technologies. Nilly Essaides, senior research director of finance, EPM and FinOps and Bill Marchionni, senior director, finance advisor at The Hackett Group, continue our segment on 2021 Key Issues identified in their survey, one of which was aggressive growth projections for several tools and solutions. Nilly Essaides starts by giving us her insights as to the top growth areas for finance digital transformation this year and elaborates on the reasons why.

ESSAIDES: When the crisis happened and we were studying things and looking and researching what was the immediate effect on finance transformation and digital transformation, we found and we were very delighted to find that even though cost revenue pressures have put great scrutiny on discretionary spending and on new or existing projects, most finance transformation efforts, regardless of the technology, either continued as they were or even got accelerated because of some of the things we've talked about. There was a need to move to remote work. There was a need to produce greater insight. So, we see a lot of acceleration, in some cases significant, as well as aggressive year-over-year growth projections for some technologies. Let me get a little bit more specific.

We have a group of technologies we call process technologies, and there's a big impact there. We saw an acceleration for example of almost 30% in the adoption of ERP or finance suites, ERPs in the cloud, and that makes sense in the way that it enables access to data remotely. It reduces cost by reducing manual intervention, and it enables finance professionals to do more with less.

Some of the other process technologies, specifically, there's going to be a 32%. There has been acceleration in the adoptions of robotic process automation or RPA, and we see that manifested in very much a quicker way and maybe an intermediate step, if you don't have an ERP in the cloud solution yet to connect, to create a connective tissue between systems and data silos. RPA comes in with a year-over-year expected growth of 16% in order to build these connective ties.

RPA is great at taking repetitive tasks, very logical tasks, and taking them away from people and moving them into a machine, into a bot that can do that 24/7, very quickly. For example, what we refer to as

Video Transcript

1. 2021 Emerging Enterprise Themes – Part II

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t swivel chair activities where you have to take data from one system and input it into another system, that can be easily handled by a robot. You don't need a person doing that. It speeds it up. So, RPA is growing. ERP in the cloud is growing 25% year-over-year growth.

We also see significant growth in point solutions. For finance, again, cloud-based. Those are designed to plug functionality gaps within your enterprise system.

For example, solutions for planning or what we call EPM in the cloud, solutions for consolidation, for end-to-end account to report. A lot of these just fit right in and are easy to integrate because all of this is cloud-based.

There's also an increase in the adoption of what we refer to as analytics or data emerging technologies, and that again, that's very clear from what we've spoken about before, this emphasis on generating insight in a better way. With advanced analytics, the fastest acceleration, 35% said they're accelerating the adoption of advanced analytics with a 24% projected year-on-year growth, and accompanying that and very much related is an acceleration and the adoption of visualization tools and data management solutions.

FOSTER: Bill Marchionni continues with his views on the topic and starts by defining what we often refer to as a service delivery model.

MARCHIONNI: I'd like to comment on what we refer to as a service delivery model, and what that says is that there's a business that we support, and we need to make sure that the way we align finance supports that business, and we need to understand complexity, and there's controllable complexity, and there's non-controllable complexity.

So, for purposes of this decision, non-controllable complexity, really the businesses that we operate in. The products and services that our organization offers, the geographies that we operate in whether we're going to go grow organically or through acquisition. So, let's just say that that's out of our control. But the people process and technology decisions are our control. We own that.

It's imperative that we understand the strategy, that we align the finance of organization of the future to that strategy and then below that to make sure our technology architecture, modern finance architecture, aligns in that information chain, if you will.

I think that's important to know, and just a couple of other things that we see organizations working toward is really that end-to-end processing, and I'm thinking about the transactional side of finance right now, but that whole idea about trying to get through pass-through processing.

Do I even have to touch this piece of paper? Is there a piece of paper? Why is there a piece of paper? Do I even have to touch the information? Can it go seamlessly from a third party outside the walls of our enterprise into our information systems and show up at the laptop and the desk of an executive? That's the vision and that's where we need to get. Keeping that vision in mind in the context of the broader strategy that the organization is going with and that modern architecture technology infrastructure to support it all.

SURRAN: More often than not, companies do have a vision, more about implementation, though they may not necessarily consider all the risks associated with it. One example is cybersecurity. Companies will build firewalls, but may not look into their insurance policy to see the limits

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t for ransomware, which can be a critical mishap especially in the current environment.

MARCHIONNI: What I would say is that, we do have to acknowledge that and particularly in 2020 when you went to a decentralized model, right? People were no longer going to the office. They're working from home.

Now, you've got security issues that you had not envisioned. Now, you have thousands of employees suddenly working from home, sharing very important information. You've got privacy issues and concerns, and I think that obviously that is something that needs to be considered.

How much that might slow down a transformation remains to be seen, but that's going to be a big part of what organizations do have to wrestle with, but I think it might be a little bit easier in the sense that it sounds like the decentralized model. People working from home or some kind of hybrid are going to be here to stay for a lot of organizations.

Now they do have to think about, "This will be an ongoing recurring thing, so now we need to make long-term investments to do that, as opposed to, "Well, maybe this is a 90-day phenomenon, and we'll just try and put some Band-Aids on it." So, at least now, they can acknowledge it's critical and it's long-term critical. So, how do we address it?

FOSTER: Nilly shares her views.

ESSAIDES: Cybersecurity was one of the top three risks this year that was cited by senior executives across G&A functions. So, it was very much top of mind for a lot of CFOs, CHROs, CIOs. Everybody's thinking about it.

It also made it to the top five objectives for finance this year, because again, finance is dealing with very sensitive information, needs to be protected. It's proprietary. It's risky, so there's a big emphasis on making sure things are tight, and there's great monitoring of potential fraud for example in the payments area. Nobody is getting into the system. Shutting down any entry points that may be there, and technology can help with that because we now see solutions that are based on artificial intelligence that run through the systems and the data and pick up on abnormalities, things that just don't look right.

So, you can get a lot of help in fraud prevention and monitoring of fraud and activities using some advanced systems like banks have had for quite some time to look at credit card fraud and things like that. So, that's one part of it, but then at the same time, we also see a rising degree of comfort with the transition to the cloud.

We ran an EPM or enterprise performance management in the cloud study late last year; we were looking at planning, budgeting, forecasting solutions that have moved to the cloud, and we asked a couple of questions that are relevant here. One was what are some of the concerns that finance executives have about transitioning to these solutions, and the cyber risks or the security risk which was paramount when we ran the same survey in 2016 really moved down the list, reflecting an understanding, a recognition that vendors are doing a much better job in allowing and enabling these security protocols.

There's greater comfort, and that's a good thing for finance. Again, risk-averse, always thinking about what can go wrong. We see greater comfort, and one of the outcomes that we see also in terms of the benefits, not just the distributed work, there's access to greater functionality, but also user friendliness.

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t It's become a big issue for companies, making sure that whatever they offer their teams is something that is intuitive that they can use easily, that is not taking 3 weeks, 10 weeks, 8 weeks of training to figure out how to use.

So, this user friendliness has come up as the number one benefit of moving to the cloud, and interestingly, and I think that's a point we're going to see a lot of movement in is a change in the ownership of who owns the solution.

In 2016, the majority of the EPM solutions were owned by the IT department. In 2020, that flipped and the majority are owned by the finance team.

Now that doesn't mean finance is going rogue and doing its own thing. It has to be done in collaboration with IT, and IT provides that advice on security and solution selection and an enterprise align solution that doesn't interfere with everything else that's going at the enterprise digital transformation level, but it does show that finance is taking a more active role in how it's charting that future technology architecture.

FOSTER: Another key area from the study is the role of talent. Finance has traditionally underestimated the role of talent in its transformation process. However, there are currently positive signs that executives are recognizing the importance of developing new skills. Bill Marchionni shares some of these signs and how clients are addressing this imperative.

MARCHIONNI: Talent has been underestimated, and we have some data, and I'll give you a couple of data points in a moment on that, but I think it's important to hear directly from a CFO, and I'd like to share a story with you that we heard from a CFO about some of the talent she described. She said, "I had an aha moment and an oh-no moment," and they were one and the same, and it happened at the same time, and her story was they went through a major transformation. They did a wonderful job, but before the transformation, they had 11 different ERP systems that didn't communicate, didn't integrate, didn't speak to each other. They had an unwieldy chart of accounts that wasn't governed properly. They had master data management issues.

They're doing a lot of manual reporting. They went through a five or six-year transformation journey and did a great job, right? So, fast forward six years and now their scenario is they've got one ERP. That's a couple of instances around the globe. They've got a reduced chart of accounts with proper governance. They've done some master data management cleanup. They've digitized a lot of the reporting. They're doing a lot of push reporting. So, that was the before and after, and right when she was congratulating herself and her team, that's when she realized they forgot about talent management, and what she described was the process that she went through to identify who her high potential employees were, and if you think about the old model, and she said, "This is how I identified who a high potential person was," I'd have a question where I needed some information. I would ask somebody to get that to me, and the skill set that they had was the following.

They could go into 11 different ERP systems. They knew how to navigate into those systems. They knew where to find the data that I was asking them for. They knew where maybe it wasn't comparable from this part of the business to that part of the business, but they could download it into Excel. They could massage it. They could make it fairly comparable. They could do that. They could clean it up, and they can get that to me,

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t and they'd get it to me quickly, and that was valuable to me, and it was of tremendous value to me, but that was then and this is now, and now that's all automated, and that skill set has been automated. I don't need that anymore, and what I need is people who understand the business, people who have the sophistication and the presence who can literally sit at the table with the business and be taken seriously.

People who understand the business drivers, who understand risk, who can identify that. People who have the softer skills of understanding, "How do I get things done in this matrix environment that we have and this very complex environment that we have?" Those are the expectations that I have now, and I don't know if my team can do that, and when I look at my list of high potential people, I think some of them can get there. I know some of them can't, and now I've got an issue because I just have failed from a talent perspective. I think that was a tremendous example, and that can say more than anything I can about the importance of talent. We talk a lot about transformation, and we're going through digital transformation. We're talking about accelerating transformation.

Things will happen quickly, but what skill set will we need when all of this stuff is automated? Will I have it in three years? Well, I personally have that skill set, or am I going to fall by the wayside because I didn't upskill myself? Am I going to be able to upskill my team? What are those skills that we need and how do I get there?

So, that's I think just really a great example. I give her credit for acknowledging that and for sharing that publicly as a learning for all of us. More to our study and just some of the data on that, talent did make the top 10 this year. It was right in the middle. I think it was number five or six in a list of 10. Just to give it some context, in prior years, it wasn't even in the top 10.

So, CFOs are recognizing, "I may have had a blind eye to this. Maybe 2020 made me realize that," and I can't be blind to that any longer," and they're putting their dollars where their mouth is. 40% of them intend to launch a talent development program in 2021.

So, talent's important. We cannot forget about it. It's a critical piece of the service delivery model. It is one-third of the people, process and technology equation.

FOSTER: Nilly Essaides adds a couple of points to Bill's description.

ESSAIDES: When we ran our studies, and we ran multiple studies about skills, and just in the last week and a half, asked questions of participants on webcasts with over 100 participants about talent requirements, and we asked, "What are the skills that you have today? What are the skills you need in the future and where are the biggest gaps? Where do you need to focus your development?"

Yeah, digital skills. So, tech savviness and data savviness were right up there, but just as important, we saw an emphasis on collaboration, communication, and this word that seems not to come from the finance world at all, storytelling.

So, for finance to be able to be that business advisor and influence decisions over which it has no control, it needs to be able to take the insight that it has and tell a story. Tell a compelling story. So, whoever they're speaking with will be able to change or will change their mind or at least challenge their thinking in a way that makes sense to them. So, I

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t think it's very important to realize that we're going to need all kinds of digital experts coming into finance. One of the big ones that surfaced in our key issue study was an RPA manager, right? Because we were expecting a lot more of the RPA deployment in finance organizations, but we need also, as Bill was saying, people with these core skills that are able to become business partners as the automation takes care of a lot of what was previously very important.

SURRAN: One of the most concerning findings was that the majority of finance organizations are struggling to meet business expectations for some of their most important objectives. Nilly Essaides discusses the more critical development areas and what finance executives do to better meet business needs.

ESSAIDES: In our study and in our experience, we asked, "What are your top objectives?" We also asked, "How ready, how prepared are you to deliver on the expectations the business needs related to them?" In some areas, finance is doing just great.

It's the traditional areas. So, cost control, working capital, even sales support, but in some more ambitious areas and in two of the top three, it's not faring as well. It's struggling. That's being a business advisor and becoming an analytics expert for the organization.

Those are areas that are relatively new and outside the scope of traditional finance, but the good news is that when we looked at the initiatives that finance has on its plate for this year, we talked about some of them. They're directly linked to closing those gaps.

Finance is aware that this is an area where it needs to do better. So, for example, on the business advisory side, what are some of the things that a finance organization can do? We talked about some of them. The communication aspect, the bringing insight to the table, influencing without owning.

These are all very important, but also what you need to do I think is look at some of the delivery, and as we were talking about the service delivery model, how you interact and engage with your business partners, and you need to take a customer or stakeholder-centric approach. What does that mean in practice because we hear that word bandied about a lot, customer-centric.

Customer-centric from a finance standpoint typically refers to an internal stakeholder. Although in some cases like in the customer-to-cash process, there is an interaction with an external party, but looking at some of those internal stakeholders and how you need to approach that, there's a focus on standardizing end-to-end processes in the background that you have to do that so you can automate. Maybe you move some of those activities into a global business services organization or shared services organization to make it more efficient to allow others to focus on other things.

So, while you're standardizing those back office processes, the backbone, you need to customize or create more bespoke solutions for your end stakeholder. We talked about visualization. Make sure that they're getting a very easy user-friendly way to look at data to understand data.

Some customers of yours may want 10 reports. Others may just want one. If it's the senior management, they want a dashboard that highlights the key things they're monitoring, the KPIs for the organization. The end user experience needs to be focused on what that end user needs, how much of it, what cadence they need to use it for, level of granularity. You can do all that cost effectively now while standardizing the back end.

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t There aren't huge adoption levels of advanced analytics solutions or the analytics suites within ERPs, but it doesn't have to be that hard or that much of a leap. It actually can be much easier if you start by laying a data foundation. Again, that sounds like a lot, taking all your data from different systems and putting it in one place. You can skip that stage almost if you migrate to a cloud solution. You can create a data pool underneath all your systems that pools the data, harmonizes it, cleans it, cleanses it, that you can then pull into an overlay of an analytic solution, and those can be point solutions that you can implement very quickly. So, it doesn't need to take months, definitely not years, but not even months to put together something that can serve you well right away as you're working perhaps towards a more holistic solution.

FOSTER: Bill Marchionni gives us his views on technology as well as people.

MARCHIONNI: I wanted to make a couple of comments around technology, and I did want to talk about experience, and in Hackett, when we work with clients, we talk about efficiency, effectiveness, and experience, and Nilly alluded to this in her comments about internal stakeholders, but let's talk very specifically about our colleagues and even more specifically, let's talk about people who are early in their career, maybe right out of university or college or very first couple of years in their career, and if they come into our environment... I guess I take a giant step back and say, a lot of people at that age in that level of their career have spent years managing their entire lives on a phone, right?

They are used to a digital experience that is phenomenal. That is the norm, and now if you come into an accounting and a finance organization that's behind the curve, and you're doing a lot of manual work, and you're doing a lot of transactional work, and you're not getting to the value-add work, that individual will not stay. They just won't. The experience will be not something they expected, not something they want to ride out, and they'll leave, and worse than that, they'll tell people, their friends, "Don't go work there because the experience isn't a good one," right? So, when we think about investments, we talk about cycle times and cost and ROI, and it's critically important, but now we get into other things.

What is that experience going to be? How is that going to help us attract talent, develop talent, retain talent and be an employer of choice, and is that something we should strive to and can we achieve that and how do we achieve that? I think that's important. Always think about experience as part of the puzzle here.

A little more specifically just on technology and ROIs, some of these technology investments are very difficult to make a standalone ROI case for, right? How many heads am I going to lose when I get a visualization tool? How many heads am I going to save when I get more analytics tools? That's not the value proposition. It's something different, right?

I think the organizations that are forward-thinking, the organizations that have been able to make the most on their transformation journey and their technology investments understand that sometimes we just have to do it because we have to do it.

We do have to understand what the financial impact is, but we're not going to get that traditional ROI case. We're certainly not going to get it

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t in a way that we can readily measure in the short term, and that takes leadership, and that takes leadership at the CFO level and other decision makers.

It also takes leadership from us to be able to articulate why we need those investments, why it's going to change, how it's going to change things, and how it's going to add value. So, it's incumbent upon us to take that leadership in trying to drive for that change and for that investment.

The other thing when we think about those investments, it is about the customer experience or the internal experience. It's also about agility, scalability, and planning for the future.

What is that roadmap? We talked about the finance service delivery model and the strategy of the organization. We have to make sure we're seamless. We have to make sure we're ready for that, and what 2020 taught us is we need to expect the unexpected and dramatic things can happen, and some organizations respond a lot better than others. So, technology, but that whole experience is an important piece that we need to be well aware of.

FOSTER: Bill Marchionni and Nilly Essaides conclude our segment and leave us with their final thoughts.

MARCHIONNI: There are three things to think about. One is speed to realization. So, this is about speed. This is not about overthinking, right?

If you think about the agile project transformation methodology, and we haven't talked about that, but that's all about speed, right? I'm not going to put it together... I'm not going to dot every I and cross every T on how I'm going to transform this process and spend a year and a half doing that and then three years implementing it. I've got to move, and I have to move quickly.

We talked about some of the learnings from the close and changing the use of estimates, changing the number of approvals, those things. They're all about speed. How can I get things done with less friction? So, speed to realization is important.

Decision making and uncertainty, right? We have to leave our comfort zones. We had good successes in that with the close examples that we gave. That's a muscle that we need to embrace and use. So, we talked about uncertainty. It can be a challenge particularly for financial and accounting people, and I'll raise my hand to that one, but that is, and I think Nilly alluded to that, decision-making and uncertainty and management in uncertain times.

We need to focus on that and the service delivery model. That really is saying we understand where the business is going. We're not guessing. We understand it. We've seen their plans. We've spoken to them. We've spoken to them about how we want to integrate, and we've shared with them how we're going to support it. So, having a well-thought-out integrated service delivery model is a key thing to focus on also. So, those are the three things. Again, speed to realization, decision making and uncertainty, and a comprehensive service delivery model.

ESSAIDES: I want to end on a positive note because 2020 was a very difficult year. It was a shock to the system for many organizations and finance in particular, and it did test or stress test a lot of what finance was doing. To Bill's point, finance was also able to prove to itself that there are things

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t that it can actually get done in ways it never believed that it can get done.

It was really a wake-up moment for a lot of the finance leaders, and I think what's important to think about going forward is how to make some of those changes operationalized and make them sustainable so that finance emerges from this not handicapped by any of these, but rather can move forward and be better because that's what it's going to have to be as it helps the organization move forward itself into the next normal.

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Segment Two

3–112

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two 2. What Makes Convertible Bonds Popular?

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Learning Objectives:

Segment Overview:

Field of Study:

Recommended Accreditation:Reading (Optional for Group Study):

Running Time:

Video Transcript:

Course Level:

Course Prerequisites:

Advance Preparation:

Accounting

Work experience in financial reporting or accounting, or an introductory course in accounting.

None

1 hour group live 2 hours self-study online

Update

“Recent FASB Simplifications to Convertible Bond Accounting”

“Diluted EPS for Convertible Debt Securities: A Primer”

“In a Crisis, Convertible Bonds Can Be an Attractive Way to Raise Cash”

“COVID-19 and Startups: The Case for Convertible Bridge Notes“

“Creative Financing Using Convertible Securities And Warrants”

See page 2–13.

See page 2–22.

34 minutes

Convertible bonds are always a discussion item as companies are often concerned with proper classification. FASB simplified issuer’s accounting for convertible instruments and contracts on an entity’s own equity with issuance of ASU 2020-06, in an effort to reduce unnecessary complexity currently in U.S GAAP. Josh Schaeffer, director at Equity Methods, discusses the sexy side of debt and why convertible bonds are gaining more and more popularity, especially in times of financial crisis.

Upon successful completion of this segment, you should be able to: l Describe the main changes under ASU 2020-06 on the

treatment of convertible bonds, l Identify some of the key features of convertible debt and the

main reasons to issue convertible bonds, l Recognize the accounting considerations of convertible

bonds, and l Understand the complexities of embedded derivatives.

Expiration Date: January 13, 2023

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A. Convertible Bonds – Equity vs Liability

i. Equity l Indexed to an entity’s own equity

b ASC 815-40-15 l Meets the equity classification

conditions b ASC 815-40-25

ii. Liability l Conditions above are not met

B. Changes Under 2020-06 – Equity Classification

i. Conditions removed l Settlement permitted in

unregistered shares l No counterparty rights rank higher

than shareholder rights l No collateral required

C. Changes Under 2020-06 – EPS Calculation

i. Denominator of diluted EPS should use l Average market price l When exercise price or number of

shares is variable

ii. Exceptions l Certain contingently issuable

shares

D. Changes Under 2020-06 – “If-Converted Method”

i. Must apply to all convertible instruments

ii. Treasury stock method is no longer available

iii. Removes an entity’s ability to rebut the presumption of share settlement

iv. Extends the scope of recognition & measurement

I. Changes Under ASU 2020-06

Outline

A. Why 2020 Was a Record Year

i. Lower stock prices don’t promote equity sales

ii. Increased interest rates make it harder to borrow

iii. Variability in the market

B. Key Features of Convertible Debt

i. Equity l Fully dilutes the capital structure l Selling company stake

ii. Debt l Fixed maturity l Expensive

C. What Do Companies Get Back?

i. Giving the option to buy stock l Offer lower interest rates

ii. When stock price goes up l Conversion feature kicks in

l Don’t have to pay interest l Allows cash inflow for operations

“…convertible debt becomes more attractive, because there's less money flowing out of the company's pocketbook on a quarterly basis when these debt payments come.”

— Josh Schaeffer

D. Reasons to Issue Convertible Bonds

i. Preferred method of financing for l Rapidly growing companies l Less access to capital l Favorable financing terms

ii. In financial downturns l Independent of company’s size l For both healthy & distressed

companies

II. Features and Benefits of Convertible Debt

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A. Approaches Retained Under ASU 2020-06

i. Traditional convertible debt l All profits are recorded as debt

ii. Convertible debt issued at a substantial premium l First measured at principal

amount l Residual amount allocated to

equity

iii. Convertible instrument with a bifurcated embedded derivative l Embedded derivative first

measured at FV l Residual amount allocated to

host contract

B. Embedded Derivative Complexities

i. Not in a standard valuation model

ii. May allow for l Early conversion l Premium conversion

iii. May include a down-round provision

iv. Pay same dividend to convert holders to prevent early conversion and dilution

v. Valuation impact

IV. Simplification Initiative

A. Accounting Considerations

i. Standard convertible bond l Mark out different ways

including fair value

ii. Standard debt

iii. Cash conversion feature

B. Historically – Needed to Break Out

i. Value of option that pays in cash

ii. Value of the underlying debt

C. Breaking Out the Value of the Feature

i. Take the value as one piece

ii. Lower the discount rate on the debt

iii. Accrete for a larger interest rate

D. Substantial Premium at Issuance

i. Certainty of conversion l Equity from day one

ii. Uncommon in the markets

iii. Beneficial conversion feature l More equity than bond is worth

iv. Common in small companies l Illiquid stock

III. Accounting for Convertible Debt

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Outline (continued)

A. Basic EPS Calculation

Income

Common Shares Outstanding

B. If-Converted Method Considerations

i. Event of conversion at the beginning of the accounting period

ii. Two effects l Interest paid on the convertible

debt l Shares of debt conversion

b Income is diluted

C. Earnings per Incremental Share

i. Calculate earnings from each share

ii. See the number of shares l Added to the model

b High earnings per incremental share

l Non-dilutive instrument

D. Bond Plus Option Treatment

i. Treat a bond as a bond l If company pays cash back

ii. Treat option component using the treasury stock method

iii. Less frequently used

iv. Requires a company’s ability to pay l Cash for the convertible bond

b Principal & initial interest

v. Method no longer allowed under ASU 2020-06

V. What Happens after Issuance

A. ASU 2020-06: The Perfect Storm

i. Low asset values

ii. Significant opportunity for potential recovery

iii. Higher bond rates

iv. Companies in need of money

B. “In times of turmoil, convertible bonds are a good way to raise capital”

— Josh Schaeffer

C. Options for Convertible Instruments

i. Use of convertible debt with paid-in-kind interest

ii. Use of convertible preferred l Allows for equity conversion

b If the company does well l Provides liquidity preference

b If the company does not do well

VI. Optimal Environment for Convertible Debt

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A. Convertible Bridge Notes

i. Better value for taking extra risk

ii. Great way to raise money quickly

iii. Short-lived

B. Embedded Derivatives – What to Look at

i. Instruments on day one

ii. Different features

iii. Total issuance price

iv. Impact

v. Movement of probabilities & the market

C. Why Are Convertible Bonds Attractive

i. Financing alternatives for companies in need of cash due to l Financing crisis l Growth

ii. Intriguing for investors l Fixed income l Upside potential

VII. Convertible Bridge Notes and Embedded Derivatives

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1. What are the main changes under ASU 2020-06 on the treatment of convertible bonds? How do these changes simplify accounting for convertible bonds for your organization?

2. What are some of the key features of convertible debt?

3. What are the main reasons to issue convertible bonds? How has your organization benefited from convertible bonds?

4. What are some accounting considerations of convertible bonds? What are the three approaches with respect to the allocation of proceeds attributable to convertible debt instruments retained under ASU 2020-06? How has ASU 2020-06 reduced the complexities of accounting for convertible debt at your organization?

5. What are the complexities of embedded derivatives?

6. What accounting methods are available for convertible debt after issuance? Which method has your organization used to calculate EPS?

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2. What Makes Convertible Bonds Popular?

l As the Discussion Leader, you should introduce this video segment with words similar to the following:

“In this segment, Josh Schaeffer discusses why convertible bonds are gaining more and more popularity, especially in times of financial crisis.”

l Show Segment 2. The transcript of this video starts on page 2–22 of this guide.

l After playing the video, use the questions provided or ones you have developed to generate discussion. The answers to our discussion questions are on pages 2–8 to 2–10. Additional objective questions are on pages 2–11 and 2–12.

l After the discussion, complete the evaluation form on page A–1.

Discussion Questions

You may want to assign these discussion questions to individual participants before viewing the video segment.

Instructions for Segment

Group Live Option

For additional information concerning CPE requirements, see page vi of this guide.

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7. What are the difficulties privately held companies face figuring out the enterprise’s value and available options? What difficulties has your organization faced regarding convertible bonds?

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sDiscussion Questions (continued)

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1. What are the main changes under ASU 2020-06 on the treatment of convertible bonds? How do these changes simplify accounting for convertible bonds for your organization? l Removal of the following

b Settlement permitted in unregistered shares

b No counterparty rights rank higher than shareholder rights

b No collateral required l Amends certain guidance on the

computation of earnings per share (EPS) b Average market price should be

used to calculate the diluted EPS denominator

b When the exercise price or the number of shares that may be issued is variable

b Except for certain contingently issuable shares

l If-converted method b Must apply to all convertible

instruments b The treasury stock method is no

longer available b Removes an entity’s ability to

rebut the presumption of share settlement

b Extends the scope of the recognition and measurement guidance in ASC 260 on financial instruments

l Participant response based on personal/organizational experience

2. What are some of the key features of convertible debt? l Equity

b Fully dilutes the capital structure in downside and upside scenarios

b Selling more stake in the company to more people

b Identical to what other holders have

l Debt b Has fixed maturity b Do not have to give away part of

the company b Has a coupon that needs to be

paid or accrued on the instrument b At the end of the day, it needs to

be repaid b Can be expensive because

investors in debt do not necessarily have the same upside potential

l What companies get back b If they are giving away the option

to buy into their stock, people will demand a lower interest rate

b If the stock price goes up v Conversion feature usually

kicks in v Do not have to pay interest v Allows cash for operations

3. What are the main reasons to issue convertible bonds? How has your organization benefited from convertible bonds? l They are a preferred method of

financing for companies that: b Are growing quickly b Have limited access to capital b Have favorable financing terms

l In financial downturns b They tend to be issued more often

and by more types of companies b Both companies that are doing

well and companies that are in some amount of distress

l Participant response based on personal/organizational experience

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s Suggested Answers to Discussion Questions 2. What Makes Convertible Bonds Popular?

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4. What are some accounting considerations of convertible bonds? What are the three approaches with respect to the allocation of proceeds attributable to convertible debt instruments retained under ASU 2020-06? How has ASU 2020-06 reduced the complexities of accounting for convertible debt at your organization? l Standard convertible bond

b Allows you to mark out different ways including using the fair value method where you mark the fair value to market

l Standard debt l Cash conversion feature

b Break out the value of the feature b Take the value as one piece b Lower the discount rate on the

debt b Accrete for a larger interest rate

because the option has been removed

l Substantial premium at issuance b Debt that is almost certainly

going to convert v Equity notion from day one

b Not typically seen in the markets b Reflects a beneficial conversion

feature v At the date of issuance, the

bond can convert into more equity that it is worth

b Typically happens with small companies where stock is illiquid

l Three approaches under ASU 2020-06 b Traditional convertible debt

v All profits are recorded as debt

b Convertible debt issued at a substantial premium v Debt is first measured at

principal amount v Residual amount is allocated

to equity

b Convertible instrument with a bifurcated embedded derivative v Embedded derivative is first

measured at fair value v Residual amount if allocated

to the host contract l Participant response based on

personal/organizational experience

5. What are the complexities of embedded derivatives? l Not in a standard valuation model l May allow for early conversion or

premium conversion b On an event that triggers, like an

IPO l May include a down-round provision l Pay the same dividend to convert

holders to prevent early conversion and dilution

l Valuation impact

6. What accounting methods are available for convertible debt after issuance? Which method has your organization used to calculate EPS? l On a go-forward basis, the bonds can

convert into shares and need to be considered as part of EPS

l EPS calculation is income divided by common shares outstanding

l If-converted method b Common way to calculate diluted

EPS b Consider what would have

happened if the convertible bond was converted as of the beginning of the accounting period

b Two different effects v Interest that you paid on the

convertible debt that you would have saved

v You have shares that the debt would have been converted into

b This dilutes all of the income, not just the income from these additional pieces su

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Suggested Answers to Discussion Questions (continued)

2–10

l Earnings per incremental share b Calculate the earnings you get out

of each share, and b Seeing how many shares are

there, that is how many are added to the model

b If the earnings per incremental share are too high, it would be a non-dilutive item

b In accounting, you take into account the dilution, but not anything that is anti-dilutive

l Bond with an option component b Treat the bond as a bond if it is

expected that company would pay the cash back

b Treat the option component using the treasury stock method

b Typically is the less frequently used accounting

b Requires a company to be able to establish that they were planning to pay cash for the convertible

b No longer allowed under ASU 2020-06

b Must use the if-converted method after adopting ASU 2020-06

l Participant response based on personal/organizational experienc

7. What are the difficulties privately held companies face figuring out the enterprise’s value and available options?

What difficulties has your organization faced regarding convertible bonds? l Private companies can’t just look at

the stock page to figure out the value of the enterprise

l They can use convertible debt with paid-in-kind interest only b Often may pay no dividends b Or it may pay dividends which

are often accrued to the security, only paid out when there is a sale or IPO at the end

b Allows the company to work on financing now, but allows people to buy in

l They can use convertible preferred b Allows for conversion into equity

as things go well b Covered by a liquidity preference b If the company does not have an

IPO or does not do well, the convertible holders are allowed to get their value out first

l Participant response based on personal/organizational experience

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1. ASU 2020-06 changed the treatment of convertible bonds by:

a) requiring the use of the treasury method

b) requiring the use of the if-converted method

c) adding an entity's ability to rebut the presumption of share settlement

d) reducing the scope of the recognition and measurement guidance

2. One of the key features of convertible debt is:

a) it does not have to be repaid

b) it gives away a part of the company

c) it has a fixed maturity

d) it does not dilute the capital structure

3. Which is NOT a method to account for convertible debt instruments under ASU 2020-06?

a) traditional convertible debt

b) convertible debt issued at a substantial premium

c) convertible instrument with a bifurcated embedded derivative

d) convertible debt with a cash conversion feature

4. Which of the following is a complexity of an embedded derivative?

a) it is not in a standard valuation model

b) it does not allow for premium conversion

c) it pays no dividends to convert holders

d) there is no valuation impact

5. Which accounting method must be used after issuance of convertible debt?

a) bond with an option component method

b) treasury stock method

c) if-converted method

d) the EPS method

6. Convertible preferred:

a) allows for equity conversion if the company does well

b) does not require dividend payments

c) does not provide liquidity preference

d) sits above the senior debt

7. Under the traditional convertible debt model:

a) the premiums are recorded as paid-in capital

b) conversion features are bifurcated as derivatives from the host contract and measured at fair value

c) the host contract is measured at fair value and conversion features are recorded as equity

d) no separation is required because the instrument as a whole is recognized as debt only

8. Under ASU 2020-06, a convertible debt instrument will be accounted for as:

a) a single equity instrument

b) a single liability

c) an expense

d) as income

You may want to use these objective questions to test knowledge and/or to generate further discussion; these questions are only for group live purposes. Most of these questions are based on the video segment, a few may be based on the reading for self-study that starts on page 2–13.

Objective Questions

2. What Makes Convertible Bonds Popular?

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9. With convertible bonds, when the stock price goes up:

a) the bonds pay out like debt

b) the company incurs greater future debt payments

c) holders can convert the bonds to equity

d) the company has to borrow at a higher interest rate

10. In times of market certainty, bridge notes offer:

a) immediate cash

b) price uncertainty

c) a longer term

d) a full funding round

Objective Questions (continued)

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Self-Study Option

Reading (Optional for Group Study)

RECENT FASB SIMPLIFICATIONS TO CONVERTIBLE BOND ACCOUNTING

By Josh Schaeffer, PhD and Nikhil Guruji Source: https://www.equitymethods.com/articles/recent-fasb-simplifications-to-convertible-bond-accounting/

A frequent concern for companies is how to classify debt and equity. Convertible bonds, which have features of both, are especially confusing because of differences in accounting for seemingly similar instruments. In response to this, on August 5, 2020, FASB released an update under ASU 2020-06. The update aims to make it easier to understand and implement the current guidance on financial instruments that have liability and equity characteristics.

For convertible instruments, FASB eliminated the need to use multiple models to handle some common convertible features. They also simplified part of the classification analysis. However, separate accounting remains in place for two other unique circumstances, specifically:

l Embedded derivatives with conversion features that are not clearly or closely related to the host contract

l Convertible debt issued with substantial premiums that are recorded as paid-in capital

Additionally, FASB amended EPS guidance and other derivative scope exceptions that are currently causing some derivative contracts — ones with similar economic characteristics — to be treated as equity for accounting purposes.

In this blog post, we step through some of the key differences applicable to most convertible bond securities.

Convertible Instruments Classifications

Prior to the new guidance, accounting for convertible debt instruments under GAAP could involve five different models. Four

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l In order to ensure adherence to

NASBA guidelines regarding self-study, the CPA Report and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers are no longer available. Customers should contact their company administrators for information on taking course exams and receiving CPE credit for the courses.

l Customers may contact Kaplan Financial Education at cpesupport@kaplan.com to obtain certificates previously earned through the CPA Report Self-Study and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers.

l Customers interested in the self-study format of the CPA Report can find information on Kaplan Financial Education's self-study libraries at Online Accounting CPE Courses.

CPA Report Update

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require separation of the debt and equity components:

1. Embedded derivative (815-15). This model accounts for embedded derivatives with conversion features that are not clearly or closely related to the host contract. Conversion features are bifurcated as derivatives from the host contract and measured at fair value. This bifurcation is still required under ASU 2020-06.

2. Substantial premium (470-20). Under this model, the premiums are recorded as paid-in capital. Under ASU 2020-06, for a convertible debt instrument issued with a substantial premium, these premiums will continue to be separated from the debt instrument and recorded as an equity component.

3. Cash conversion (470-20). This model accounts for convertible debt instruments that may be settled partially or wholly in cash upon conversion, an extremely common feature. The host contract is measured at fair value as any other non-convertible debt instrument, and conversion features are recorded as equity components at residual value. This separation is no longer applicable under the ASU 2020-06.

4. Beneficial conversion feature (470-20). This model accounts for convertible debt instruments that are in the money at issuance, or become in the money at a later date upon the occurrence of certain contingent events. Conversion features are recorded as equity components at intrinsic value, and the host contract is recorded at the residual amount. This separation is no longer applicable under ASU 2020-06.

The remaining model requires no separation because the instrument as a whole is recognized as debt only:

5. Traditional convertible debt (470-20). Under this model, the convertible debt instrument as a whole is recorded as a single debt instrument measured at amortized cost. This remains applicable under ASU 2020-06.

Preparers of financial statements have often faced confusion over the models that require separate accounting. This leads to financial statements that are inconsistent with the results of analyses, as well as interest expense that excludes convertible note features and therefore can significantly differ from the note coupon rates.

To address this problem, FASB simplified the accounting treatment for convertible debt by removing these separation models from subtopic 470-20, Debt – Debt with Conversion and Other Options, for convertible instruments:

Consequently, a convertible debt instrument will be accounted for as a single liability measured at its amortized cost and a convertible preferred stock will be accounted for as a single equity instrument measured at its historical cost, as long as no other features require bifurcation and recognition as derivatives. By removing those separation models, the interest rate of convertible debt instruments typically will be closer to the coupon interest rate when applying the guidance in Topic 835, Interest.

Disclosure Updates FASB amended the standard convertible instrument disclosures so that it’s easier to understand the detailed disclosure requirements. Companies will need to add disclosure information about anything that causes conversion contingencies to significantly change over a reporting period. In addition, companies will have to disclose which party controls the conversion rights. Finally, they’ll need to disclose information for each convertible instrument individually instead of aggregating them.

FASB also changed the disclosure guidelines for contingently convertible instruments as well as for convertibles with substantial premiums. The idea was to make the accounting more consistent with standard convertibles. These types of securities are less common, so they aren’t covered in detail.

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Derivatives Scope Exception for Contracts in an Entity’s Own Equity

Under the current guidance in Subtopic 815-40, Derivatives and Hedging – Contracts in Entity’s Own Equity, companies had to determine whether a contract related to derivative instruments — such as those with embedded features, freestanding financial instruments, and instruments settled in entity’s own stock — qualified for a scope exclusion from derivative accounting and the related mark-to-markets. According to the FASB, this was resulting in form over substance conclusions based on some of the potential factors. The conversion feature in convertible debt, as well as the structure of warrants, are frequent subjects of this analysis.

Two analyses are required for this scope: The contract must be equity classified and also considered indexed to an entity’s own stock. At the same time, legal opinions are no longer required for settlement in unregistered shares, collateral, and shareholder rights. These three conditions often either required in-depth analysis or caused instruments to fail to meet this exception, even though they had no effect on the instrument’s economics. Excluding these components means more consistent identification of substantially similar instruments.

EPS Historically, most companies have used the if-converted method for convertible debt. But if a company could support the assumptions that they could and would settle their convertible debt with cash versus stock, they could use the treasury stock method instead. Under the new guidance, this different treatment is eliminated. All convertible debt will require the if-converted method.

Other Notes

In addition to the factors noted above, the new guidance contains significant clarifications on the application of this accounting and the disclosure requirements, based on differences seen in reporting and less common features of various contracts.

One of the most anticipated pieces of this guidance was a remote-likelihood threshold for features that violated the indexation and classification guidance. In other words, a feature would not trigger derivative accounting just from being in a contract. Instead, it would have to have a reasonable probability of occurring. This has been pushed to a future project. Even so, if the probability of these features is remote, the value of these specific features is typically negligible since they’ll be triggered only rarely.

Effective Date The amendments are effective for public business entities that meet the definition of an SEC filer — excluding entities eligible to be smaller reporting companies as defined by the SEC — for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. FASB has specified that an entity should adopt the guidance as of the beginning of its annual fiscal year.

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By Josh Schaeffer, PhD Source: https://www.equitymethods.com/articles/diluted-eps-for-convertible-debt-securities-a-primer/

Convertible securities can be an attractive source of capital for mature and early-stage companies alike, especially in today’s environment of sustained low interest rates. But their dilutive impact is a potentially complicated issue. For that, we can thank their unique combination of debt and equity-like features.

In this issue brief, we take a closer look at that impact, including:

l A review of the nature of EPS dilution and its effect on convertible debt

l An introduction of the “if-converted method” as the prescribed approach for convertible debt and other similar convertible securities

l Three examples of the if-converted method in action

Discover what makes the if-converted method an elegant way to determine the dilutive impact of convertible securities.

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DILUTED EPS FOR CONVERTIBLE DEBT SECURITIES: A PRIMER

IN A CRISIS, CONVERTIBLE BONDS CAN BE AN ATTRACTIVE WAY TO RAISE CASH

By Josh Schaeffer, PhD Source: https://www.equitymethods.com/articles/in-a-crisis-convertible-bonds-can-be-an-attractive-way-to-raise-cash/

The Wall Street Journal, Barrons, and the Financial Times have all recently taken note of convertible bonds’ rise to prominence. Evidently more than half of April capital raises—versus the usual 20%—were in the form of converts. That’s the largest share of the bond market in recent memory.

Convertible bonds are debt instruments that promise a specific cash flow stream. As we explain in our booklet, if the stock price goes up, holders can convert the bonds to equity and capture this upside. If the stock price goes down, the bonds pay out like debt based on the principal value and the company’s available capital. The benefit to companies is that they can borrow at a lower interest rate. What’s more, if the stock price increases, companies often can retire the debt early by forcing conversion—getting rid of future debt payments.

In today’s economy, convertible bonds offer a unique value proposition. Here’s why:

Companies need cash. Perhaps more than ever, companies have seen a rapid decline in available cash. Brick-and-mortar stores have closed, restaurants are committed to carryout, and travel is down. Meanwhile, production in many industries has been cut to the bone—and for energy companies, the prices they’re receiving for their product is at historic lows. All this happened suddenly, leaving companies with little room to prepare.

Even so, companies still need cash to operate and many companies have discovered that their reserves aren’t sufficient to cover their needs. As the economic impact continues to unfold, we expect more companies to do what they can to get cash, including going to public and private markets for new issuances.

Equity is unissuable. “Buy low, sell high” makes sense for investors and companies alike. By issuing low-priced equity,

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companies can dilute the holdings of existing shareholders. Companies going through the math will quickly determine that these issuances are quite unfavorable. Others may find that the number of authorized shares is simply insufficient to raise the amount they need at current prices.

Borrowing is expensive. Although the Federal Reserve has lowered its core interest rates to near zero, there’s been a dramatic flight to quality. As a result, we’ve seen the required returns on government bonds—effectively certain to pay out—go down. Meanwhile, returns on corporate bonds, even controlling for credit rating, have gone up.

Figure 1 shows the trend by comparing the movements in BBB (investment grade) and BB (non-investment grade) interest rates from the beginning of this year.

Note that bond agencies have also been downgrading companies at their fastest rate since 2008, potentially raising borrowing costs even more. The exposure to high interest rates can be especially unsettling when cash flow is uncertain.

Volatility is high. Volatility is a measure of uncertainly about future stock prices. The more volatile the company’s stock, the greater the interest savings on a convertible bond, as Figure 2 shows.

Said differently, although the option value of the conversion feature lowers the effective interest rate, the amount of savings depends on the company’s stock volatility. Under current economic conditions, volatilities are quite high. Figure 3 shows how the CBOE Volatility Index, or VIX, has moved based on short-term S&P options.

The same pattern is present in long-term options, meaning that companies using converts may get substantial interest savings over fixed bonds.

Investors fear missing out. Although issuing convertible bonds in a down market can help companies save on interest, investors also benefit because they can get closer to market returns in a recovery. This can be very appealing to investors eager to avoid falling behind in an up market.

Of course, companies should be aware of the downstream implications of convertibles. First, these bonds will dilute shareholders if the company increases in value. Beyond that, accounting classifications can vary depending on what the conversion and other features look like. Special terms can

sometimes result in embedded derivatives and features which are marked-to-market. Other cases may at least require an upfront accounting for the conversion feature and bifurcation. In addition, future EPS may rely on the if-converted method which can be confusing, especially with multiple

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issuances. The upshot is that while these financings are attractive, being careful about your issuance can further improve the usefulness of this unique and important financing tool.

If you have any questions about convertible debt—or any other financings—please contact me.

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COVID-19 AND STARTUPS: THE CASE FOR CONVERTIBLE BRIDGE NOTES

By Josh Schaeffer, PhD and Gavin Hagfors Source: https://www.equitymethods.com/articles/covid-19-and-startups-the-case-for-convertible-bridge-notes/

It’s been an unsettling time for global financial markets. Covid-19 has created the uncertainty that was lacking in the bull market of the last 10 years. The result has been volatility in public company valuations rarely seen before, not to mention significant cash flow issues within multinational companies. Inevitably, the pandemic shock has also hatched financing problems for startup companies as capital markets grow increasingly competitive for fewer available dollars.

Startups rely on funding until they can generate sufficient revenues to operate. However, issuing a new round of preferred stock may not be feasible today because valuations and timing are more uncertain, leading investors to demand additional concessions. Further, a down round in these situations may trigger features for older investors, an outcome many would prefer to avoid.

For startups that need cash, the question becomes how to continue operations without locking the company or current investors into unfavorable terms. Convertible bridge notes, which allow investors to invest today to get into future rounds at a discount, can be a great solution. Before we explain why, let’s walk through some of the alternatives.

Traditional Funding Sources A new round of preferred stock. This is the favored approach for early stage private companies. Buyers of preferred stock provide essential funding and are willing to take on the risks and lack of liquidity from private companies. That being said, market downturns can find these investors sitting on a smaller amount of capital for investment (what the industry calls “dry

powder”) while they contemplate a larger number of opportunities. Beyond that, for a traditional investment they need to establish a good sense of what the company is worth and how and when they’ll be able to recoup their investment and profit. Finally, if the round is below past issuances, various down round protections may kick in, diluting investors without these protections.

An IPO. The company could take a stab at the public market, but this has several drawbacks:

l Price uncertainty is still an issue. The company will likely be locking in unfavorable pricing and triggering events for previous rounds of preferred financing.

l The IPO process is long and difficult. Even if the company has an existing relationship with an investment bank, requirements like disclosures, accounting processes, and underwriting agreements take time and money—two things the company doesn’t have right now.

l It’s expensive. The investment bank will take 4-7% just for assisting with the IPO, the company will need to update its internal infrastructure to match SEC requirements, and the incremental costs of being publicly traded are considerable. A PwC survey found 83% of CFOs estimate spending more than $1 million in one-time costs associated with the IPO, and two-thirds of CFOs surveyed estimate that being public costs $1-2 million annually.

The upshot? An IPO can be an expensive, long-term solution to a temporary problem—which is why the IPO market tends to dry up in a crisis.

Bank loans. In general, we see limited borrowing from startups. Traditional loans are costly, take longer than immediate needs require, and can tie down a company with

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unfavorable terms for years. For their part, banks face more repayment risk with market volatility. Private companies that pursue this route may have to accept a higher interest rate or not get approved for a loan at all.

Government assistance. Funding from the CARES Act and other relief packages has been hard to come by and is often reserved for specific sectors. For instance, the Paycheck Protection Program ran out of cash within days and largely depended on banking relationships that many startups lack. Government aid also may come with rules around employment, executive compensation, or other factors at odds with the company’s economics.

Bridge Notes to the Rescue Bridge notes can cut through a number of these problems. As a short-term loan meant to “bridge” a company into the next round of financing, these notes usually are for smaller amounts than a full funding round. At the end of the period, a bridge note can be converted into equity in the company at a fixed price, often at a premium or with special terms for investors.

In times of market uncertainty, these terms offer many benefits to both investors and companies, including:

1. Price certainty. This is one of the concerns that can stop investment banks and private equity firms from investing in the first place. By locking in terms for the conversion to equity, funders are more likely to agree to terms that will be beneficial to them. Also, investors get downside protection in that they will still get repayment of the note and principal. In addition to removing obstacles to funding, price certainty makes it easier for investors to assess the true value of a company. We’ve even seen less sophisticated investors step in, with comfort that the future round will be a negotiated transaction allowing them fair terms and a premium.

2. A shorter term. This helps both the investor and the business in disruptive times.

From the company’s perspective, there’s no multiyear lock-in with unfavorable terms—especially important when the market situation could turn around in a year or so. From the investor’s perspective, giving money to businesses over time (instead of all at once) offers flexibility and limits risk. In both cases, the short-term factor allows everyone to wait and see before more significant moves.

3. Immediate cash. For a business, timing can spell the difference between life and death. Does a startup really want to lock themselves into a preferred round at $10, despite a long-term fair value of $15? The company will receive less money, and the transaction reflects poorly on the company’s prospects due to investor anchoring. The lesson is that a large investment isn’t always the answer. Sometimes, the better path is to focus on the vision and just use a bridge to get to the next major round or issuance.

The volatility in markets in the last few months reflects deep uncertainty about the future expectation of the economy. And for now, it’s creating ripples like the ones we’re seeing for startups. Although no tool is perfect for a situation like this, convertible bridge notes can be a clever way to sidestep the drawbacks of traditional funding sources and help fledgling companies persevere.

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Presented by Josh Schaeffer, PhD Source: https://www.equitymethods.com/webinars/equity-methods-convertible-securities-webinar/

Convertible securities are tools which combine features of debt and equity financing, and include convertible debt, convertible preferred stock, and warrants. They help companies raise capital while minimizing debt servicing outlays.

Convertible securities appeal to high-growth firms, firms with low credit ratings, as well as any firms looking to save on interest expense from financing. Stock warrants are a valuable capital raising tool, and are also often used in negotiating intercompany agreements, including mergers, acquisitions, and joint ventures.

The catch? They’re tricky to value and can lead to complicated accounting treatment.

l The landscape of financing instruments outside of pure debt and equity

l Ways that convertibles and warrants can impact financing activities

l How the use of complex securities differs between mature and early stage companies

l Techniques for estimating the fair value of convertibles and warrants

l Idiosyncratic features that can lead to accounting surprises

l How to prepare and plan pre-issuance to optimize the deal terms

Learn ways to manage the risks and benefits of these complex securities.

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CREATIVE FINANCING USING CONVERTIBLE SECURITIES AND WARRANTS

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tVideo Transcript

SURRAN: Convertible bonds are always a discussion item as companies are often concerned with proper classification. A freestanding contract on an entity's own equity, under current U.S. GAAP, is accounted for as an asset or a liability.

If it is considered to be indexed to an entity's own equity under ASC 815-40-15 and meets the equity classification conditions under ASC 815-40-25, it is then classified as equity. If those criteria do not apply, it is then classified as a liability.

In addition, if that contract has the characteristics of a derivative instrument, it is accounted for as a derivative at fair value under ASC 815, unless a scope exception applies.

FASB simplified issuer's accounting for convertible instruments and contracts on an entity's own equity with issuance of ASU 2020-06. Some of the changes under the Accounting Standard Update include the removal of the following three conditions for equity classification under ASC 815-40-25-10

l "Settlement permitted in unregistered shares."

l "No counterparty rights rank higher than shareholder rights.", and

l "No collateral required."

ASU 2020-06 amends certain guidance in ASC 260 on the computation of earnings per share (EPS) for convertible instruments and contracts on an entity's own equity and clarifies that the "average market price should be used to calculate the diluted EPS denominator" when the exercise price or the number of shares that may be issued is variable, except for certain contingently issuable shares.

Another change is that entities must apply the "if-converted method" to all convertible instruments, where the treasury stock method is no longer available. It removes an entity's ability to rebut the presumption of share settlement and extends the scope of the recognition and measurement guidance in ASC 260 on financial instruments that include down-round features to include equity-classified convertible preferred stock that contains such features.

FOSTER: There is nothing sexy about debt but convertible bonds are gaining more and more popularity and have become a hot topic. Josh Schaeffer, director at Equity Methods is here to tell us why.

SCHAEFFER: What we saw in the first half of 2021, especially when COVID came through and dropped asset prices, we saw quite a number of convertible bonds come out, which allowed 2020 to become the record year it was. And there are a few factors at play there.

The first factor is when stock prices are lower, companies are less willing to sell equity given that they get less money for what they sell. On the other hand, interest rates during this time period actually increased, making it harder to borrow because people really didn't want to bear a lot of risk.

2. What Makes Convertible Bonds Popular?

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t A final piece is that the variability in the market or the volatility was quite high. Everybody knew that the market could move a lot, either up or down, but nobody really knew which way it was going to go. So with those three components, you end up in what looks like a perfect storm situation. The convertible feature in these bonds is more valuable, which allows for more of a cheapening of the interest rate a company needs to pay to issue.

Meanwhile, because stock prices are lower, companies who are investing are more willing to take on the convert in cases that the equity values go back up, because they don't want to be stuck with just a lower bond rate when this higher potential rate is on the table.

FOSTER: Josh discusses some of the key features of convertible debt.

SCHAEFFER: To think about convertible debt, it really helps to look at the two pieces that it is comprised of, which are typically the other types of financing you might issue.

So the first one of those is equity. Equity fully dilutes the capital structure in downside and upside scenarios. And basically, you're just selling more stake in the company to more people, identical to what other holders have.

On the other hand, you have debt. Debt has a fixed maturity. You're going to pay that money back. So you're not going to give away part of your company in the upside, but debt also has a few other features. It has a coupon that you need to pay, or continue to accrue on the instrument, and at the end of the day, you're going to need to repay it. So while debt doesn't dilute, it can often be expensive because investors in debt don't necessarily have the same upside potential.

Meanwhile, if the company goes down in value, debt holders take over and equity holders get wiped out if the value is not sufficient to pay the debt. So when we put a convertible bond in, we're starting with a debt instrument, which means the payoff in okay or bad states of the world looks just like debt. But on the other hand, in good states of the world, the debt holder can say, "Hey, wait a second. I don't just want this debt, the equity holder did really well. I want my stake to look like theirs." So what does that mean? That means in low states of the world, very low, you get the recovery just like debt. In the middle, you get your value back and you get some interest payment. But when the company does well, you get company stock. Now, right now, you might be thinking, "Boy, that sounds like a terrible idea for the company.

"What do they get back for the fact that they're losing this best of both worlds?" And what they get back is simple.

If they're giving away this option to buy into their stock, people are going to demand a lower interest rate. You can't get something for nothing and in this case, by lowering the interest rate, the company is on the hook for less interest over time.

If indeed the stock price goes up, they usually have a feature where they can just say, "Hey, look. You need to convert now," which means they don't need to pay interest, but they've still gotten their value. So for a company that needs cash for operations, convertible debt becomes more and more attractive, because there's less money flowing out of the company's pocketbook on a quarterly basis when these debt payments come.

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SURRAN: Convertible bonds have been around for a long time, and they've been a "go to" mode of financing for younger companies that need more cash. What we see in times of financial crisis, and we'll discuss in a moment, is more convertible bonds, and we see them in companies of all sizes.

Convertible bonds have always been a preferred method of financing for companies that are growing quickly, with less access to capital and favorable financing terms. What we see in financial downturns, for a few different reasons, is that they tend to be issued more often and by more types of companies.

They tend then to spread from just this small growth segment across the market into companies that are doing well and companies that are also in some amount of distress.

FOSTER: Josh Schaeffer gives us a few examples of companies that he believes have benefited from convertible bonds.

SCHAEFFER: Let's give a first example, going back to our big growth companies, and let's talk about Tesla. Tesla's the poster child lately for convertible bonds and what they can do.

In 2014, they issued some converts, the first in a long string of them.

Now, in 2013, they have sold 22,300 cars. That's about one eighth of what they sell now in 2021 in a single quarter. So really, this is a growth story. Now in 2013, they didn't have a rating yet from the agencies, but they sold $600 million in convertible bonds. And in 2014, they sold $2 billion. Now, investors were pretty bullish on the company and gave them some pretty sweet interest rates. They were borrowing at between a quarter, and one and a quarter percent interest. Now, take yourself back to 2013 and 2014, and realize this is not Tesla that we see today where they seem to be every other car on the road; this is an upstart company with a product that they don't know about.

And for every car that they sell, if they sold a car for $100,000 on average, they're bringing in four times that in the sales of these convertible bonds. Now, what happens over time? We know that in 2020 and 2021, a lot of those bonds are maturing. They're coming off the table and investors in them have received an 840 plus percent return based on when they're maturing.

So here, the investors got that debt assurance, knew that if electric cars weren't going to be a thing, or maybe GM came on and captured the market before Tesla could, they still had some claim on their money back, right? As long as this didn't fall apart, they would get something. On the other hand, if Tesla became something special, which it effectively did, they would be able to participate in the outsized returns along with the common stockholders. Maybe they wouldn't get as much if they hadn't invested in equity, but they still got a quite large return on something that has this guarantee.

FOSTER: Josh gives us two more examples that are pandemic-related.

SCHAEFFER: There are two of these that I think are great examples and I'll tell you why in a second. Southwest and Carnival both had severe cashflow issues in March of last year as travel slowed to a stop.

Carnival stock price while rebounding has been quite hurt by the pandemic. Southwest is flying planes again, but does not have near the volume that they had pre-pandemic. What we've seen with both of their

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t issuances is they needed enough money and couldn't get all of it from the convertible bond market. So they issued some converts and some non-convertible bonds. That's great when we think about what a convert does because we actually can see exactly how much interest they saved between the two issuances.

Taking Carnival, they would be in a situation where they were issuing debt at 11.5%.

They sold $4 billion of this, and they sold about $2 billion with a convertible feature. That convertible feature allowed them to cut the interest on the bond by half down to 5.75%. What does that mean in real dollars on the amount of money they issued? They saved $300 million in cash. Now meanwhile, after March, after this issuance, we did see their value come back a bit. It still hasn't reflected where it was pre-pandemic, but on the other hand, as the stock price has gone up, the convertible bond has gone up in value. Now, the non-convertible bond went up a little but not much, because it's not reflecting the fact that the stock price has more than doubled over the time since the issuance.

Southwest is very much the same story. In their case, they were able to sell more $2 billion in convertible debt at a coupon of 1.25% versus regular debt of 5.25%. Now, fantastically, these have almost identical terms, and are at the same senior unsecured level.

So we can really look at how investors are doing over time based on them. Now, at the time we bought it, we didn't know what was going to happen to Southwest, right? We didn't know where it was going to go, and it could have gone further down. Now if it goes further down, at the end of the day, these convert investors would end up even saving a little bit of interest from the people who bought the non-convert. But on the other hand, if the stock was going to come back, and indeed to some extent it has and and potentially will continue as travel picks up further, we'll see that the convertible bond holders will convert and get that extra value. Now, one other case that I find particularly interesting deals with the fact that the stock can go up and that will definitely help a company out.

For those who remember, during the GameStop, we'll call it an event, that happened where Reddit investors were rushing into GameStop and other stocks, one of the stocks that was rushed into was AMC.

The chain of movie theaters, obviously, another company that had pandemic related issues.

Now, they had a hedge fund to own $600 million in convertible debt. And when that debt went into the money, they were able to convert and they sold it right at the top. What does that mean? That means that AMC, yes, is a little bit more diluted than they were because there was this conversion and sale. But the good news is that at this time of peak, which collapsed fairly quickly, they were able to eliminate a lot of the interest they were paying on their debt. So they're going to save money long-term, which in a time of turbulence will impact their long-term viability potentially quite positively, because they had a short-term unsustained situation where their stock price went up. So that certainly seems to be a good advantage, right? If the stock goes up, you might end up opting out of paying interest, either because you take it out yourself because if the stock price goes high enough, you typically have a term that allows it, or

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t because the company holding it just says, "Hey, look, this is the best time to get out for whatever reasons."

FOSTER: Josh continues by discussing the accounting treatment of convertible bonds, starting with classifications.

SCHAEFFER: For accounting treatments, we have two situations. And that depends on when bonds were issued because the SEC, in trying to clarify some of the guidance, did clean up some of these treatments when they released accounting standards update 2020-06. Going before that, when things were a bit more complicated, you could have a few different ways that these things could have to be considered.

You could have just what's considered a plain vanilla garden variety standard convertible bond, which allows you to mark out a few different ways including using the fair value method where you simply mark the fair value to market. Or you could do it as standard debt.

So the next step is if we have a cash conversion feature, and what that allows to happen is that the holder can say, "Instead of giving me the actual equity that I'm entitled to, why don't you just give me the cash difference in the value of the bond versus the value of the stock? Why don't you just give me that premium?" Now, fundamentally from an economic value, those two are the same.

But you were historically required to break out what the value of that option was, that pays in cash potentially, and what the value of the underlying debt was.

The way we typically do that is by looking at a bond model with the various inputs we have and saying, "Okay. This is the value, this is the price that I'm paying. This is the price that I would be paying if I didn't have that convertible bond feature." Going back to the Carnival or Southwest examples, I was trying to say, "This is what the bond would have looked like had I issued both a convertible and non-convertible bond."

So in this case, you had to break out the value of that feature. You would take that as one piece, and then you would lower the discount rate on the debt and accrete for a larger interest rate, basically because the option had been removed.

A third case, very uncommon, is a substantial premium at issuance. What that basically means is that you've got debt that's almost certainly going to convert. So for example, you can convert it at $1 when the stock is trading at $4. In that case, you have this equity notion from day one. We don't typically see this in the markets.

That also reflects a beneficial conversion feature, which means that at the date of issuance, I can convert this bond into more equity than it's worth. Typically, that happens with small companies where the stock is particularly illiquid.

We also see it in situations where when I want to issue the bond in April and sign all of the agreements, the stock price is $10. And by the time I actually get around to signing everything, the stock price has gone to $15, but we're already locked in.

SURRAN: The FASB has been working on a simplification initiative in an effort to reduce unnecessary complexity in US. GAAP. Under that initiative, one of the Accounting Standards Updates (ASUs) issued was ASU 2020-06

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t in August 2020. ASU 2020-06 simplifies the accounting for certain financial instruments with characteristics of liabilities and equities, including, among other things, convertible instruments and contracts on an entity's own equity.

There have been five approaches under ASC 470-20, Debt-Debt with Conversion and Other Options, with respect to the allocation of proceeds attributable to convertible debt instruments, of which only three were retained under ASU 2020-06. Those three are:

Traditional convertible debt where all profits are recorded as debt Convertible debt issued at a substantial premium; debt is measured first at principal amount and the residual amount is allocated to equity, and Convertible instrument with a bifurcated embedded derivative; embedded derivative is first measured at fair value and the residual amount is allocated to the host contract.

ASU 2020-06 requires entities to provide expanded disclosures about "the terms and features of convertible instruments," and "information about events, conditions, and circumstances that can affect how to assess the amount or timing of an entity's future cash flows related to those instruments."

FOSTER: Josh Schaeffer continues our discussion on ASU 2020-06 and the changes due to the new accounting guidance and also provides us with examples of the complexity of embedded derivatives.

SCHAEFFER: In 2020-06, the SEC did away with the beneficial conversion and the cash conversion guidance; they did include leave in. At this time, they left in another classification, which I've avoided, which is an embedded derivative within the debt.

An embedded derivative is a piece that is seen as not clearly and closely related to the underlying, which if you're familiar with debt equity accounting, means that it's not something that would be in a standard valuation model.

So that might be something where if we receive FDA approval for our drug, the conversion price changes. It may be something that allows for early conversion or premium conversion on an event that triggers like an IPO. It may be a down-round, where if I have a situation where I issue a lower round of funding, that you get to catch up with this.

Now, in ASU 2017-11, we have a situation where the down-round provisions were changed, making everybody's life quite a bit easier.

We have other situations where companies pay a high dividend. So they pay the same dividend to their convert holders to prevent early conversion and dilution.

Those are all examples of complexities of embedded derivatives. Embedded derivatives need to be broken out in the valuation and mark-to-market over time.

These are things that you definitely want to be concerned with and looking forward to what the valuation impact is going to be.

Now, we do see some situations where this might be something where, "Hey, look. If an asteroid hits the Earth, or if somebody comes to take over our company, and it's these parties, one of these, that we would change the conversion ratio." There is some working group within the SEC that is continuing to talk about these and saying, "If the chances of

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t something occurring are remote, do we still need to classify it as an embedded derivative?"

To date, that determination hasn't been met. People were hoping that it would come out in the 2020-06 guidance, but it did not. Oftentimes, if things are based on something that's remote, of course, we might have to value them. But if there's zero probability of something occurring, then having that right might well have zero value. So a lot of the times, our discussions are limited to saying, "Yes, this feature exists. Yes, we believe that there's potentially some value, but we don't believe a holder of the security, or a buyer of the security would pay significantly extra for something that happens only in very rare circumstances."

FOSTER: Josh gives us his insights as to what happens after issuance.

SCHAEFFER: So the treatments we just covered are basically how you recognize your convertible bond at issuance, and allocate it between debt and equity. On a go-forward basis, we note that these bonds can convert into shares, and therefore need to be considered as part of EPS.

So obviously, our basic EPS calculation is simply income divided by common shares outstanding. The common way to calculate diluted EPS is by using the "if-converted method."

The if-converted method is just like what it sounds like. You're going to consider what would have happened if the convertible bond was converted as of the beginning of the accounting period. So in this case, you have two different effects.

The first effect is that you had interest that you paid on the convertible debt that you would have saved. So that increases your income.

On the other hand, you have shares that the debt would have been converted into. Of course, that dilutes all of the income, not just the income from these additional pieces. We have a concept called earnings per incremental share, which is taken by calculating the earnings you get out of each share and seeing how many shares are there, and that's how much we're adding to the model.

Now, if you have one convertible, it's fairly easy, right? You look at whether that earnings per incremental share is lower than the actual earnings per share on an undiluted basis. If it is, you incorporate that and you dilute your earnings per share because of it.

If however, the earnings per incremental share are too high, this would not dilute. It would be non-dilutive item. As we know in accounting, you take into account the dilution, but you don't take into account anything that's anti-dilutive. So in this case, you would not apply and not consider that.

FOSTER: Josh discusses a second method, the bond with an option component, and the impact on EPS.

SCHAEFFER: A second treatment for these bonds would be to treat the bond as a bond if it's expected that the company would pay the cash back, and to treat the option component using the treasury stock method. So that goes to a full on bond plus option treatment. We noted that that was typically the less frequently used accounting, and it required a company to be able to establish that they were planning to pay cash for the convertible, at least for the portion of the bond with the principal and initial interest.

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t In this case, things change and under ASU 2020-06, companies are no longer allowed to use this method. Instead, all companies with convertible bonds after adopting that standard need to use the if-converted method.

FOSTER: Josh summarizes why ASU 2020-06 was the perfect storm for convertible debt.

SCHAEFFER: So as we discussed, 2020-06 really had the perfect storm for converts. Asset values were low, there was a significant opportunity for a potential recovery, bond rates were a bit higher than we would otherwise expect because of the crisis, and companies needed money. So we saw a lot of converts.

Now, after everything sweated out, we saw asset prices did come back quite a bit and quite quickly. And so investors in these bonds have gotten the returns. We've also seen a situation where borrowing rates have leveled out a bit, and so we don't see as many converts now. We still expect to see more coming into the market, the Teslas of the world will still want this very attractive way of capital. And we still see private companies, which we'll discuss in a moment, tapping into various pieces of convertible debt as part of their growth strategy. We do know that when the market experiences this turmoil again, as it did in 2020 and it did in multiple financial crises beforehand, we'll turn back to convertible bonds as a good opportunity to raise capital.

FOSTER: Josh discusses difficulties privately held companies face figuring out the enterprise's value and available options.

SCHAEFFER: So private companies, as often as the case, have a lot more structures available to them, and a lot more difficulty because if you're a private company, we can't just look at the stock pages, or the modern equivalent of them to figure out what the value of the company's enterprise is. And that results in a few different things. Also, they're often on a big growth trajectory and don't want to spend any more money than they have to in the meantime.

One way they can get around this is by using convertible debt with paid-in-kind interest only, or convertible preferred, which is very similar, sits in the capital structure below the senior debt, but above equity but allows for conversion into equity as things go well.

Convertible bonds often may pay no dividends, and you get it all based on the potential upside, or it may pay dividends which are often accrued to the security, and only paid out when there's a sale or IPO at the end.

That allows the company to work on financing now, but allows people to buy in. And for convertible preferred, they're covered by a liquidity preference which means that if the company doesn't have an IPO and doesn't do as well, the convertible holders are allowed to get their value out first.

FOSTER: Next, Josh discusses convertible bridge notes.

SCHAEFFER: Convertible bridge notes are ones where you commonly have a notion of, if you convert in the future, or if somebody invests in the future, you convert, but you convert at a premium price.

So you get a better value for being willing to take that extra risk. Now, because getting a full round of financing can be quite expensive and quite time consuming, and also take into account 2020 where we didn't know what any asset values really were, convertible bridge notes are a great way for companies to raise money in a pinch between financing rounds.

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t Now, of course, we need to consider the accounting fairy here, because the accounting fairy says that things like special terms where you get more value if the company has an IPO, or another round of financing, or might get higher than their principal in a changing-in-full scenario, those all fit back into embedded derivatives.

To deal with that, we look at the instrument on day one, and see what the different features seem to be worth based on solving for the notes, total issuance price based on the weighting of all of these features. What might be likely? And what impact does that have?

Then as time goes on, we can look at how those probabilities have moved, and how the market has moved, and we can look at the value of those embedded derivatives over time.

Because convertible bridge notes are short-lived by design, many of them only have a six-month to 12-month, maybe two years is the longest we'll see. They don't have long-term accounting implications because they're going to go away when you get the next financing round. But anybody issuing these types of securities should be aware that you're probably going to have some long discussions about valuing the security, identifying the embedded derivative, which can get tricky because these things all have their own little quirks, and breaking out the value for the embedded derivative, and bringing that forward in a mark-to-market basis.

FOSTER: Josh Schaeffer concludes our segment on convertible bonds and leaves us with his final thoughts.

SCHAEFFER: We always look at convertible bonds as an interesting middle ground financing alternative. They have some very attractive features, especially for companies that are in need of cash, either because they're being hit in a crisis mode for the economy, for themselves, or because they're growing and need to put that cash to work.

On the other hand, they're quite intriguing for investors because investors might be very attracted to something that offers most of the safety of fixed income bonds, but also offers some of the upside potential that you get along with stock investing.

So having that "happy medium," we think is just a great opportunity all around. Of course, as with any interesting piece, the accounting and valuation can get tricky. Those are things to consider. But we always advise companies not to let the accounting and the valuation requirements get in the way of what's right for their business.

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Segment Three

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3. Auditing Standards Update: NOCLAR,

Management Specialists and Pricing Services

Learning Objectives:

Segment Overview:

Field of Study:

Recommended Accreditation:

Running Time:

Video Transcript:

Course Level:

Course Prerequisites:

Advance Preparation:

Expiration Date:

Auditing

January 13, 2023

Work experience in financial reporting or auditing, or an introductory course in auditing.

None

1 hour group live 2 hours self-study online

Update

See page 3–21.

34 minutes

The AICPA has issued guidance in 2021 on a number of issues that impact the auditor’s work. In February, an Exposure Draft was issued dealing with Non-Compliance with Laws and Regulations (NOCLAR). In June, new guidance was issued on the use of specialists and pricing information. Ahava Goldman, associate director with the AICPA, reviews the standards in detail and explains the implications of the new rules.

Upon successful completion of this segment, you should be able t l Describe the AICPA changes dealing with

Non-Compliance with Laws and Regulations (NOCLAR); l Recognize how to make and document inquiries related to

NOCLAR; l Describe the new AICPA guidance for situations where a

specialist is used and when pricing information is obtained from external sources; and

l Identify the factors that may affect the relevance and reliability of the management specialist’s work and that of pricing information.

Reading (Optional for Group Study):

“Exposure Draft Proposed Statement On Auditing Standards” “Statement on Auditing Standards 144” See page 3–13.

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A. NOCLAR Covers

i. Fraud

ii. Corruption

iii. Bribery

iv. Money laundering

v. Securities markets and trading

vi. Data protection

vii. Other such matters

B. PEEC’s Proposed Revisions

i. Auditor required to ask predecessor auditor about NOCLAR

ii. Predecessor auditor required to respond fully and timely

iii. Predecessor auditor required to indicate if response is limited

C. AICPA’s Confidential Client Information Rule: Member

i. Shall not disclose without client consent

ii. Does not relieve member of professional obligations of compliance

I. Raising the Bar for The Global Accountancy Profession

A. Auditing Standards Board Deliberations

i. Should management authorization be a precondition of the audit?

ii. Conclusion: Sometimes there are valid reasons not to talk to the prior auditor

B. Reasons Management May Not Want You to Talk to the Prior Auditor

i. Disputes

ii. Relationships sometimes end badly

iii. The auditor is not always right in a dispute

C. Auditing Standards Board: Did Not Want to

i. Make management authorization a precondition

ii. Allow the successor auditor to communicate with the predecessor without the client’s permission

D. Successor Auditor Needs to

i. Understand management’s rationale

ii. Listen with a healthy dose of skepticism

iii. Consider not accepting the engagement

E. Goldman’s Observations

i. Auditors are not required to do an audit

II. ASB on Client Inquiries & Confidentiality

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A. ASB’s Revisions: Predecessor Auditor

i. Should make them more comfortable in responding fully

ii. If they don’t want to respond fully, they need to say they’re not

B. Inquiries About NOCLAR

i. Depends on nature and circumstances

ii. Should do more than a few

iii. Should include people outside the reporting process

iv. Stop when you have sufficient evidence and not hearing new information

v. Get a variety of views

C. What Changed:

i. Successor auditor: l Ask about fraud and NOCLAR

ii. Predecessor auditor: l Provide an answer

D. How to Document?

i. Write it down

ii. If Zoom, record the call

iii. Make sure both parties understand they are being recorded

iv. Sum up your points at the end

v. Email to confirm

E. Whom Else Should the Auditor Talk to?

i. People with different levels of authority

ii. People who deal with complex transactions

iii. People who monitor transactions

iv. In-house counsel

v. Chief ethics officer

vi. People who deal with allegations of fraud

F. ASB and PEEC Exposure Drafts

i. Issued on February 25, 2021

ii. Comment period ended on June 30, 2021

III. ASB on Auditor-Client Communications

A. SAS No. 143: Comment Letters

i. Useful guidance in ASB’s standards

ii. Would it enhance audit quality for non-issuer audited financial statements?

B. Goldman’s Observations on the Comment Letters

i. All 19 respondents expressed support

ii. All 19 respondents agreed the proposed amendments are appropriate

iii. All proposed amendments are for guidance

C. Proposed Amendment to AU-C Section 540

i. Add a new appendix: Use of pricing information from third parties as audit evidence

ii. Appendix provides guidance on the use of pricing information obtained from external sources

iii. Based on AS 2501, appendix A

iv. Standard is principles-based and not prescriptive

IV. SAS 143 and AU-C Section 540

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Outline (continued)

A. SAS No. 144: Provides Guidance for

i. Management on use of a specialist

ii. Auditors evaluating the work of a management specialist

iii. Use of pricing services

B. Evaluating an Estimate

i. The auditor’s procedures are the same if done by management or management specialists

C. Auditing the Estimate: Get an Understanding of

i. Competency of the specialist

ii. Relevance of information

iii. Reliability of the information

iv. Significant assumptions

D. Factors to Consider Over Specialist’s Work

i. Nature and complexity of estimates

ii. Risk of material misstatement

iii. Other sources of evidence

iv. Scope and objectives

v. Whether employed by the entity or are external

vi. Management’s control over specialist’s work

vii. Professional requirements & controls in place

viii. Auditor’s familiarity & previous experience

V. SAS 144 – Management Specialists

A. When Using Pricing Information from an External Source

i. Requirements in section 500 apply

B. Factors That Affect Reliability of Pricing Information

i. Factors that affect relevance

ii. Similarity of financial instruments that can be treated as a group

iii. Potential for contradictory information

C. AU-C Section 620: Additional Guidance

i. Information can come from work done in accordance with section AU-C 550

ii. Emphasis on the connection between AU-C 540 and AU-C 620

iii. Same considerations apply in sections AU-C 540 and AU-C 620

iv. Maintain professional skepticism

D. Management Also Needs to

i. Be cognizant that they are responsible for the estimate

ii. Evaluate the specialist’s competence

iii. Consider relevance and reliability of information

iv. Try to understand the specialist’s methods and assumptions

VI.Pricing and Additional Guidance

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Outline (continued)

A. NOCLAR: Auditor Needs to

i. Consider a client’s ethics l Are they involved in illegal

activities? l Are they involved in fraud? l Is there non-compliance with

laws/regulations?

ii. Reach out to the predecessor auditor if there is non-compliance

iii. Ask specifically about fraud

iv. Decide whether to take on the client if management won’t authorize you to ask

B. Goldman’s Observations on AU-C Sections 501, 540 and 620

i. The pricing service guidance is valuable

ii. The new guidance is meant to help the auditor obtain sufficient audit evidence

“Standards aren't done for risk management, but one of the best ways to manage risk and not get involved in a malpractice suit, is not to take on a bad client in the first place.”

— Ahava Goldman

VII. Key Takeaways Looking Forward

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3. Auditing Standards Update: NOCLAR, Management Specialists and Pricing Services

l As the Discussion Leader, you should introduce this video segment with words similar to the following:

“In this segment, Ahava Goldman reviews recent guidance of the AICPA that impacts the auditor's work in detail and explains the implications of the new rules.”

l Show Segment 3. The transcript of this video starts on page 3–21 of this guide.

l After playing the video, use the questions provided or ones you have developed to generate discussion. The answers to our discussion questions are on pages 3–8 to 3–10. Additional objective questions are on pages 3–11 and 3–12.

l After the discussion, complete the evaluation form on page A–1.

1. What is included in the AICPA’s proposed Exposure Draft regarding asking predecessor auditors about NOCLAR and how these new disclosures apply to the client confidential information rule?

2. What should an auditor consider if management does NOT authorize inquiry of a predecessor auditor and how does that relate to accepting the engagement? Has your organization or clients decided to pursue or not pursue an engagement for this reason and what was the result?

3. To whom should an auditor make inquiries about fraud and NOCLAR and how should the auditor determine the number of inquiries required? How will your organization or clients go about planning for the inquiries it makes regarding fraud and NOCLAR?

4. What are some considerations with respect to the documentation process of inquiries by an auditor and whom the auditor should talk to regarding fraud?

Discussion Questions

You may want to assign these discussion questions to individual participants before viewing the video segment.

Instructions for Segment

Group Live Option

For additional information concerning CPE requirements, see page vi of this guide.

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s5. What are the assumptions that need to be

evaluated by the auditor with respect to a management specialist and what factors may affect the reliability of the specialist’s work?

6. What are auditors likely to be asking of management regarding management specialists as a result of the new AICPA guidance? What has been the experience of your organization or clients in communications with management about their use of specialists?

7. How will the nature and extent of audit procedures vary depending on the nature and source of audit evidence obtained from external parties? What has been the experience of your organization or clients in auditing such external evidence?

Discussion Questions (continued)

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1. What is included in the AICPA’s proposed Exposure Draft regarding asking predecessor auditors about NOCLAR and how these new disclosures apply to the client confidential information rule? l Added a requirement that the auditor

is required to ask the predecessor auditor about NOCLAR

l Predecessor auditor is required to respond fully and timely, and to indicate if their response is limited

l Client confidential information rule prohibits disclosing confidential information without the specific consent of the rule

l A member is not relieved of professional obligations related to compliance with the standards or accounting principles rules

l If the standards require a member to disclose confidential information, it is not a violation of the confidential client information rule and the standard overrides

2. What should an auditor consider if management does NOT authorize inquiry of a predecessor auditor and how does that relate to accepting the engagement? Has your organization or clients decided to pursue or not pursue an engagement for this reason and what was the result? l Considerations:

b ASB considered making the authorization a precondition for accepting the audit but decided against it

b ASB concluded that there could be valid reasons for management to not authorize talking to the prior auditor

b In disputes between management and the auditor, the auditor is not necessarily always right

b The auditor needs to understand management’s rationale for not authorizing the inquiry, but listen with a dose of professional skepticism

b Aside from governmental or state auditors, an auditor is not compelled to take on a client

b Not the auditor’s responsibility to get a company to be clear from fraud or NOCLAR

l Participant response based on personal/organizational experience

3. To whom should an auditor make inquiries about fraud and NOCLAR and how should the auditor determine the number of inquiries required? How will your organization or clients go about planning for the inquiries it makes regarding fraud and NOCLAR? l Inquiry considerations:

b Inquiries about fraud and NOCLAR should be made to management and those charged with governance

b Auditors should also talk to employees with a significant role in internal controls

b Determining the number of inquiries should be based on an auditor’s professional judgement

b Number of inquiries depends on the nature and circumstances

b Auditor should talk to people who are not necessarily in the financial reporting process

b Auditor can stop when they have sufficient appropriate audit evidence and if they are not hearing new information

l Participant response based on personal/organizational experience

3. Auditing Standards Update: NOCLAR, Management Specialists and Pricing Services

Suggested Answers to Discussion Questions

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respect to the documentation process of inquiries by an auditor and whom the auditor should talk to regarding fraud? l Documentation is a well-accepted

audit procedure but not always well done

l Information can be written down or calls recorded

l There are laws about recording conversations and it is best for all parties to understand they are being recorded

l Follow up after conversations with confirmation email that the discussion was appropriately captured b Confirmation email could suggest

that lack of objection will be taken as positive confirmation

l Standards suggest that auditors talk to people with different levels of authority

l Auditors should also talk to in-house counsel, ethics officer, and others responsible for dealing with allegations of fraud

5. What are the assumptions that need to be evaluated by the auditor with respect to a management specialist and what factors may affect the reliability of the specialist’s work? l No difference from an auditor

perspective if management or a management specialist made the estimate

l Need to consider the assumptions, methods, relevance, and competence of whomever makes accounting estimates

l Using a specialist does not relieve management responsibility for accounting estimates

l Factors to consider include the nature and complexity of the matter being estimated and the risk of material misstatement of the specific estimate

l Auditors should consider if there are other sources of getting evidence

l Reliability depends on the nature and objective of management specialists,

technical or professional requirements, and how much control management has over the work

6. What are auditors likely to be asking of management regarding management specialists as a result of the new AICPA guidance? What has been the experience of your organization or clients in communications with management about their use of specialists? l What auditors will be asking of

management about specialists: b More information than in the past,

although ideally management will be looking at these things already

b Recognition of the fact that management is still responsible for estimates made with the assistance of specialists

b Evaluation by management of the specialist’s competence

b Evidence that management is considering the relevance and reliability of the information the specialist is using

b Evidence that management is making the effort to understand methods and significant assumptions

l Participant response based on personal/organizational experience

7. How will the nature and extent of audit procedures vary depending on the nature and source of audit evidence obtained from external parties? What has been the experience of your organization or clients in auditing such external evidence? l Nature and extent of audit procedures:

b When market or industry data is obtained from a single external information source, auditor may seek data from an alternative source with which to compare

b When market or industry data is obtained from multiple independent sources and points to consensus, the auditor may not need as much evidence about data reliability

Suggested Answers to Discussion Questions (continued)

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sb Auditor may seek to understand

the reasons for diversity of views if information from multiple sources points to divergent market views

b Professional judgment is important in considering information about methods, assumptions, or data applied

b If a pricing source for derivatives might have impaired objectivity, the auditor may need to obtain estimates from more than one pricing source

l Participant response based on personal/organizational experience

Suggested Answers to Discussion Questions (continued)

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1. Which of the following is INCORRECT regarding the new NOCLAR disclosures and the AICPA's client confidential information rules?

a) a member has some very limited discretion to disclose confidential client information without client consent

b) an auditor is prohibited from asking a predecessor auditor about NOCLAR

c) if a member must disclose information without client consent, it is considered a violation of the confidential client information rule

d) a predecessor auditor can choose NOT to respond to an inquiry from a new auditor about NOCLAR

2. To whom should inquiries about fraud and NOCLAR be made by an organization's auditor?

a) management and those charged with governance

b) bankers

c) internal auditors

d) outside legal counsel

3. Which of the following is used by an auditor to determine the number of inquiries required in regards to fraud and NOCLAR?

a) client engagement budget

b) professional judgment

c) organization's revenue and net income

d) number of individuals with a significant role in internal controls

4. Which of the following is correct in regards to inquiries and documentation relating to fraud and NOCLAR under the new Exposure Draft?

a) inquiry is NOT an accepted audit procedure as it is not the strongest audit procedure

b) inquiries about fraud are very different from inquiries about NOCLAR

c) inquiries made by a successor auditor of a predecessor auditor are a relatively new problem

d) documentation is NOT always done well but is a well-accepted audit procedure

5. What will auditors be asking management for related to the specialists that management uses as a result of the latest guidance in sections 501, 540, and 620?

a) confirmation that the specialist is responsible for all estimates

b) evaluation by management of the specialist's competence and methods

c) costs of retaining the specialist

d) alternatives to the information the specialist is using to make their estimates

You may want to use these objective questions to test knowledge and/or to generate further discussion; these questions are only for group live purposes. Most of these questions are based on the video segment, a few may be based on the reading for self-study that starts on page 3–13.

Objective Questions

3. Auditing Standards Update: NOCLAR, Management Specialists and Pricing Services

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6. Which of the following is correct about auditor evaluations with respect to estimates made by a management specialist?

a) there is a significant difference from an audit perspective if the estimate was made by management or a management specialist

b) using a specialist relieves management of responsibility for the estimate

c) an understanding of the specialist's competency and capabilities are NOT included in the guidance in AU-C 501

d) the use of a specialist does NOT relieve the auditor of responsibility of auditing in the same way as if management had done it

7. What are the effective dates relating to AU-C sections 501, 540 and 620, which will be published in SAS number 144?

a) December, 2024

b) December, 2023

c) December, 2022

d) December, 2021

8. Which of the following is correct regarding retaining the requirements that an auditor request management to authorize predecessor auditors to respond to inquiries?

a) the ASB was concerned that requiring this authorization as a precondition might result in an entity being unable to engage an auditor

b) the ASB requires that the auditor obtain this authorization as a precondition for the audit

c) the ASB did NOT allow for management to provide an auditor with its understanding of the reasons for the termination or resignation of a predecessor auditor

d) an auditor should NOT consider the implications of a management refusal to authorize a response by the predecessor auditor in the engagement acceptance process

9. What is the intent of the proposed required inquiries and response related to suspected fraud and NOCLAR matters between auditors?

a) liability protection

b) establishing materiality

c) knowledge transfer

d) governance

10. Which of the following is correct as it relates to audit procedures for accounting estimates made using external information sources?

a) the reliability of audit evidence decreases when it is obtained from external parties

b) the auditor does NOT need to seek data from an alternative source when industry data is obtained from a single external source

c) the auditor may need more evidence about the reliability of the data if there is consensus among multiple independent external information sources

d) the auditor may need to obtain estimates from more than one pricing source for derivatives if the pricing source might have impaired objectivity

Objective Questions (continued)

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Self-Study Option

Reading (Optional for Group Study)

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EXPOSURE DRAFT PROPOSED STATEMENT ON AUDITING STANDARDS

INQUIRIES OF THE PREDECESSOR AUDITOR REGARDING FRAUD AND NONCOMPLIANCE WITH LAWS AND REGULATIONS (Amends Statement on Auditing Standards [SAS] No. 122, Statements on Auditing Standards: Clarification and Recodification, as amended, section 210, Terms of Engagement [AICPA, Professional Standards, AU-C sec. 210]) February 25, 2021 Comments are requested by June 30, 2021 Prepared by the AICPA Auditing Standards Board for comment from persons interested in auditing and reporting issues. Comments should be submitted in Word format and sent to CommentLetters@aicpacima.com Source: https://www.aicpa.org/content/dam/aicpa/research/exposuredrafts/accountingandauditing/downloadabledocuments/20210225a/20210225a-noclar-ed.pdf

Introduction This memorandum provides background to the proposed Statement on Auditing Standards (SAS) Inquiries of the Predecessor Auditor Regarding Fraud and Noncompliance With Laws and

Regulations to require an auditor, once management authorizes the predecessor auditor to respond to inquiries from the auditor, to inquire of the predecessor auditor regarding identified or suspected fraud or noncompliance with laws or regulation (NOCLAR). If issued as final, the proposed SAS will amend SAS No. 122, Statements on Auditing Standards: Clarification and Recodification, as amended, section 210, Terms of Engagement (AICPA, Professional Standards, AU-C sec. 210).1

Background The International Ethics Standards Board for Accountants (IESBA) Code of Ethics for Professional Accountants (IESBA code) requires a predecessor auditor to “provide all relevant facts and other information concerning the identified or suspected non-compliance (with laws and regulations) to the proposed accountant. The predecessor accountant shall do so even… where the client fails or refuses to grant the predecessor accountant permission to discuss the client’s affairs with the proposed accountant, unless prohibited by law or regulation.2 ”

l In order to ensure adherence to NASBA guidelines regarding self-study, the CPA Report and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers are no longer available. Customers should contact their company administrators for information on taking course exams and receiving CPE credit for the courses.

l Customers may contact Kaplan Financial Education at cpesupport@kaplan.com to obtain certificates previously earned through the CPA Report Self-Study and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers.

l Customers interested in the self-study format of the CPA Report can find information on Kaplan Financial Education's self-study libraries at Online Accounting CPE Courses.

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In 2016, the International Auditing and Assurance Standards Board (IAASB) revised ISA 250, Consideration of Laws and Regulations in an Audit of Financial Statements, to reflect certain relevant changes as adopted in the IESBA code. For example, ISA 250 (Revised) includes a conforming change to paragraph .A9 of ISA 220 (Revised), Quality Control for an Audit of Financial Statements, which states, in part, “where the predecessor auditor has withdrawn from the engagement as a result of identified or suspected non-compliance with laws and regulations, the IESBA Code requires that the predecessor auditor, on request by a proposed successor auditor, provide all such facts and other information concerning such non-compliance that, in the predecessor auditor’s opinion, the proposed successor auditor needs to be aware of before deciding whether to accept the audit appointment.” As the AICPA Code of Professional Conduct (AICPA code) has not been similarly revised, the Auditing Standards Board (ASB) has not revised AU-C section 250, Consideration of Laws and Regulations in an Audit of Financial Statements. AU-C section 250 was last revised in October 2011 with the issuance of SAS No. 122, Statements on Auditing Standards: Clarification and Recodification.

In March 2017, the AICPA’s Professional Ethics Executive Committee (PEEC) issued an exposure draft with proposals for two new interpretations entitled “Responding to Non-Compliance with Laws and Regulations.” Although similar to the IESBA code, the exposure draft explained that certain differences were necessary to enhance the clarity of the proposed interpretations and make them relevant to AICPA members in the United States. Most notably, certain provisions were not included in the AICPA proposals because they were believed to be incompatible with most state laws and regulations on client and employer confidentiality. The AICPA code does not permit a CPA to disclose confidential client information without client or employer consent unless required by professional standards. The following is the applicable excerpt from the AICPA code:

1.700.001 Confidential Client Information Rule .01 A member in public practice shall not disclose any confidential client information without the specific consent of the client. .02 This rule shall not be construed (1) to relieve a member of his or her professional obligations of the “Compliance With Standards Rule” [1.310.001] or the “Accounting Principles Rule” [1.320.001]

In response to PEEC’s exposure draft, comments were received expressing concern that the proposed language would discourage CPAs from acting in the public interest even after the CPA demonstrated compliance with all relevant professional standards. PEEC issued a revised exposure draft on February 25, 2021. That exposure draft is available at https://www.aicpa.org/content/dam/aicpa/interestareas/professionalethics/community/exposured rafts/downloadabledocuments/2021/2021-Feb-NOCLAR-ED.pdf

The ASB is not proposing a revision to the existing audit requirement that the auditor request management to authorize the predecessor auditor to respond fully to the auditor’s inquiries regarding matters that will assist the auditor in determining whether to accept the engagement. However as an option to address identified or suspected fraud and matters involving NOCLAR, the ASB is proposing narrow revisions to auditing standards generally accepted in the United States of America (GAAS) to require an auditor, once management authorizes the predecessor auditor to respond to inquiries from the auditor, to inquire of the predecessor auditor regarding identified or suspected fraud and matters involving NOCLAR. The ASB believes this approach is similar to the approach included in the PCAOB’s AS 2610, Initial Audits – Communications Between Predecessor and Successor Auditors (PCAOB AS 2610) that directs the auditor to make more specific inquiries of the predecessor auditor after requesting permission from management to make an inquiry of the predecessor auditor. Furthermore, the absence of authorization by management for an auditor to make

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inquiries of a predecessor auditor should alert the auditor to carefully consider engagement acceptance, irrespective of the basis for the lack of authorization.

The ASB is not currently considering revisions to GAAS that would require auditors to report fraud or NOCLAR to other outside parties, such as the appropriate authorities.

The following flowchart illustrates the proposed narrow revisions to existing GAAS. The proposed additional procedures are in purple.

Effective Date If issued as final, the proposed amendment to AU-C section 210 will be effective for audits of financial statements for periods ending on or after December 15, 2022. Early implementation would be permitted.

Explanation of Proposed Changes

Management Authorization of Communication Between Auditor and Predecessor Auditor

The ASB decided to retain the requirement in paragraph .11 of extant AU-C section 210 for the auditor, prior to accepting an initial audit, including a reaudit engagement, to request management to authorize the predecessor auditor to respond fully to the auditor’s inquiries. The ASB did consider a requirement for

the auditor to obtain, as either a precondition for the audit or as a required element of the terms of the engagement, management’s agreement to this request. The ASB concluded to not propose such a requirement because of the following:

a. The ASB was concerned that such a requirement or precondition might result in an entity being unable to engage an auditor. The ASB concluded that this was

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not in the public interest, nor was it necessary, because the requirement to request management to authorize the predecessor auditor to respond fully to the auditor’s inquiries regarding matters that will assist the auditor in determining whether to accept the engagement would now be in the auditor’s professional standards, which management would be broadly acknowledging.

b. The construct in extant AU-C section 210 enables management to provide its understanding of the reasons for the termination or resignation of the predecessor auditor to the auditor prior to the auditor learning of the predecessor auditor’s understanding of the termination or resignation. The ASB believes that this construct is appropriate.

The ASB also considered an approach in which the auditor would be required to make inquiries of the predecessor auditor but would not be required to request management to authorize the predecessor auditor to respond fully to the auditor’s inquiries. A majority of the ASB members concluded that such an approach would not be practical for the audit of financial statements of a nonpublic entity because the predecessor auditor may have no way of verifying that management was considering engaging the auditor, or the auditor may not be aware of the identity of the predecessor auditor.

Further, the ASB believes that the requirement for the auditor to inquire about the reasons for a refusal to authorize the predecessor auditor to respond fully to the auditor’s inquiries and to consider the implications of that refusal or limitation in deciding whether to accept the engagement results in sufficiently drawing the auditor’s attention to potential concerns that could influence the engagement acceptance process.

The requirement is consistent with the requirements in PCAOB AS 2610 for audits of financial statements of issuers.

Request for Specific Comment #1 Does the respondent agree with the ASB’s determination that it is appropriate to retain

the requirement for the auditor, prior to accepting an initial audit, including a reaudit engagement, to request management to authorize the predecessor auditor to respond fully to the auditor’s inquiries? If not, why not, and how would the respondent revise the requirement (for example, by making the procurement of management’s agreement a precondition for the auditor to accept the engagement or requiring the auditor to communicate with the predecessor auditor without management’s authorization)?

Knowledge Transfer From Predecessor Auditor to Auditor

The ASB believes that it is in the public interest for a knowledge transfer to occur from the predecessor auditor to the auditor with respect to identified or suspected fraud and matters involving NOCLAR. To effect such knowledge transfer with respect to the audit of the financial statements of a nonpublic entity, the ASB proposes that a requirement be added to AU-C section 210 whereby, if management authorizes the predecessor auditor to respond to the auditor’s inquiries, the auditor makes specific inquiries regarding identified or suspected fraud and matters involving noncompliance with laws and regulations:

.12 If, pursuant to paragraph .11, management authorizes the predecessor auditor to respond to the auditor’s inquiries regarding matters that will assist the auditor in determining whether to accept the engagement, the auditor should inquire of the predecessor auditor about matters that will assist the auditor in determining whether to accept the engagement, including (Ref: par. .A30–.A32)

a. identified or suspected fraud involving i. management, ii. employees who have significant roles in internal control, or iii. others, when the fraud resulted in a material misstatement in the financial statements.

b. matters involving noncompliance or suspected noncompliance with laws and regulations that came to the predecessor auditor’s attention during the audit, other than when the matters are clearly inconsequential.

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The proposed additional required inquiries are consistent with matters that the predecessor auditor is required to communicate to those charged with governance by paragraph .40 of extant AU-C section 240, Consideration of Fraud in a Financial Statement Audit, and paragraph .21 of AU-C section 250, Consideration of Laws and Regulations in an Audit of Financial Statements.

If management does not authorize the predecessor auditor to respond or limits the predecessor’s response, the requirement in extant AU-C section 210 for the auditor to inquire about the reasons and consider the implications of that refusal or limitation in deciding whether to accept the engagement is not changed.

If management limits the predecessor auditor’s response and such limitation relates to the matters that the auditor is required to inquire about pursuant to paragraph .12, paragraph .15 requires that the auditor document the inquiries and that the predecessor was not authorized by management to respond to the inquiries.

Further, although the AICPA code states that members have a responsibility to cooperate with each other and paragraph .A32 of extant AU-C section 210 states that, “therefore, the predecessor auditor is expected to respond to the auditor’s inquiries promptly and, in the absence of unusual circumstances, fully, on the basis of known facts,” the proposed revision would also include the following new requirement:

.13 If, pursuant to paragraph .11, management authorizes the predecessor auditor to respond to the auditor’s inquiries regarding matters that will assist the auditor in determining whether to accept the engagement, the predecessor auditor should respond to the auditor’s inquiries on a timely basis and, on the basis of known facts, unless prohibited by applicable law. However, when the predecessor auditor decides, due to impending, threatened, or potential litigation; disciplinary proceedings; or other unusual circumstances, not to fully respond to the auditor’s inquiries, the

predecessor auditor should clearly state that the response is limited. Such circumstances are expected to be rare. (Ref: par. .A33–.A35)

The penultimate sentence in proposed paragraph .13 is intended to more explicitly state that the predecessor auditor is expected to respond fully to the auditor’s inquiries while acknowledging that circumstances may exist in which the predecessor auditor may not fully respond to the auditor’s inquiries. The proposed language from that sentence is taken from paragraph .A32 of extant AU-C section 210. The statement in the AICPA code that members are expected to cooperate with each other is not affected. The final sentence in proposed paragraph .13 is intended to further elaborate the ASB’s intent that the situations in which the predecessor auditor may limit its response to the auditor’s inquiries were expected to be infrequent while retaining the predecessor’s ability to limit its responses when circumstances warrant.

The intent of the proposed required inquiries and response is to facilitate a knowledge transfer of identified or suspected fraud and matters involving NOCLAR from a predecessor auditor to an auditor.

If the predecessor auditor decides not to fully respond to the auditor’s inquiries, paragraph .15 requires that the auditor document the inquiries and that the predecessor did not fully respond.

The ASB is unaware of significant practice issues involving predecessor auditors inappropriately limiting their responses and believes that the statement in the AICPA code that members are expected to cooperate with each other helps protect against the potential of a predecessor auditor inappropriately limiting the response to the auditor’s inquiries.

Request for Specific Comment #2: Are the proposed requirements appropriate and complete, including whether it is appropriate to continue to provide an exception that permits the predecessor auditor to decline to respond to the

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auditor’s inquiries due to impending, threatened, or potential litigation; disciplinary proceeding.

Documentation

The proposed SAS includes the following requirement:

.15 The auditor should document its inquiries and the results of those inquiries with the predecessor auditor.

Request for Specific Comment #3 Is the proposed requirement appropriate and complete? If not, please suggest specific revisions.

Proposed Effective Date

If issued as final, the ASB proposes that the revisions to AU-C section 210 be effective for audits of financial statements for periods ending on or after December 15, 2022. Practically, any auditor changes during the calendar year 2022 and thereafter would be subject to the proposed revisions to AU-C section 210.3 Early implementation would be permitted.

Request for Specific Comment #4 Are respondents supportive of the proposed effective date? If you are not supportive, please provide reasons for your response.

ASB Vote for Issuance of the Exposure Draft

Eighteen members voted to issue the proposed SAS as an exposure draft, but Mr. Jon Heath dissented to issuance of the exposure draft. Mr. Heath’s reasons for dissenting are included on pages 14–18 of this explanatory memorandum. Please consider this dissent as you develop your response.

Guide for Respondents

Respondents are asked to comment on the proposed changes to AU-C section 210.

Comments are most helpful when they refer to specific paragraphs, include the reasons for the comments, and, when appropriate,

make specific suggestions for any proposed changes to wording. When a respondent agrees with proposals in the exposure draft, it will be helpful for the ASB to be made aware of this view, as well.

Written comments on the exposure draft will become part of the public record of the AICPA and will be available for public inspection at the offices of the AICPA for one year, beginning June 30, 2021. Responses should be submitted in Word format, sent to commentletters@aicpa-cima.com, and received by June 30, 2021. Respondents may also submit a PDF version of their response for posting to the AICPA website.

Comment Period

The comment period for this exposure draft ends June 30, 2021.

For the full exposure draft please visit: https://www.aicpa.org/content/dam/aicpa/research/exposuredrafts/accountingandauditing/downloadabledocuments/20210225a/20210225a-noclar-ed.pdf

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June 2021 Issued by the Auditing Standards Board

Amendments to AU-C Sections 501, 540, and 620 Related to the Use of Specialists and the Use of Pricing Information Obtained From External Information Sources (Amends Statements on Auditing Standards

l No. 122, Statements on Auditing Standards: Clarification and Recodification, as amended

— Section 501, Audit Evidence — Specific Considerations for Selected Items [AICPA, Professional Standards, AU-C sec. 501]

— Section 620, Using the Work of an Auditor’s Specialist [AICPA, Professional Standards, AU-C sec. 620]

l No. 143, Auditing Accounting Estimates and Related Disclosures [AICPA, Professional Standards, AU-C sec. 540])

Source: https://www.aicpa.org/content/dam/aicpa/research/standards/auditattest/downloadabledocuments/sas-144.pdf

Starting on page 37 of 48

Amendment to AU-C Section 540, Auditing Accounting Estimates and Related Disclosures

(Boldface italics denotes new language. Deleted text is shown in strikethrough.)

3. AU-C section 540, Auditing Accounting Estimates and Related Disclosures, addresses the auditor’s responsibilities

relating to auditing accounting estimates and related disclosures. It expands on how AU-C section 500, Audit Evidence, and other relevant AU-C sections are to be applied with regard to accounting estimates and related disclosures. AU-C section 500 requires the auditor to take into account the relevance and reliability of information to be used as audit evidence, including its source, and contains an appendix addressing the use of external information sources. This amendment to AU-C section 540 adds a new appendix, “Use of Pricing Information From Third Parties as Audit Evidence,” that provides guidance on the use of pricing information obtained from external information sources to be used as audit evidence for estimates related to the fair value of financial instruments. This appendix takes into account PCAOB AS 2501, Appendix A, “Special Topics, Identifying and Assessing Risks of Material Misstatement Related to the Fair Value of Financial Instruments”

4. This amendment is effective for audits of financial statements for periods ending on or after December 15, 2023. [Footnote text not amended is omitted for purposes of this amendment. No amendment to paragraphs .01–.A106.]

.A107 AU-C section 500 requires the auditor to evaluate information to be used as audit evidence by taking into account, among other things, the relevance and reliability of the information, including its source. The auditor’s evaluation of such information to be used as audit evidence is required to include evaluating whether the information is sufficiently precise and detailed for the auditor’s purposes and obtaining audit evidence about the accuracy and completeness of the information, as necessary. Paragraphs .A126–.A129 provide further guidance related to evaluating information from external information sources. [No amendment to paragraphs .A108–.A126.]

.A127 As explained in AU-C section 500, the reliability of evidence depends on the

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STATEMENT ON AUDITING STANDARDS 144

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nature and source of the audit evidence and the circumstances under which it is obtained. Generally, the reliability of audit evidence increases when it is obtained from external parties because the information is less susceptible to management bias.53 Consequently, the nature and extent of the auditor’s further audit procedures to consider the reliability of the information used in making an accounting estimate may vary depending on the nature of these factors. Examples follow:

l When market or industry data, prices, or pricing-related data are is obtained from a single external information source specializing in such information, the auditor may seek a price data from an alternative independent source with which to compare.

l When market or industry data, prices, or pricing-related data are obtained from multiple independent external information sources and points to consensus across those sources, the auditor may need to obtain less evidence about the reliability of the data from an individual source.

l When information obtained from multiple information sources points to divergent market views, the auditor may seek to understand the reasons for the diversity in views. The diversity may result from the use of different methods, assumptions, or data. For example, one source may be using current prices, and another may be using future prices. When the diversity relates to estimation uncertainty, the auditor is required by paragraph .26b of this SAS to obtain sufficient appropriate audit evidence about whether, in the context of the applicable financial reporting framework, the disclosures in the financial statements that describe the estimation uncertainty are reasonable. In such cases, professional judgment is also important in considering information about the methods, assumptions, or data applied.

l When information obtained from an external information source has been developed by that source using its own

models (for example, for a derivative instrument or security, a pricing model or cash flow projection model), SAS No. 142, Audit Evidence, 54 provides relevant guidance for the auditor.

l When, for derivative instruments or securities, a pricing source has a relationship with an entity that might impair its objectivity, such as an affiliate or a counterparty involved in selling or structuring the product, the auditor may determine that it is necessary to obtain estimates from more than one pricing source.

For full document please visit

https://us.aicpa.org/content/dam/aicpa/research/exposuredrafts/accountingandauditing/downloadabledocuments/20210225a/20210225a-noclar-ed.pdf

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tSURRAN: NOCLAR, which stands for Non-Compliance With Laws and

Regulations, is defined as acts of omission or commission, intentional or unintentional, committed by a client, by those charged with governance, by management or by other individuals working for or under the direction of a client that are contrary to prevailing laws and regulations.

In 2017, the International Ethics Standard Board for Accountants (IESBA) updated the rule that dictates how accountants can respond to a client's non-compliance with laws and regulations.

The new standard aimed to raise the bar for the global accountancy profession and to increase the emphasis on the accountant's duties and responsibilities in this area.

Examples of what is covered by the NOCLAR pronouncement are laws and regulations that deal with: fraud, corruption, bribery, money laundering, securities markets and trading, data protection, and other such matters.

FOSTER: On February 25, 2021 the American Institute of CPAs' Professional Ethics Executive Committee, PEEC, issued a revised Exposure Draft, Proposed Interpretations and Definition – Responding to Noncompliance with Laws and Regulations. It first issued an Exposure Draft in March of 2017 dealing with Responding to Non-Compliance with Laws and Regulations.

Ahava Goldman is an Associate Director with the AICPA Audit & Attest Team. She is also the staff liaison for the Auditing Standards Board. Ahava provides us with some background on the NOCLAR project.

GOLDMAN: There are a number of groups that have been involved in this project starting with IESBA, The International Ethics Standards Board for Accountants. They do a code of ethics for professional accountants, the IESBA code, and a while back, they changed the IESBA code to require a predecessor auditor to provide all relevant facts and information about NOCLAR to the successor auditor. They have to do that even if the client fails or refuses to grant the predecessor accountant permission to do this, unless prohibited by the laws or regulations.

Once the IESBA made that change to their code, then the IAASB, The International Auditing and Assurance Standards Board, revised ISA 250, consideration of laws and regulations in an audit to align with that. So that it mentions that the IESBA code requires a predecessor auditor to reveal or disclose all this information.

FOSTER: How about the AICPA? What did they do? Ahava Goldman explains

GOLDMAN: The AICPA Code of Professional Conduct was not similarly revised. So, the ASB did not make any changes at that point. However, the AICPA's Professional Ethics Committee, PEEC, took up a project and issued an Exposure Draft for proposals for new interpretations that talk about responding to non-compliance with laws and regulations. And there were certain differences that were necessary because of the U.S. jurisdiction, and because of client confidentiality in the U.S.

The AICPA code does not permit a CPA to disclose confidential client information without client or employer consent, unless required by

Video Transcript3. Auditing Standards Update: NOCLAR, Management

Specialists and Pricing Services

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t professional standards. What these proposed revisions do, is add a requirement that the auditor is required to ask the predecessor auditor about NOCLAR, and the predecessor auditor is required to respond fully and timely, and to indicate if their response is limited.

Before this, it was kind of suggested in application material to the Code of Professional Conduct, that the predecessor auditor has a responsibility to cooperate, that auditors have a responsibility to cooperate with each other. But the predecessor auditor was not required to respond fully and timely about NOCLAR and now they are.

FOSTER: Ahava tells us how these new disclosures apply to the AICPA's client confidential information rule.

GOLDMAN: The AICPA's client confidential information rule says that a member in public practice shall not disclose any confidential client information without the specific consent of the client. But then part two of the rule, says this rule shall not be construed to relieve a member of his or her professional obligations of the compliance with the standards rule or the accounting principles rule.

What that means is that if the standards require the member to disclose this information, then it's not a violation of the confidential client information rule, the standard overrides. And we've checked and that's okay with state law.

FOSTER: But what happens if management does not authorize the inquiry, and, if so, would that be a reason for the CPA to not accept the engagement?

GOLDMAN: The answer to that is about a reason for not accepting the engagement, is probably but not necessarily.

So, one of the things that the ASB discussed in coming up with this amendment, was whether to make management's authorization a precondition for the audit, so that if management did not authorize the inquiry, then you could not accept the audit. They concluded that sometimes there are valid reasons for management, not to want you to talk to the prior auditor.

Sometimes there are disputes, relationships sometimes end badly. Sometimes there were disputes between management and the auditor, and while a bias for the profession, the auditor is not necessarily always right.

Management may have good and valid reasons for not wanting to authorize that.

So, the ASB did not want to make it a precondition, nor did they want to allow the successor auditor to communicate with the predecessor without the client's permission. For a number of reasons, including the fact that honestly, a lot of us thought it wasn't necessarily practicable that if you were the predecessor auditor, you wouldn't talk to a successor unless you knew that they had been authorized, because who knows who they are, maybe it's the newspaper calling up and trying to get dirt.

FOSTER: What happens if management does not authorize an inquiry from the successor auditor to speak with his or her predecessor? Ahava offers her insights.

GOLDMAN: But, generally speaking, if management does not authorize that inquiry, it's a big red flag. You would need to understand management's rationale for not authorizing that. You need to listen to management's rationale with

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t a good healthy dose of professional skepticism. That may in fact be a reason for you not to accept the engagement.

Now, does that make it difficult for a company to engage an auditor? It may, but a company may be required for whatever reason to get an audit, but you as the auditor are not required to do that audit. No auditor, unless maybe you're a governmental auditor and you're a state auditor, but no auditor is required to take on a client. You're not compelled to take on a client. It's the same thing as if you're doing your due diligence in coming to understand the client acceptance and you conclude that the client does not have the appropriate ethics, ethical values that you want to be involved in.

Well, if a company can't get an audit because they're not ethical or for whatever reasons, because there really is fraud or NOCLAR, let them clean up their act. It's not the auditor's responsibility.

FOSTER: Ahava shares her thoughts about the revisions proposed by the Auditing Standards Board's Exposure Draft.

GOLDMAN: This is very much in the public interest. That's why we're proposing these revisions. These revisions are to help the predecessor auditor feel more comfortable in responding fully because now they don't have to worry about violating the client confidentiality rule.

But if they don't want to respond fully, they need to say that they're not responding fully. Then again, it goes to the successor auditor's professional judgment. You need to think about, if they say to you, "I can't tell you that, I know some stuff, but you know what? I can't tell you." Well, that's another big red flag. And then you have to think about it, go back to management, see what management says and think long and hard about whether you want to accept this client.

FOSTER: Next Ahava discusses inquiries made regarding NOCLAR. To whom should the auditor make these inquiries?

GOLDMAN: Inquiries about fraud and NOCLAR should be made to management and those charged with governance, and to employees who have a significant role in internal controls. You don't want to ask as few people as possible. You want to ask those people who know, who are in a position to know and who are in position to talk to you.

FOSTER: Is there a specific number of inquiries required? Ahava tells us what the criteria is for determining the number of inquiries.

GOLDMAN: Well, it goes down to those favorite words, professional judgment. Of course, there's no way to say 10 or 43 or two.

It depends of course on the nature and circumstances of the client, but it's certainly going to be more than one, and more than a few as possible. You want to talk to people who are not necessarily in the financial reporting process. It can be helpful to get their perspective.

You stop when you have sufficient appropriate audit evidence, and maybe you stop when you're asking people and you're not hearing new information. But you want to get a variety of views because you're talking about fraud and NOCLAR.

So, you want to talk about people who, maybe they wouldn't speak up if you're asking them in front of their boss, but maybe, if you catch them at the right time and ask them the right way, you'll get some valuable information.

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t SURRAN: The Auditing Standards Board's issued an Exposure Draft early in 2021 entitled, "Inquiries of the Predecessor Auditor Regarding Fraud and Noncompliance with Laws and Regulations (NOCLAR) to amend SAS No. 122, as amended, section 210, Terms of Engagement."

This proposed standard would require immediate past auditors and presumed successor auditors, once management consents to the past auditor responding, to communicate about potential NOCLAR situations.

According to Jennifer Burns, AICPA Chief Auditor, "The Board's overall objective is to help auditors properly understand potential issues in determining whether to accept an engagement."

FOSTER: When it comes to a successor auditor conducting interviews with a predecessor auditor about fraud and NOCLAR, has the new Exposure Draft added any new requirements? Ahava Goldman tells us if anything has changed.

GOLDMAN: This isn't a new problem. This all exists now, the only thing that's changed here is now we're saying, "Make sure you ask about fraud and NOCLAR." We're saying to the predecessor auditor, "Make sure you answer." But it's not new.

Inquiries about NOCLAR are very similar to inquiries about fraud. In both cases, you're talking about not doing something that should be done or doing something that shouldn't be done in the case of fraud, and noncompliance, of course, is not doing something that should be done. Inquiry is an accepted audit procedure. It's not the strongest audit procedure, but it is an accepted audit procedure.

FOSTER: Another well-accepted audit procedure is documentation. Ahava discusses what's involved when it comes to documentation.

GOLDMAN: Documentation is also well-accepted, what may be not always well done, but well accepted, people know that they have to document. How do you document inquiries?

You write down what you heard. If you're doing Zoom calls, you can do it through Zoom, you can record the call. Though of course, you have to be careful about recording laws, and it's always best to make sure that both parties understand that they're being recorded. Again, on a Zoom call or Microsoft team calls, you know that you're being recorded, you can see if you're on the screen.

I think the way to avoid the, "No, I never said that" of course is one, to sum up your points at the end. To say, "This is what I've heard, is this consistent with what you meant to say?" That's one and then two, you can always, emails are nice and quick. You can always send your documentation of the call to the other person and say, "Have I appropriately captured our discussion. Please confirm and I will take lack of objection as positive confirmation."

FOSTER: Ahava Goldman offers some additional insights with respect to the documentation process and who the auditor should talk to.

GOLDMAN: Some of the other people that you might want to talk to and actually The Standard suggests this, are people who, as I said, are not involved in the financial reporting process, people with different levels of authority, because sometimes people lower down, know things, people who are involved in initiating, processing or recording complex or unusual

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t transactions. The people who monitor them, then of course you want to talk to people like in-house counsel.

If they have a chief ethics officer, which many larger companies do, and whoever the people are who are responsible for dealing with allegations of fraud.

FOSTER: Next Ahava Goldman gives us information relating to the timetable of the Exposure Drafts.

GOLDMAN: The comment period on this Exposure Draft ends on June 30th. And I should mention that PEEC has also put out an Exposure Draft addressing NOCLAR, the two Exposure Drafts work in conjunction with each other. They were issued on the same day and the comment periods end on the same day, and the ASB and PEEC will continue to consult with each other to make sure that our amendments and proposed amendments stay consistent.

FOSTER: Moving on to another topic, Ahava gives us some background on Statement on Auditing Standards No. 143, Auditing Accounting Estimates and Related Disclosures.

GOLDMAN: When SAS 143 was issued as an Exposure Draft, we got comment letters and the comment letters suggested that the ASB consider certain material in the PCAOB auditing standards. There was guidance related to auditor's use of pricing information from third party sources as evidence relating to accounting estimates, and PCAOB AS 2501, appendix A is special topics Identifying and Assessing Risks of Material Misstatement Related to the Fair Value of Financial Instruments.

There were comment letters that said, "Hey, this would be useful guidance in the ASB's standards." And then there was also commenters, responders to the comments suggested that the ASB look into, whether the PCAOB's amendments for the auditor's use of the work of specialists, which was PCAOB release number 2018- 006, Amendments to the Auditing Standards for Auditor's Use of Work of Specialists.

They asked if we looked into whether those amendments included material that, if included in the requirements or application of GAAS, would enhance audit quality for audits of financial statements of non-issuers in an effective and efficient manner. So, that was what prompted this project.

FOSTER: Ahava discusses some of her observations on the comment letters received, during the open period, on the SAS No. 143 project.

GOLDMAN: First let me tell you the comment period ended in February 2021, and we got 19 respondents; 19 people sent in comment letters, and all of them expressed support for the project, which of course is always gratifying to hear. All of the respondents agreed that the proposed amendments are appropriate. By the way, all of the proposed amendments in this standard are for guidance. We're not amending requirements because we felt that would be overly prescriptive.

FOSTER: How significant are the proposed amendments to AU-C section 540? Ahava Goldman offers her opinion.

GOLDMAN: So the proposed amendments to 540, and I think this is, I don't know if it's right to refer to it as the heart of the Standard, but it's certainly, I think one of the more substantive amendments that are proposed.

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t The proposed amendment is to add a new appendix, Use of Pricing Information from Third Parties as Audit Evidence. This appendix provides guidance on the use of pricing information obtained from external Information sources, which is something that AU-C 500 talks about, external information sources, when that information is to be used as audit evidence for estimates relating to the fair value of financial instruments.

As I had mentioned before, the proposed appendix is based on appendix A special topics of AS 2501, and of course, AS 2501 contains requirements for audits of issuers and GAAS is for audits of non-issuers. It's not applicable to the same, PCAOB standards apply, our standards don't and vice versa.

FOSTER: Next Ahava tells us how the Auditing Standards Board feels about appendix A.

GOLDMAN: The ASB believes that the requirements included in appendix A are consistent with procedures that would be performed by auditors to comply with the principles-based requirements in AU-C section 540, so that we thought that putting these in as requirements would be overly prescriptive, because that's what you'll be doing anyway, under GAAS when you're using pricing information from third parties as audit evidence for estimates relating to the fair value of financial instruments. It's a long phrase.

The risk of material misstatement isn't different, whether you're an issuer or a non-issuer, but again, we try to keep our standards principles-based and not heavily prescriptive. So, we included them as application material as this appendix and an appendix has the same authority as the other application material so it's authoritative, it's just we didn't do it. It fit better in an appendix, but we didn't think it needed to be requirements.

SURRAN: More and more companies today make use of outside specialists who have expertise in fields other than accounting and auditing when preparing their financial statements. The use of management specialists is increasing in both frequency and significance.

The Auditing Standards Board issued a standard in June of 2021 that provides guidance on the use of specialists. The guidance is included in Statement on Auditing Standards No. 144, Amendments to AU-C Section 501, 540 and 620 Related to the Use of Specialists and the Use of Pricing Information Obtained from External Information Sources.

The guidance is for situations when management has used the work of a specialist in developing accounting estimates. It also has enhanced guidance for auditors about evaluating the work of management's specialist.

There is also guidance on the use of pricing services when evaluating management's estimates related to the fair value of financial instruments.

FOSTER: What are the assumptions that need to be evaluated by the auditor with respect to a management specialist? Ahava Goldman helps us understand what the auditor needs to do.

GOLDMAN: From the auditor's perspective, there's really no difference if management or a management specialist made the estimate in terms of auditing the accounting estimate.

The same assumptions, the same methods, the relevance, the reliability, the competence, all of that, that you're looking at, if management made

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t the estimate, it's the same things you'll be looking at if management specialists had made the estimate.

The standard AU-C 500 gives guidance about this all. The guidance has been moved to AU-C 501. But it's really, you have to think just because management used a specialist, doesn't relieve them of any responsibility for the estimate, nor does it relieve you the auditor of any responsibility that you would audit it the same way as if management had done it.

You just need to get an understanding of the specialist's competency and capabilities and the relevance and reliability of the information they're using, the significant assumptions they're using and so forth.

FOSTER: Ahava reviews the factors that may affect the relevance and reliability of the management specialist's work.

GOLDMAN: This is kind of a laundry list of factors that you're going to be looking at. So, some of the factors that you're looking at, you're looking at how the nature and complexity of the matter that's being estimated, some are, presumably, if they're using a specialist, it's a more complex matter.

Of course, you're always thinking about the risks of material misstatement of the specific estimate. You need to think about what are my other sources of getting evidence? Is this the only place I can get evidence or do I have other things that are going to contradict or collaborate this evidence?

You're looking at the nature and scope and objectives of management specialists, whether the management specialist is employed by the entity, or whether they're employed by the entity, or they're an external to the entity, how much control management has over the specialist's work, whether the specialist is subject to technical or professional requirements, what are the controls that management has over the work of the specialists? How much do you, as the auditor, know about the work of the specialists? And have you ever worked with that specialist before? What was your previous experience with that specialist?

FOSTER: SAS No. 144 also provides guidance on pricing information obtained from external information sources. Ahava offers some insights into the guidance.

GOLDMAN: Well, one of the things that The Standard emphasizes, is that when you're using pricing information from an external information source, be it one pricing service or multiple pricing services or a broker or a dealer. And you're using that information to develop an independent expectation or you're evaluating the pricing information provided by one of these third parties, the requirements in section 500, audit evidence, to evaluate information, to be used as audit evidence applies.

So, you need to think about things that affect the relevance and reliability of that information and this guidance that's being added to the standard addresses factors that affect the reliability, they include factors that address the relevance of pricing information provided by a pricing service, as well as considerations for determining the similarity of financial instruments that can be treated as a group.

Because sometimes it can be much more efficient to group financial instruments and say, "Well, these are all the same, so we'll treat them as a group." The additional guidance talks to you about how to do that.

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t Of course when you're getting pricing information from multiple services, as opposed to just one, assuming that they are not totally contradictory from each other and all over the place that tends to give you more confidence in the evidence.

FOSTER: Ahava tells us about the proposed amendments to AU-C section 620, using the work of an auditor specialist.

GOLDMAN: In AU-C section 620 we're proposing amendments to various application materials. Really again, to enhance the guidance relating to the use of the work of an auditor specialist. For example, we've added guidance that information about the specialist may come from information obtained from procedures performed in accordance with 550, the work you do on related parties.

We're also adding in 620 information, that guidance that emphasizes the connection between AU-C 540 Auditing Accounting Estimates and 620. That 540, the same considerations that you have, the same requirements from AU-C 500, the considerations you have in 540 apply to estimates that are performed by the auditor specialist.

So, regardless of whether the estimate is done by management, or by a management specialist or by the auditor specialist, you still have to maintain professional skepticism and you have to get evidence to be sure that that information that you're going to be using as evidence is relevant, reliable, consider and assess the significant assumptions, assess the significant methods that there's a lot of connectivity there.

FOSTER: So what are auditors likely to be asking of management as a result of the new guidance?

GOLDMAN: The auditors may be asking management to get more information about the specialists than they may have in the past. Ideally, management will be looking at all these things already.

That when they're hiring a specialist, management is cognizant of the fact that even though they're hiring this specialist to assist them in making the estimate, management is still responsible for that estimate.

One would hope that management is already doing these things that we're asking the auditor to do, that management is evaluating the specialist's competence, that management is considering the relevance and reliability of the information the specialist is using to make their estimates, that management is making the effort to understand their methods, their significant assumptions, so that management has the assurance that the estimate is appropriate for the financial statements that they are responsible for.

FOSTER: Ahava gives us the effective dates relating to AU-C sections 501, 540 and 620.

GOLDMAN: The effective dates, there are not really, well, they're by section, but it's the same for all three sections because it's the same for this SAS, these amendments will be published in a SAS, I guess it will be SAS number 144, because that's what we're up to. And the amendments in the proposed amendments in that SAS will be effective for audits of financial statements for periods ending on or after December 15th, 2023.

FOSTER: We end our segment with Ahava Goldman's key takeaways on Auditing Standards Update.

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t GOLDMAN: The key takeaway on the NOCLAR is that the auditor needs to be concerned when you're taking on a new client, you need to be considering the client's ethics, whether they're involved in illegal activities, whether they're involved in fraud, whether there's non-compliance with laws or regulations, which by the way, may not be intentional. Non-compliance with laws and regulations may be due to error or ignorance, nonetheless it's non-compliance and you need to reach out to that predecessor.

You need to ask them specifically about fraud and NOCLAR in your inquiries, they now have to answer or tell you that they can't answer. As has always been the case, if management doesn't want to authorize you to ask them or if the predecessor auditor can't respond fully, you need to consider those as big red flags, apply your professional skepticism and think long and hard about whether this is a client that you want to include.

Standards aren't done for risk management, but one of the best ways to manage risk and not get involved in a malpractice suit, is not to take on a bad client in the first place. It's useful to take a look at this and understand the guidance. The pricing service guidance is really, really valuable if you have clients that get information from pricing services or from brokers or dealers.

This guidance will be very helpful to auditors that have to address using that information as audit evidence. And I think it also helps to remember that AU-C 500 is the overarching standard that talks about audit evidence and then the requirements in 540, the requirements in 620, the information in 501 about the use of management specialists are all there to help you apply the requirements of 500 and make sure that you get the sufficient appropriate audit evidence you need on which to base your conclusion.

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4. Corporate & Individual Tax Updates

(November 2021)

Segment Overview:

Field of Study:

Recommended Accreditation:

Reading (Optional for Group Study):

Running Time:

Video Transcript:

Course Level:

Course Prerequisites:

Advance Preparation:

Expiration Date:

Taxes

January 13, 2023

Work experience in tax planning or tax compliance, or an introductory course in taxation.

None

1 hour group live 2 hours self-study online

Update

“Guidance on Reporting Qualified Sick Leave Wages and Qualified Family Leave Wages Paid For Leave Provided in 2021”

See page 4–12.

See page 4–18.

35 minutes

Even though the temporary measures established during the pandemic to help businesses and employees are coming to an end, the guidance isn't ending. Barbara Weltman, president at Big Ideas for Small Business, discusses guidance on affording paid sick leave and paid family leave under Notice 2021-53. She also covers potential tax implications with respect to demolitions, foreclosures and debt cancellation, provides tax updates on marijuana businesses and discusses deductibility of expenses and the new Form 7203 for figuring basis for S corporation shareholders

Learning Objectives:

Upon successful completion of this segment, you should be able to:

l Understand the proper reporting on form W-2 of paid sick leave and paid family leave to employees,

l Recognize potential tax implications on real estate in the events of demolition, foreclosures and debt cancellation,

l Identify tax updates on marijuana businesses and deductibility of expenses, and

l Understand reasons paid preparers may be subject to tax penalties.

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A. Measures for Consideration by Congress

i. $1.5 trillion infrastructure

ii. $3.5 trillion reconciliation

iii. Higher rates for corporations and top tax bracket individuals

iv. Repeal of SALT cap

B. Properly Reporting Payments on W-2

i. Payments are taxable compensation l Boxes 1, 3 & 5

ii. Break down payments by periods l Q1, Q2 & Q3 l Report on

b Box 14 b Separate statement

C. Self-Employed Individuals

i. Can claim an equivalent refundable credit l Tax refunds based on credit

ii. If also eligible employees l Reduced qualified sick and

family leave amount

D. If Credits Are Erroneously Calculated

i. Corrected W-2s are required

ii. Assessment of erroneous refunds l Effective September 10, 2021 l Treated as underpayments

E. COBRA – Initial Premium Payment

i. Outside initial 60-day election l 1 year and 105 days after the

election

ii. Within the initial 60-day election l 1 year and 45 days after the

election l Due after November 1, 2021

iii. Additional payments l One year from original due date l Not applicable to COBRA

premium assistance under ARPA

I. Sick and Paid Family Leave

A. Construction Industry Audit Techniques Guide:

i. IRS recommends users research l Tax issues & tax law

i. Not an official pronouncement of the law

ii. Does not represent the position of the IRS

iii. Cannot be used, cited, or relied upon as such

iv. Last revision – April 9, 2021

B. Casualty Losses Deduction

i. Allowed for investment property

ii. Disallowed for personal use of property l Exception – federal disaster

II. Construction Audits and Casualty Losses

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A. Distribution Amount

i. Money received

ii. Plus FMV of property received l Becomes basis of property

B. Solo 401(k) Benefits

i. Self-employed individuals l Adjustment to gross income l Does NOT reduce business

income

C. Lesson Learned

i. Have a paper trail for contributions made

D. Gain Recognition Deferral

i. Property needs to be replaced

ii. Replacement period ends l Four years after the close of first

taxable year involuntary conversion is realized

iii. Replacement period extended l End of taxpayer’s first taxable

year b After drought-free year for

applicable region

E. First Drought-Free Year

i. Ends August 31

ii. Ends in or after the last year of taxpayer’s 4-year replacement period

iii. Does NOT include any weekly period of reported drought that was l Exceptional l Extreme l Severe

III. Business Related Tax Deductions and Deferrals

A. Deductibility of Hobby Losses

i. Allowed to the extent of hobby income

ii. Deducted only as miscellaneous itemized deductions l Subject to 2% AGI floor

B. IRS Closer Look Statement on Cannabis

i. New initiative

ii. Help marijuana business understand tax obligations

iii. IRS position on noncompliance l Trained examiners to conduct

quality audits

iv. Use of cryptocurrency in cannabis industry l Encourages use of reputable

exchanges

IV. Hobby Losses and Marijuana Business Expenses

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A. Types of Acceptable Electronic Signatures

i. Typed name on signature block

ii. Scanned or digitized image of handwritten signature

iii. Handwritten signature input on e-signature pad

iv. Handwritten signature mark on display screen

v. Signature created by 3rd party software

B. Willfulness Requires

i. Conscious act or omission made in the knowledge that a duty is therefore not being met

C. Willful Blindness

i. Belief there is high probability that fact exists

ii. Deliberate actions to avoid learning facts

V. E-Signatures and Preparer Penalties

A. Unpaid Tax to Private Collection Agencies

If any of three criteria are met:

i. IRS lacks resources and can’t locate taxpayer

ii. Interaction with the IRS on the debt is longer than a year

iii. More than 3 years since assessment

B. Joint Committee Review Triggers

i. Refund claim previously assessed l Paid taxes from a tentative

refund from NOL capital losses carryback

ii. Refund of income tax due to disaster losses

“Not many taxpayers have such large refund claims, but it's always helpful to have more information available just in case.”

— Barbara Weltman

VI. Unpaid Tax Accounts and Big Refunds

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l As the Discussion Leader, you should introduce this video segment with words similar to the following:

“In this segment, Barbara Weltman discusses guidance on affording paid sick leave and paid family leave under Notice 2021-53 among other updates.”

l Show Segment 4. The transcript of this video starts on page 4–18 of this guide.

l After playing the video, use the questions provided or ones you have developed to generate discussion. The

answers to our discussion questions are on pages 4–7 to 4–9. Additional objective questions are on pages 4–10 and 4–11.

l After the discussion, complete the evaluation form on page A–1.

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4. Corporate & Individual Tax Updates (November 2021)

1. Certain employers will soon be required to provide paid sick and paid family leave to employees. What are the reporting requirements for such benefits? How will your organization or your clients seek to ensure compliance with the new mandate?

2. Certain employers with group health plans must offer and pay for COBRA for their employees. What are the rules for payment of such coverage? How have these rules impacted your organization?

3. The real estate industry may be affected by certain tax regulations. What are some of the rules that may impact real estate investment? How will these rules affect your organization’s investments in real estate?

4. Congress recently provided tax breaks for farmers and ranchers who are forced to sell livestock because of a drought. What are the rules in this area? Has your organization or clients taken advantage of these rules?

Discussion Questions

You may want to assign these discussion questions to individual participants before viewing the video segment.

Instructions for Segment

Group Live Option

For additional information concerning CPE requirements, see page vi of this guide.

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s5. Recent cases have challenged the IRS’

denial of deductions for marijuana businesses. What are the implications of the denials for these businesses? How do you advise your business or your clients on taking deductions?

6. Paid preparers are often subject to penalties by the IRS. Which circumstances that may lead to a preparer being subject to penalties were discussed in the interview ? Do you agree with the IRS’ position on this matter? Why or why not?

7. In certain instances, the IRS will turn over uncollected accounts to a private collection agency (PCA). What are the situations in which the IRS will do so? What has been your or your organization’s experience with PCAs?

Discussion Questions (continued)

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Suggested Answers to Discussion Questions

4. Corporate & Individual Tax Updates (November 2021)

1. Certain employers will soon be required to provide paid sick and paid family leave to employees. What are the reporting requirements for such benefits? How will your organization or your clients seek to ensure compliance with the new mandate? l Small employers were required to

provide paid sick leave and paid family leave to employees in 2020 b May continue to do so voluntarily

in 2021 through September 30th b IRS has provided guidance on

reporting these payments l Properly reporting payments on W-2

b Payments are taxable compensation v Boxes 1, 3 & 5

b Break down payments by periods v Q1, Q2 & Q3 v Report on

k Box 14 k Separate statement

l Self-employed individuals b Can claim an equivalent

refundable credit v Tax refunds based on credit

b If also eligible employees v Reduced qualified sick and

family leave amount l If credits are erroneously calculated

b Corrected W-2s are required b Assessment of erroneous refunds

v Effective September 10, 2021 v Treated as underpayments

l Participant response based on personal/organizational experience

2. Certain employers with group health plans must offer and pay for COBRA for their employees. What are the rules for payment of such coverage? How have these rules impacted your organization?

l Generally, 60-day election period for someone losing coverage b Premiums are not required to be

paid before 45 days after a qualified beneficiary makes an election to continue coverage

l The IRS and DOL extended the election period until 60 days b After the announced end of the

COVID-19 national emergency or b Other date to be announced

l COBRA – Initial Premium Payment b Outside initial 60-day election

v 1 year and 105 days after the election

b Within the initial 60-day election v 1 year and 45 days after the

election v Due after November 1, 2021

b Additional payments v One year from original due

date v Not applicable to COBRA

premium assistance under ARPA

l Participant response based on personal/organizational experience

3. The real estate industry may be affected by certain tax regulations. What are some of the rules that may impact real estate investment? How will these rules affect your organization’s investments in real estate? l Casualty loss deductions

b Allowed for investment property b Disallowed for personal use of

property v Exception – federal disasters

l Foreclosures and debt cancellation b IRS updated the audit technique

guide on real estate property foreclosures and cancellation of debt

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Suggested Answers to Discussion Questions (continued)

b Exceptions to reporting cancellation of debt income v Bankruptcy or insolvency v Qualified farm indebtedness v Qualified real property

business indebtedness l Participant response based on

personal/organizational experience

4. Congress recently provided tax breaks for farmers and ranchers who are forced to sell livestock because of a drought. What are the rules in this area? Has your organization or clients taken advantage of these rules? l Deferral of gain recognition for

farmers and ranchers b Forced to sell their livestock other

than poultry due to drought l Property needs to be replaced

b Replacement period ends v Four years after the close of

first taxable year involuntary conversion is realized

b Replacement period extended v End of taxpayer’s first

taxable year k After drought-free year for

applicable region l First Drought-Free Year

b Ends August 31 b Ends in or after the last year of

taxpayer’s 4-year replacement period

b Does NOT include any weekly period of reported drought that was

v Exceptional v Extreme v Severe

l Participant response based on personal/organizational experience

5. Recent cases have challenged the IRS’ denial of deductions for marijuana businesses. What are the implications of the denials for these businesses? How do you advise your business or your clients on taking deductions? l Several cases challenging the IRS'

denial of deductions for marijuana businesses, other than the cost of goods sold b IRC section 280E, bars deductions

for businesses trafficking in controlled substances

v Cannabis is a Schedule One controlled substance

v Even though legal in the majority of states

b The IRS posted a closer look statement from the commissioner of the SBSE Division

v New initiative v Helps marijuana business

understand tax obligations v IRS position on

noncompliance k Trained examiners to

conduct quality audits v Use of cryptocurrency in

cannabis industry k Encourages use of reputable

exchanges l Participant response based on

personal/organizational experience

6. Paid preparers are often subject to penalties by the IRS. Which circumstances that may lead to a preparer being subject to penalties were discussed in the interview ? Do you agree with the IRS’ position on this matter? Why or why not? l Paid preparers may be subject to a

variety of tax penalties for certain actions or inactions b Willfulness requires

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Suggested Answers to Discussion Questions (continued)v Conscious act or omission

made in the knowledge that a duty is therefore not being met

b Willful blindness v Belief that high probability

facts exist v Deliberate actions to avoid

leaning facts l Participant response based on

personal/organizational experience

7. In certain instances, the IRS will turn over uncollected accounts to a private collection agency (PCA). What are the situations in which the IRS will do so? What has been your or your organization’s experience with PCAs? l Unpaid tax to private collection

agencies if any of three criteria are met: b IRS lacks resources and can’t

locate taxpayer b Interaction with the IRS on the

debt is longer than a year b More than 3 years since

assessment l The private debt collection program

b Established in 2016 after being authorized by the Fixing America Service Transportation Act of 2015

l Participant response based on personal/organizational experience

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1. Payments made by employers for employee sick and paid family leave:

a) are included as taxable compensation on the employee’s Form W-2

b) are NOT taxable income

c) are taxable only up to the first $1,000

d) must be reported as one annual number

2. Individuals electing COBRA coverage within the initial 60-day election period:

a) have one year and 105 days after the date of the COBRA election to make the initial COBRA premium payment

b) must make the election within one year from the original due date

c) have one year and 45 days after the date of the COBRA election to make the initial COBRA premium payment

d) must do so before November 1, 2021

3. Under current rules, casualty losses:

a) are allowed for personal property only

b) are allowed for investment property only

c) are allowed for investment property and personal property involved in a federal disaster

d) are never allowed

4. Which of the following scenarios does NOT require reporting of cancellation of debt as income?

a) qualified farm indebtedness

b) discharge of debt resulting from a personal injury award

c) bankruptcy or insolvency

d) qualified real property indebtedness

5. When it comes to the taxation of hobby activities:

a) losses are allowed to be deducted to the extent of income generated from such activities

b) all losses are allowed to be deducted in full

c) income from hobby activities is NOT required to be reported

d) losses are allowed as above the line deductions

6. Paid preparers are subject to potential penalties for acts involving:

a) acts of willful blindness

b) reckless disregard

c) conscious acts or omissions

d) all of the above

7. In which instance would an unpaid tax account be turned over to a private collection agency?

a) the interaction with the IRS on the debt has been longer than 3 years

b) the IRS lacks the resources and can’t locate the taxpayer

c) it has been more than 1 year since the initial assessment by the IRS

d) the taxpayer is a victim of identity theft

8. Refund requests of more than _____ are subject to a review by the Joint Committee on Taxation.

a) $5 million for any taxpayer

b) $2 million for any taxpayer

c) $5 million for C corporations

d) $2 million for C corporations

You may want to use these objective questions to test knowledge and/or to generate further discussion; these questions are only for group live purposes. Most of these questions are based on the video segment, a few may be based on the reading for self-study that starts on page 4–12.

4. Corporate & Individual Tax Updates (November 2021)

Objective Questions4–10

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9. The Emergency Paid Sick Leave Act entitles workers ___ paid sick leave time.

a) up to 80 hours of

b) at least 80 hours

c) unlimited

d) NO

10. An employee who receives paid sick leave due to the inability to work for reasons related to COVID-19 must be paid sick leave wages:

a) of at least $200 per day

b) up to a maximum of $2,000 per day

c) the of the employee’s regular rate of pay, the federal or state minimum wage

d) the highest of the 2/3 of the employee’s regular rate of pay, or any applicable federal or state minimum wage

Objective Questions (continued)

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Self-Study Option

Reading (Optional for Group Study)

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GUIDANCE ON REPORTING QUALIFIED SICK LEAVE WAGES AND QUALIFIED FAMILY LEAVE WAGES PAID FOR LEAVE PROVIDED IN 2021

Source: https://www.irs.gov/pub/irs-drop/n-21-53.pdf

Notice 2021-53 I. PURPOSE

This notice provides guidance to employers on the requirement to report the following qualified sick leave wages and qualified family leave wages (qualified leave wages)1 paid to employees for leave provided in 2021:2

• Qualified leave wages under the Families First Coronavirus Response Act (Families First Act), Pub. L. No. 116-127, 134 Stat. 178 (March 18, 2020), as amended by the COVID-related Tax Relief Act of 2020 (Tax Relief Act), enacted as Subtitle B of Title II of Division N of the Consolidated Appropriations Act, 2021, Pub. L. No. 116-260, 134 Stat. 1182 (December 27, 2020), paid for leave provided to employees beginning January 1, 2021, through March 31, 2021.3

l Qualified leave wages under sections 3131, 3132, and 3133 of the Internal Revenue Code (Code), added by section

9641 of the American Rescue Plan Act of 2021 (ARP), Pub. L. No. 117-2, 135 Stat. 4 (March 11, 2021), paid for leave provided to employees beginning April 1, 2021, through September 30, 2021.

Employers are required to report qualified leave wages either on a 2021 Form W-2, Box 14, or on a separate statement. This reporting provides employees who are also self employed with information necessary for properly claiming qualified sick leave equivalent or qualified family leave equivalent credits for the 2021 taxable year under the Families First Act or the ARP.

II. BACKGROUND

In general

The Families First Act and sections 3131 and 3132 of the Code provide refundable tax credits to employers with fewer than 500 employees (eligible employers) to reimburse them for the cost of providing qualified leave wages. Sections 3131 and 3132 also permit certain governmental employers to claim these tax credits, without regard to the number of their employees.4 Accordingly, when this Notice

l In order to ensure adherence to NASBA guidelines regarding self-study, the CPA Report and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers are no longer available. Customers should contact their company administrators for information on taking course exams and receiving CPE credit for the courses.

l Customers may contact Kaplan Financial Education at cpesupport@kaplan.com to obtain certificates previously earned through the CPA Report Self-Study and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers.

l Customers interested in the self-study format of the CPA Report can find information on Kaplan Financial Education's self-study libraries at Online Accounting CPE Courses.

CPA Report Gov/Not-for-Profit Update

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addresses the credits provided under these Code sections, the term “eligible employer” also includes these governmental employers.

Division E of the Families First Act, the Emergency Paid Sick Leave Act (EPSLA), and Division C of the Families First Act, the Emergency Family and Medical Leave Expansion Act (EFMLEA), generally required eligible employers to provide paid sick leave and expanded family and medical leave, respectively, beginning April 1, 2020, through December 31, 2020, up to specified limits, to employees unable to work or telework due to certain circumstances related to COVID-19. The EPSLA entitled workers to up to 80 hours of paid sick time and the EFMLEA entitled workers to up to 10 weeks of paid family and medical leave if they were unable to work for certain reasons related to COVID-19. The Families First Act also provided eligible employers with fully refundable tax credits to cover the cost of the leave required to be paid under the EPSLA and EFMLEA. The requirement that eligible employers provide leave under the EPSLA and EMFLEA does not apply after December 31, 2020. However, the Tax Relief Act extended the availability of the tax credits under the Families First Act through March 31, 2021, for paid leave that would have satisfied the EPSLA or EFMLEA requirements.

Specifically, sections 7001 and 7003 of the Families First Act provide refundable tax credits against the tax imposed by section 3111(a) of the Code (referring to the eligible employer’s share of the social security portion of the Federal Insurance Contributions Act (FICA) tax), and so much of the Railroad Retirement Tax Act (RRTA) Tier 1 tax as is attributable to the rate in effect under section 3111(a), on all wages or compensation paid to all employees for each calendar quarter in an amount equal to the qualified leave wages paid by the eligible employer, plus allocable qualified health plan expenses, with respect to leave provided to employees beginning April 1, 2020, through March 31, 2021. The credits under sections 7001 and 7003 of the Families First Act are increased by the amount of the tax imposed by section 3111(b) of the Code (referring to the

employer’s share of Medicare tax) and so much of the RRTA Tier 1 tax imposed as s attributable to the rate in effect under section 3111(b) on qualified leave wages. See section 7005(b)(1) of the Families First Act.

Section 9641 of the ARP added sections 3131 through 3133 to the Code, which extend the availability of the credits for paid leave through September 30, 2021. Section 3131 provides the credit for paid sick leave, section 3132 provides the credit for paid family leave, and section 3133 provides that the credits allowed under sections 3131 and 3132 are increased by the eligible employer’s share of both the social security and Medicare portions of FICA tax (and the eligible employer’s share of the RRTA Tier 1 tax) imposed on the qualified leave wages. Sections 3131 and 3132 of the Code provide that eligible employers are entitled to claim refundable tax credits with respect to leave provided voluntarily to employees beginning April 1, 2021, through September 30, 2021, if the leave would have satisfied the EPSLA or EFMLEA requirements.5 Specifically, sections 3131 and 3132 of the Code provide refundable tax credits against the tax imposed by section 3111(b) (referring to an eligible employer’s share of Medicare tax), and so much of the RRTA Tier 1 tax as is attributable to the rate in effect under section 3111(b), on all wages or compensation paid to all employees for each calendar quarter in an amount equal to the qualified leave wages paid by the eligible employer plus (i) the allocable qualified health plan expenses and (ii) certain collectively bargained contributions allocable to qualified leave wages. See sections 3131(d), 3131(e), 3132(d), and 3132(e).

Sections 7001(c) and 7003(c) of the Families First Act and sections 3131(f)(2) and 3132(f)(2) of the Code define the terms wages and compensation to mean “wages” as defined in section 3121(a), but without regard to section 3121(b)(1) through (22), and “compensation” as defined in section 3231(e), but without regard to the exclusions under section 3231(e)(1).6

A self-employed individual carrying on a trade or business in 2021 within the

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meaning of section 1402 who would have received qualified leave wages if the individual were treated as an employee of an employer (other than himself or herself) may claim refundable tax credits if the individual is unable to work or telework (eligible self-employed individual). Specifically, sections 7002 and 7004 of the Families First Act permit an eligible self-employed individual to claim refundable tax credits for qualified sick leave equivalent amounts and qualified family leave equivalent amounts (qualified leave equivalent amounts) if the individual is unable to work or telework during the period beginning April 1, 2020, through March 31, 2021, due to certain circumstances related to COVID-19. Sections 9642 and 9643 of the ARP permit an eligible self employed individual to claim refundable tax credits for qualified leave equivalent amounts if the individual is unable to work or telework during the period beginning April 1, 2021, through September 30, 2021, due to certain circumstances related to COVID19. An eligible self-employed individual may have to reduce qualified leave equivalent amounts by some or all of the qualified leave wages the individual received from an employer. See sections 7002 and 7004 of the Families First Act and sections 9642 and 9643 of the ARP.

Sections 7002(g) and 7004(e) of the Families First Act provide that the Secretary of the Treasury will prescribe such regulations or other guidance as may be necessary to carry out the purposes of sections 7002 and 7004 of the Families First Act, respectively. Section 9642(h) and section 9643(h) of the ARP provide that the Secretary of the Treasury will prescribe such regulations or other guidance as may be necessary to carry out the purposes of sections 9642 and 9643 of the ARP, respectively.

Qualified leave wages paid for leave beginning January 1, 2021, through March 31, 2021

With respect to paid leave provided under the Families First Act to employees beginning January 1, 2021, through March 31, 2021, qualified sick leave wages are

wages and compensation, as defined under section 7001(c), paid for leave that would have satisfied the requirements of the EPSLA. In general, eligible employers are permitted to claim refundable tax credits if they provide employees with up to 80 hours of paid sick leave due to the employee being unable to work or telework because the employee—

(1) is subject to a Federal, State, or local quarantine or isolation order related to COVID-19;

(2) has been advised by a health care provider to self-quarantine due to concerns related to COVID-19;

(3) is experiencing symptoms of COVID-19 and seeking a medical diagnosis;

(4) is caring for an individual who is subject to a Federal, State, or local quarantine or isolation order related to COVID-19, or has been advised by a health care provider to self-quarantine due to concerns related to COVID-19;

(5) is caring for a son or daughter of such employee if the school or place of care of the son or daughter has been closed, or the child care provider of such son or daughter is unavailable, due to COVID-19 precautions; or

(6) is experiencing any other substantially similar condition specified by the Secretary of Health and Human Services in consultation with the Secretaries of the Treasury and Labor.7

An employee who receives paid sick leave due to the inability to work or telework for reasons related to COVID-19 described in (1), (2), or (3) above must be paid sick leave wages at the employee’s regular rate of pay or, if higher, the Federal minimum wage or any applicable State or local minimum wage, up to $511 per day and $5,110 in the aggregate, for the eligible employer to claim the credit for leave provided to that employee during the period beginning April 1, 2020, through March 31, 2021. An employee who receives paid sick leave due to the inability to work or telework for reasons related to COVID-19 described in

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(4), (5), or (6) above must be paid sick leave wages at two-thirds the employee’s regular rate of pay or, if higher, the Federal minimum wage or any applicable State or local minimum wage, up to $200 per day and $2,000 in the aggregate. Because the sick leave wage cap is not increased for the period beginning January 1, 2021, and ending March 31, 2021, no more than $5,110 (or $2,000 for absences described in (4), (5), and (6) above) in the aggregate may be claimed by an employer with respect to leave provided to an employee during the period beginning April 1, 2020, through March 31, 2021.

With respect to paid leave provided to employees during the period beginning January 1, 2021, through March 31, 2021, qualified family leave wages are wages and compensation, as defined under section 7003(c) of the Families First Act, paid for leave that would have satisfied the requirements of the EFMLEA. In general, eligible employers are permitted to claim refundable tax credits if they provide employees with up to 10 weeks of paid family leave due to the employee being unable to work or telework because the employee is caring for a son or daughter whose school or place of care is closed or whose child care provider is unavailable for reasons related to COVID19. To receive the credit, the eligible employer must pay the employee family leave wages at two-thirds the employee’s regular rate of pay, up to $200 per day and $10,000 in the aggregate. Because the family leave wage cap is not increased for the period beginning January 1, 2021, and ending March 31, 2021, no more than $10,000 in the aggregate may be claimed by an employer with respect to leave provided to an employee during the period beginning April 1, 2020, through March 31, 2021.

Reduction to qualified leave equivalent amounts for qualified leave wages paid beginning January 1, 2021, through March 31, 2021

If a self-employed individual is entitled to a refundable tax credit for a qualified sick leave equivalent amount under section 7002(a) of the Families First Act and also receives qualified sick leave wages as an

employee, section 7002(d)(3) of the Families First Act reduces the qualified sick leave equivalent amount for which the eligible selfemployed individual may claim a credit to the extent that the sum of the qualified sick leave equivalent amount described in section 7002(c) of the Families First Act and any qualified sick leave wages under section 7001(b)(1) of the Families First Act exceeds $2,000 (or $5,110 in the case of any day any portion of which is paid sick time described in paragraphs (1), (2), or (3) of section 5102(a) of the EPSLA). Similarly, if a self-employed individual is entitled to a refundable tax credit for a qualified family leave equivalent amount under section 7004(a) of the Families First Act and also receives qualified family leave wages as an employee, section 7004(d)(3) of the Families First Act reduces the qualified family leave equivalent amount for which the self-employed individual may claim a credit to the extent that the sum of the qualified family leave equivalent amount described in section 7004(c) of the Families First Act and the qualified family leave wages under section 7003(b)(1) of the Families First Act exceeds $10,000.

Under the Families First Act, the requirement to reduce qualified leave equivalent amounts is not applied separately for 2020 and 2021. Instead, the reduction to the qualified leave equivalent amounts in each case is figured using the sum of the qualified leave equivalent amounts and the qualified leave wages for the entire period beginning April 1, 2020, through March 31, 2021. As a result, if an eligible self-employed individual reduced a qualified sick leave equivalent amount for 2020 because the sum of the qualified sick leave equivalent amount and the qualified sick leave wages exceeded $5,110, then no credit under section 7002 of the Families First Act will be available for 2021. Likewise, if an eligible self-employed individual reduced a qualified family leave equivalent amount for 2020 because the sum of the qualified family leave equivalent amount and the qualified family leave wages exceeded $10,000, then no credit under section 7004 of the Families First Act will be available for 2021.

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Qualified leave wages paid for leave beginning April 1, 2021, through September 30, 2021

With respect to leave provided under sections 3131 and 3132 of the Code to employees beginning April 1, 2021, through September 30, 2021, qualified sick leave wages are wages and compensation, as defined under section 3131(f)(2), paid with 10 respect to leave that would have satisfied the requirements of the EPSLA. In general, eligible employers are permitted to claim refundable tax credits under section 3131 if they provide employees with up to 80 hours of paid sick leave due to the employee being unable to work or telework because the employee—

(1) is subject to a Federal, State, or local quarantine or isolation order related to COVID-19;

(2) has been advised by a health care provider to self-quarantine due to concerns related to COVID-19;

(3) is experiencing symptoms of COVID-19 and is seeking a medical diagnosis; or is seeking or awaiting the results of a diagnostic test for, or a medical diagnosis of, COVID-19 and has been exposed to COVID-19, or the employer has requested such test or diagnosis, or is obtaining immunization related to COVID-19 or is recovering from any injury, disability, illness, or condition related to such immunization;8

(4) is caring for an individual who is subject to a Federal, State, or local quarantine or isolation order related to COVID-19 or has been advised by a health care provider to self-quarantine due to concerns related to COVID-19;

(5) is caring for a son or daughter of such employee if the school or place of care of the son or daughter has been closed, or the child care provider of such son or daughter is unavailable, due to COVID-19 precautions; or

(6) is experiencing any other substantially similar condition specified by the Secretary of Health and Human Services in consultation with the Secretaries of the Treasury and Labor, including if the employee is accompanying an individual to obtain immunization related to COVID-19, or is caring for an individual who is recovering from any injury, disability, illness, or condition related to the immunization.9

An employee who receives paid sick leave due to the inability to work or telework for reasons related to COVID-19 described in paragraphs (1), (2), or (3) above after March 31, 2021, and before October 1, 2021, must be paid sick leave wages at the employee’s regular rate of pay or, if higher, the Federal minimum wage or any applicable State or local minimum wage, up to $511 per day and $5,110 in the aggregate for the eligible employer to claim the credit for leave provided to that employee beginning April 1, 2021, through September 30, 2021. An employee who receives paid sick leave due to the inability to work or telework for reasons related to COVID-19 described in paragraphs (4), (5), or (6) above after March 31, 2021, and before October 1, 2021, must be paid sick leave wages at two-thirds of the employee’s regular rate of pay or, if higher, the Federal minimum wage or any applicable State or local minimum wage, up to $200 per day and $2,000 in the aggregate for the eligible employer to claim the credit for leave provided to that employee beginning April 1, 2021, through September 30, 2021.

With respect to leave provided to employees during the period beginning April 1, 2021, through September 30, 2021, qualified family leave wages are wages and compensation, as defined under section 3132(f)(2) of the Code, paid with respect to leave that would have satisfied the requirements of the EFMLEA. In general, eligible employers are permitted to claim refundable tax credits under section 3132 if they provide employees with up to 12 weeks of paid family leave due to the employee being unable to work or telework for any of the same reasons for which an employee can

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take paid sick leave. To receive the credit, the eligible employer must pay the employee family leave wages at two-thirds of the employee’s regular rate of pay, up to $200 per day and $12,000 in the aggregate, with respect to leave provided to that employee during the period beginning April 1, 2021, through September 30, 2021.

Reduction to qualified leave equivalent amounts for qualified leave wages paid beginning April 1, 2021, through September 30, 2021

If a self-employed individual is entitled to a refundable tax credit for a qualified sick leave equivalent amount under section 9642(a) of the ARP and also receives qualified sick leave wages as an employee, section 9642(e)(2) of the ARP reduces the qualified sick leave equivalent amount for which the eligible self-employed individual may claim a credit to the extent that the sum of the qualified sick leave equivalent amount described in section 9642(c) of the ARP and any qualified sick leave wages under section 3131(b)(1) of the Code exceeds $2,000 (or $5,110 in the case of any day any portion of which is paid sick time described in paragraph (1), (2), or (3) of section 5102(a) of the EPSLA). Similarly, if a self-employed individual is entitled to a refundable tax credit for a qualified family leave equivalent amount under section 9643(a) of the ARP, and also receives qualified family leave wages that meet the requirements of the EFMLEA, section 9643(e)(2) of the ARP reduces the qualified family leave equivalent amount for which the self-employed individual may claim a credit to the extent that the sum of the qualified family leave equivalent amount described in section 9643(c) of the ARP and the qualified family leave wages under section 3132(b)(1) of the Code exceeds $12,000.

For reporting requirements and the full Notice 2021-53 please visit https://www.irs.gov/pub/irs-drop/n-21-53.pdf rea

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SURRAN: A lot of temporary measures, established by the previous administration during the pandemic and continued by the current government in an effort to help businesses and individuals, are coming to an end. But before we get into our discussion, we wanted to briefly discuss what is happening on the legislative front.

When we prepared this program, Congress was still debating various measures, the $1.5 trillion infrastructure measure, a bipartisan measure that passed the Senate, and the $3.5 trillion reconciliation measure, still being debated in the House. We don't know what will be in the final package. Higher rates for corporations and top tax bracket individuals, likely.

Repeal of the SALT cap, possible.

Most of the proposed changes wouldn't take effect until 2022, but some could apply for 2021, such as a higher rate on capital gains for high tax bracket individuals for transactions after September 13, 2021.

Too much to speculate on now. We'll bring you details in the next program, if they're available by then.

FOSTER: Even though the temporary measures established during the pandemic to help businesses and employees are coming to an end, the guidance isn't ending. Barbara Weltman, president at Big Ideas for Small Business, starts with guidance on affording paid sick leave and paid family leave under Notice 2021-53.

WELTMAN: As you know, small employers will be required to provide paid sick leave and paid family leave to employees in 2020 and could continue to do so voluntarily in 2021 through September 30th. Now the IRS has provided guidance on reporting these payments to employees.

First of all, be sure to recognize that these payments are taxable compensation. So they're included in box one of form W-2, as well as in boxes three and five. Employers who claim credits are required to separately report qualified sick leave and qualified family leave wages to employees. What's more, these wages must be broken down for the period from January 1st, 2021, through March 31st, 2021, and then from April 1st, 2021 through September 30th, 2021. This is done in box 14 of form W-2 or a separate statement included with an employee's W-2.

If a separate statement is provided and the employee receives a paper form W-2, then the statement must be included with the form W-2 sent to the employee. And if the employee receives an electronic form W-2, then the statement must be provided in the same manner and at the same time as the W-2. Notice 2021-53 has model language that may be used for this statement.

FOSTER: And what about self-employed individuals? Barbara explains.

WELTMAN: Self-employed individuals can claim an equivalent refundable credit if they're unable to work or tele-work due to the pandemic. Because self-employed individuals don't deposit employment taxes, they simply take

Video Transcript

4. Corporate & Individual Tax Updates (November 2021)

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t the credit into account in figuring their estimated taxes for the year. They figure the credit when they file their 2021 return in the 2022 filing season.

As I said, the credit is refundable, so self-employed individuals may receive tax refunds based on their credit, but if they are also employees eligible for paid sick leave and paid family leave from an employer, this reduces the qualified sick leave and family leave equivalent amount for which they can claim the credit.

They use the information on their W-2s regarding qualified sick leave wages and qualified family leave wages to determine if they're eligible for any personal tax credit. The credit is figured on form 7202.

FOSTER: We know that payments have to be reported on the W-2s, but what if the employer figured the credits wrong?

WELTMAN: If an employer figured the paid sick leave and paid family leave credits incorrectly, corrected W-2s are required. There are also temporary and proposed regulations, which authorize the assessment of any erroneous refund of paid sick leave, paid family leave, and the employee retention credits paid to employers.

The temporary regs became effective on September 10th, 2021 with comments on proposed regulations accepted through November 9th, 2021.

Erroneous refunds of the paid sick leave and family leave credits and the employee retention credit are treated as underpayments of taxes and can be assessed accordingly.

FOSTER: Barbara gives us some of the reasons why there may have been erroneous credits.

WELTMAN: Employers may not receive the paid family leave credit the same way for which they received the paid sick leave credit. An eligible employer that receives the credits for qualified sick leave wages and qualified family leave wages, which is referred to as qualified leave wages, may not receive the employee retention credit based on the same wages. The paid sick leave and family leave credits are also reduced by the amount of the research credit used as an offset to employment taxes. And wages taken into account in determining paid sick leave and family leave credits cannot be taken into account as wages for purposes of the Indian Employment Credit, the wage differential credit for employees on active duty in the military, the paid family and medical leave credit if employers are not obligated to provide pay, and the work opportunity credit.

FOSTER: Barbara discusses a potential extension of the paid sick leave and paid family leave credits that expired on September 30, 2021 and the IRS clarification on certain rules related to COBRA premium assistance, another credit for employers.

WELTMAN: As the economy recovers and the pandemic wanes, it's unlikely that the paid sick leave and paid family leave credits will be extended, but you never know.

As you know, certain employers with a group health plan must offer COBRA coverage. From April 1st, 2021 through September 30th, 2021, these employers were required to pay for the coverage for certain employees.

The IRS has clarified the general election period for COBRA, as well as explaining how this meshes with the required premium assistance.

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t Usually there's a 60-day election period for someone losing coverage, and premiums are not required to be paid before 45 days after a qualified beneficiary makes an election to continue coverage.

Last year, the IRS and DOL extended the election period until 60 days after the announced end of the COVID-19 national emergency or other date to be announced. Now, the IRS explains the election period for those who acted within the 60-day election period and those who didn't.

An individual who elected COBRA coverage outside the initial 60-day election time frame generally will have one year and 105 days after the date the notice was provided to make the initial premium payment.

An individual who elected COBRA coverage within the initial 60-day election timeframe will have one year and 45 days after the date of the election to make the initial premium payment.

No initial COBRA premium payment will be due before November 1st, 2021, so long as the payment is within one year and 45 days after the election date. For each additional payment while the outbreak period continues, the individual has one year from the date the payment originally would have been due, but these timeframes don't apply for the COBRA premium assistance under ARPA. There were special election periods for this purpose.

SURRAN: The IRS issues the Construction Industry Audit Techniques Guide in order to provide guidance for examiners conducting audits in the construction industry and information for taxpayers and practitioners associated with the construction industry. There are numerous participants in the construction industry that play an important role in the process that include general or prime contractors, construction managers, commercial contractors, commercial project owners, residential construction developers, subcontractors, highway and heavy construction contractors, architects and engineers, material suppliers, construction leaders and surety companies.

Even though it is to be used as a guide, the IRS recommends users to do research on specific tax issues and tax law. It also clearly states that the guide is “not an official pronouncement of the law or the position of the Service and cannot be used, cited or relied upon as such.” The guide is current through the revision date, which was April 19, 2021.

FOSTER: Real estate is hot these days, but there could be problems when it comes to taxes. Barbara Weltman discusses tax implications in the event of a demolition.

WELTMAN: We had a case in which a taxpayer's investment property, a home in a bad neighborhood, burned down. The following year, he got a permit and had the remains demolished. On his return for that year, he deducted the cost of demolition, plus the permit, plus the basis in the building.

The tax court wasn't having it. You have to keep things straight. He could have claimed a casualty loss deduction for the building in the year of the fire. Casualty losses for investment property are still allowed, even though casualty losses for personal use property are not, unless they result from a federal disaster.

The cost of demolition is not a separate deduction. It's a capital expenditure that is added to the basis of the land. That's clear from code section 280B. I'm excerpting, but in essence it says no deduction shall be allowed for any amount expended for demolition. This taxpayer will get the benefit of the cost of demolition when he sells the land.

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t FOSTER: One of the helpful tools from the IRS is the audit techniques guide. Barbara covers the new information for the construction and real estate industries.

WELTMAN: Earlier this year, the IRS updated its audit techniques guide for the construction industry. This guide instructs examiners what to look for when auditing those in the construction industry. This includes not only contractors and subcontractors, but also residential construction developers, commercial project owners, architects and engineers, material suppliers, construction lenders, surety companies, and others.

FOSTER: And how about foreclosures and debt cancellation?

WELTMAN: More recently, the IRS updated the audit technique guide on real estate property foreclosures and cancellation of debt.

The guide instructs auditors on the tax consequences for real estate property that is disposed of through foreclosure, short sales, deed in lieu of foreclosure, and abandonments. Taxpayers may be individuals, investors, or businesses because the foreclosures relate to properties held for investment, primary residences, second homes and jumbo mortgage properties.

FOSTER: But isn't there a real estate exception from having to report cancellation of debt income?

WELTMAN: Besides the general exceptions from reporting a cancellation of debt income on account of bankruptcy or insolvency, which you look for first, there are two other exceptions relevant to real estate. There's qualified farm indebtedness. The exclusion for qualified farm indebtedness allows a taxpayer who is in the business of farming to reduce tax attributes in lieu of recognizing discharge of indebtedness income. And there's qualified real property business indebtedness. An eligible taxpayer makes an election on a timely filed return including extensions, to exclude discharged qualified real property business debt from income by attaching form 982 to the tax return.

FOSTER: So when it comes to business, one of the areas of interest is distributions from corporations and their tax treatment.

WELTMAN: When corporations make distributions to shareholders, there are consequences to the corporation and the shareholders. Final regulations address rules for distributions of property and are effective as of September 22nd, 2021. But the upshot is that they merely adopt regulations that were proposed in 2019 with no changes.

The amount of any distribution is the amount of money received plus the fair market value of other property received. The basis of property received in a distribution is the fair market value of such property.

The only reason we haven't talked about these new regulations before is because they weren't changed when this rule was enacted in 1988 for distributions made in taxable years beginning after December 31st, 1986. Yes, nearly 35 years ago. So the new regs merely bring the old ones up to date, finally.

FOSTER: Another business related deduction is a solo 401(k) for someone in business with no employees. Barbara Weltman gives us her insights on potential problems that can surface.

WELTMAN: A person who's in business alone with no employees may use a solo 401(k) to maximize retirement plan contributions. If the person is self-

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t employed, the deduction is an adjustment to gross income and doesn't reduce business income.

It's a matter of proving that the money has actually been contributed. We had a case where a spouse was a personal trainer and claimed a big deduction for a solo 401(k) contribution. The problem was that more than the mere contribution went into the account in that year. Some funds allegedly were paid as part of a rollover from a prior 401(k), or maybe it was a SEP. That was the real problem.

The taxpayer couldn't show that new contribution money was for the 401(k), so the entire deduction was disallowed. The lesson: it's important to have a paper trail for the contribution, a check or electronic transfer limited to the contribution amount. If the contribution is made in parts, keep a paper trail for each part.

FOSTER: One of the most important tax breaks for farmers and ranchers relates to the sale of livestock sold due to drought. Barbara gives us an update.

WELTMAN: Farmers and ranchers forced to sell their livestock, other than poultry, on account of drought can defer recognition of gain on this involuntary conversion. Usually deferral applies as long as the property is replaced within a replacement period. The replacement period ends four years after the close of the first taxable year in which any part of the gain from the conversion is realized. The replacement period is extended until the end of the taxpayer's first taxable year ending after the drought-free year for the applicable region.

The first drought-free year for the applicable region is the first 12-month period that one, ends August 31, two, ends in or after the last year of the taxpayer's four-year replacement period, and three, does not include any weekly period for which exceptional, extreme or severe drought is reported for any location in the applicable region.

The IRS announced the drought areas within 36 states for the period between September 1st, 2020 and August 31st, 2021, for which this deferral rule applies. We won't know the drought areas for the balance of 2021 until next September, when the IRS announces the drought areas from September 1st, 2021 through August 31st, 2022.

FOSTER: Barbara elaborates on the deductibility of hobby losses due to the limitation on the 2% of AGI floor.

WELTMAN: Through 2025, if you have a hobby activity, it's a one-way street. You have to report all of your income, but you can't deduct any of your expenses. The reason? Hobby losses are allowed to the extent of hobby income from the activity, but can only be deducted as miscellaneous itemized deductions subject to the 2% of AGI floor.

One couple who had boat chartering activities that the IRS said was a hobby because they lacked a profit motive, challenged the section 183 limitation. The tax court denied their deductions, reiterating what we already knew, that the 2% of AGI floor in section 67A applies here.

Section 67B enumerates miscellaneous itemized deductions not subject to the 2% of AGI floor, and hobby losses under section 183 aren't one of them. The court rejected the taxpayer's argument that section 183 expenses should be allowed as above the line deductions. The court said the taxpayer's interpretation of statutory language was just plain wrong.

FOSTER: Barbara gives us an update on marijuana businesses and deductibility of expenses.

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The statement also indicated the IRS is cracking down on noncompliance. This means IRS examiners will be trained to conduct quality audits of marijuana businesses.

The commissioner also said one of its top enforcement priorities in the cannabis industry is the use of cryptocurrency, and he highly recommends anyone using cryptocurrency in their business to work with a reputable exchange.

Bottom line here, until Congress makes pot legal, marijuana businesses must report all income minus the cost of goods sold, but cannot take any deductions or credits, and they must follow all employment tax rules. Congress could legalize pot as a way to increase federal revenues, as various states have done. The Marijuana Opportunity Reinvestment and Expungement, or MORE Act, of 2021, which cleared the House Judiciary Committee, would decriminalize marijuana and impose an excise tax on its sales. You may recall a similar measure was passed by the House last year with bipartisan support, but the Senate never considered it. Will things be different this year? Who knows? We'll watch this.

SURRAN: After a temporary acceptance of certain e-signatures during 2020 as a response to the COVID-19 pandemic, then extending that program twice, dropping the “temporary” designation in the most recent extension, the IRS now appears to have made the program permanent in IRS Fact Sheet 2021-12.

The IRS justifies allowing e-signatures on certain forms:

“to help reduce burden for the tax community, the IRS allows taxpayers to use electronic or digital signatures on certain paper forms they cannot file electronically. The agency is balancing the e-signature option with critical security and protection needed against identity theft and fraud. Understanding the importance of electronic signatures to the tax community, the IRS offers an overview about using them on certain forms.”

FOSTER: Barbara gives us an update on electronic signatures and the extension.

WELTMAN: The IRS posted a fact sheet on the use of e-signatures on certain forms. Previously, I told you about the extension to December 31, 2021 for using e-signatures on certain forms, including form 3115 as well as on a section 83 B election. The fact sheet lists the more than three dozen paper file forms on which e-signatures may be used at this time.

The fact sheet spells out the types of acceptable electronic signatures. These include one, a typed name typed on the signature block, two, a scanned or digitized image of a handwritten signature that's attached to an electronic record, three, a handwritten signature input onto an electronic signature pad, four, a handwritten signature mark or command input on a display screen with a stylus device, five, a signature created by a third party software.

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FOSTER: We never like to hear about penalties against preparers, but unfortunately they do occur.

WELTMAN: Paid preparers may be subject to a variety of tax penalties for certain actions or inactions. There was a recent appellate court case against a return preparer who prepared returns for two individuals and their related companies. He understated their taxes willfully and was subject to penalties. The willfulness includes reckless disregard.

I think it's worth understanding how willfulness is viewed. Willfulness requires a conscious act or omission made in the knowledge that a duty is therefore not being met.

The district court applied the theory of willful blindness, which the appellate court upheld. Willful blindness is a two part test. First, the person must subjectively believe that there is a high probability that a fact exists. Second, the person must take deliberate actions to avoid learning of that fact.

Here, the return preparer knew there was a high probability that he was understating the tax on the tax returns in question and took deliberate action to avoid learning of these facts. The willful blindness doctrine is most commonly raised in tax crimes and other criminal matters. Interesting that the doctrine applied here to civil penalties against a return preparer.

FOSTER: The IRS has been using outside firms to collect unpaid taxes in certain situations. So how's that been working out for the government?

WELTMAN: The IRS awarded three contracts to private sector collection agencies for collecting overdue taxes. One is in Iowa, two in New York. These three agencies are assigned debt after September 23, 2021.

What we need to do is warn our clients about bogus collection agencies posing as legit. Remember first, the IRS will send a letter to the taxpayer and their representative informing them that their account was assigned to a PCA and giving the name and contact information for the PCA. This mailing will include a copy of Pub 4518, what you can expect when the IRS assigns your account to a private collection agency.

Then the agency will send its own letter. To protect the taxpayer's privacy and security, both the IRS letter, notice CP40, and the PCA's letter will contain information that will help taxpayers identify the amount owed and assure taxpayers that future collection agency calls they receive are legitimate.

FOSTER: So, when does the IRS turn over uncollected tax accounts to a private collection agency?

WELTMAN: An unpaid tax account is turned over to a private collection agency if any of the three criteria are met. One, the IRS lacks resources and can't locate a taxpayer, two, it's been a year since the taxpayer or a third party representative has interacted with the IRS about the account or three, it's been more than three years since assessment and the account hasn't been assigned for collection. But even accounts meeting a condition won't be assigned in certain situations, such as where the taxpayer has died or is a victim of identity theft.

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WELTMAN: The private debt collection program was set up in 2016 after being authorized by the Fixing America Service Transportation Act of 2015. The taxpayer FAST Act in 2019 made some changes to the program to provide relief for low income individuals. And some of the changes became effective this year.

The treasury inspector general for tax administration does a biannual assessment of the private collection agency performance. The report issued last December found the IRS had assigned over 3.28 million taxpayer accounts, totally more than $30.1 billion in delinquencies to private collectors since inception of the program. The PCAs have collected approximately $498.4 million from these accounts. PCAs also established more than 130,000 payment arrangements, although taxpayers later defaulted on more than half of them. The report also notes that the agencies continued to perform well on telephone calls in terms of quality metrics. The PCAs were averaging 99.4% for quality and each PCA individually has a quality score close to 100%.

FOSTER: Are taxpayers' rights protected with PCAs?

WELTMAN: With collections in the hands of PCAs, you may be wondering whether taxpayers are being protected or abused. A recent treasury inspector general for tax administration report found 39 possible violations of the Fair Debt Collection Practices Act by PCAs in the government's fiscal year 2021. It also found 10 possible violations of the Fair Tax Collection Practices rules under code section 60304. PCAs are required to perform quality assurance reviews by sampling telephone calls and other case actions for each of its employees using the PCA policy and audit procedure guide, with results submitted to the IRS each month in the quality PCA quality review report.

PCAs must also report incidents and threats to the TIGTA's office of investigations, which in turn will report potential violations to the IRS. Some PCAs utilize analytical tools such as speech analytics, which enable them to identify problematic interactions with taxpayers.

When potential violations are identified, PCAs use corrective action reports to document potential violations and disciplinary actions that were taken against employees. The TIGTA report noted that violations this year decreased from last year. The IRS already updated its guidelines to help with reporting potential violations. Let's see how the newly contracted PCAs do going forward.

FOSTER: Barbara Weltman discusses what a big refund is and potential additional review.

WELTMAN: When a taxpayer requests a big refund or credit, it's subject to additional review by the IRS, which then must submit a report to the joint committee on taxation. A big amount is $2 million or $5 million in the case of a C corporation. The IRS launched a new webpage to help taxpayers with refunds subject to this JCT review. The point of the webpage is to provide answers to questions about when and how a review is handled.

A joint committee review case can arise from a refund claim for previously assessed and

paid taxes from a tentative refund from carrybacks of NOLs capital losses in the case of C corporations and tax credits, or from a refund of income tax due to disaster losses from federally declared disasters.

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t Remember, there's the option to claim the loss on the prior year return. Not many taxpayers have such large refund claims, but it's always helpful to have more information available just in case.

FOSTER: Form 8867 is the due diligence form preparers must sign for clients who are claiming certain refundable tax credits. Barbara comments on the draft that’s currently out.

WELTMAN: Preparers must complete form 8867, a due diligence form, if clients claim certain tax credits, earned income credit, child tax credit, refundable portion of the American opportunity credit or head of household status.

The IRS posted a draft of the form that will be used in the 2022 filing season. There's nothing new. The draft form did not expand to include the refundable dependent care credit.

FOSTER: Barbara Weltman ends our segment by telling us about a new form, form 7203, for figuring basis for S corporation shareholders.

WELTMAN: Until now, we figured the basis that S corporation shareholders have in their debt and stock using worksheets in the shareholders’ instructions for schedule K-1 of form 1120-S. Starting with the 2021 return, we're supposed to use new form 7203 for this purpose. You may recall, I mentioned this form early because the IRS was asking for comments.

The odd thing is that no draft of form 7203 has been posted. If you had wanted to make comments, you had to ask the IRS to see the draft. I haven't seen the form. More details to follow, I'm sure.

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ive 5. The AICPA’s 2021 Not-for-Profit Entities Audit

Risk Alert: An Overview

Segment Overview:

Field of Study:

Recommended Accreditation:

Reading (Optional for Group Study):

Running Time:

Video Transcript:

Course Level:

Course Prerequisites:

Advance Preparation:

Expiration Date:

Auditing

January 13, 2023

Work experience in financial reporting or auditing, or an introductory course in auditing.

None

1 hour group live 2 hours self-study online

Update

“Not-for-Profit Entities Industry Developments – Audit Risk Alert”

“ASU 2014-09 Revenue From Contracts With Customers (Topic 606)”

“Donations soar but nonprofits still struggle with pandemic”

“COVID-19 and Nonprofits”

“The Impact of Noncompliance and Internal Control Deficiencies on Going Concern Audit Opinions and Viability of Nonprofit Charitable Organizations”

See page 5–12.

See page 5–24.

32 minutes

The AICPA’s 2021 Not-for-Profit Entities Audit Risk Alert reviews what auditors need to know with regards to current business environment issues, accounting and audit challenges, and changes on the horizon for not-for-profits. Kaplan Financial Education discussion leader Allen Fetterman reviews the key elements contained within the Alert, in particular the impact of the pandemic on both clients and auditors.

Learning Objectives:

Upon successful completion of this segment, you should be able to: l Recognize what is covered in the AICPA's Not-for-Profit

Audit Risk Alert, l Describe IT best practices that nonprofits should consider as

a result of the pandemic, l Recognize what nonprofits have had to do regarding internal

controls as a result of COVID-19, and l Describe the impact of COVID-19 on auditors and the audit.

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A. The 2021 AICPA Not-for-Profit Audit Risk Alert Reviews

i. Current business environment issues

ii. Accounting and auditing challenges

iii. Changes on the horizon

B. Emerging Practice Issues

i. Operating/auditing in a COVID-19 environment

ii. Accounting for PPP loans and COVID-19 funding

iii. Implementation of new accounting standards

iv. Changes to the auditor’s report

v. Other issues

C. Nonprofit Audit Risk Alert: An Overview of

i. Economic

ii. Industry

iii. Technical

iv. Regulatory

v. Professional developments

D. The Nonprofit Audit Risk Alert Covers

i. How the alert helps the auditor

ii. Economic and industry developments

iii. Legislative and regulatory developments

iv. Audit and attestation developments

v. Accounting issues and developments

vi. Recent pronouncements

vii. What’s on the horizon

viii. A few other areas

I. Addressed in the Audit Risk Alert

A. The Audit Risk Alert Helps the Auditor

i. Plan and perform the audit

ii. Achieve a robust understanding of the not-for-profit environment

iii. Identify significant risks

iv. Recognize emerging practice issues

v. Understand the meaning of audit risk

B. What Auditors Do During an Audit

i. Risk assessment procedures

ii. Tests of controls

iii. Substantive procedures

C. Planned Risk Assessment Procedures

i. Obtain an understanding of the entity and its environment

ii. Assess risks of material misstatement

II. Leveraging the New Audit Alert

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A. Economic Activities Includes Factors Such As

i. Interest rates

ii. Availability of credit

iii. Consumer confidence

iv. Overall economic expansion and contraction

v. Real estate values

vi. Labor market conditions

B. Impact of COVID-19

i. Domestic violence incidents have increased

ii. Loss of staff

iii. Staff working remotely

iv. Changes in internal controls

v. Changes in fundraising plans

C. IT Best Practices Nonprofits Should Consider

i. Establishing and communicating remote work security policies

ii. Addressing authorization and authentication of information

iii. Ensuring employees are aware of current phishing and malware campaigns

iv. Securing communication channels

v. Providing IT support

vi. Encrypting sensitive data

D. Nonprofits May Need to Consider

i. Taking strategic cost-saving measures

ii. Increasing spending from endowments

iii. Using board-designated funds

iv. Asking donors to reclassify contributions

E. Workforce Issues and Challenges

i. Flexibility

ii. Focus on security and communication

iii. Health and safety of staff

iv. Staff retention and recruitment

III. Challenges Presented by External Factors

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A. Internal Controls: Nonprofits Have Had to

i. Reevaluate existing controls

ii. Design and implement new or mitigating controls

iii. Update existing or create new policies

iv. Create appropriate segregation of duties

B. Management Needs to Consider

i. Who holds physical custody of assets?

ii. Who is responsible for recordkeeping?

iii. Who can authorize and approve transactions?

iv. Explanations and documentation for estimates

v. Detailed recordkeeping for funding

C. Fetterman’s Observations on Data

i. Arguably an organization’s most important asset

ii. If you don’t have data, you can’t operate

iii. Organizations must maintain all aspects of data

iv. Housed on an internal network, control of data is relatively simple

v. With remote work, managing data is more complex

“If organizations do not know what technology staff are implementing, they cannot secure it.”

— Allen Fetterman

D. When Enforcement and Centralization Are Not Possible

i. Create enhanced acceptable use policies

ii. Increase training and awareness

iii. Plan for the inevitable

iv. Make sure incident management policies are effective

IV. Impact of Pandemic on Controls

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A. The Impact of COVID on Nonprofit Financial Statements

i. Are there disclosable circumstances?

ii. Will they continue into the future?

iii. How will future risks affect the financial statements?

B. The Impact of COVID: Auditors

i. Adjusted audit operating procedures

ii. Performed virtual and remote audits

C. The Auditor and Internal Controls

i. Auditing standards requirement to understand internal controls

ii. Identify new controls due to the pandemic

iii. Consider controls that no longer work properly

iv. Change way of thinking due to remote working environment

v. Brainstorm and collaborate with clients

vi. Assess fraud risk

D. The Audit Risk Alert – Recap

i. The auditor should obtain an understanding of these factors relevant to the entity l Economic l Industry l Legislative l Regulatory l Other external factors

E. Responses to Significant Risks of Material Misstatement

i. Increasing the extent of audit procedures

ii. Performing procedures closer to year-end

iii. Modifying audit procedures

iv. Remaining alert to developments

v. Consider changes in the environment throughout the audit

V. New Audit Parameters Due to COVID-19

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l As the Discussion Leader, you should introduce this video segment with words similar to the following:

“In this segment, Allen Fetterman reviews the key elements contained within the AICPA’s 2021 Not-for-Profit Entities Audit Risk Alert, in particular the impact of the pandemic on both clients and auditors."

l Show Segment 5. The transcript of this video starts on page 5–24 of this guide.

l After playing the video, use the questions provided or ones you have developed to generate discussion. The answers to our discussion questions are on pages 5–8 and 5–9. Additional objective questions are on pages 5–9 and 5–10.

l After the discussion, complete the evaluation form on page A–1.

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5. The AICPA’s 2021 Not-for-Profit Entities Audit Risk Alert: An Overview

1. What is the purpose of the AICPA Nonprofit Audit Risk Alert and what does it cover?

2. Based on the Audit Risk Alert, how should auditors approach an audit and what is the impact of the economy on the audit?

3. How has the pandemic specifically impacted not-for-profit entities? In what ways have these same issues impacted your organization or clients?

4. What has been the impact from COVID-19 on the financial resources of not-for-profits and what have they had to do as a result? What has been the impact on your organization or clients?

5. How do remote work risks involving data have an impact on a nonprofit organization’s financial statement and what should the organization do to meet

6. What steps can auditors take to do their work differently in the age of COVID? What type of audit work is being conducted differently by your clients and organization in this environment?

Discussion Questions

You may want to assign these discussion questions to individual participants before viewing the video segment.

Instructions for Segment

Group Live Option

For additional information concerning CPE requirements, see page vi of this guide.

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auditors of nonprofits regarding internal controls in the COVID-19 environment? What has been the experience of your clients or organization reviewing internal controls in a remote environment?

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Discussion Questions (continued)

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Suggested Answers to Discussion Questions

5. The AICPA’s 2021 Not-for-Profit Entities Audit Risk Alert: An Overview

1. What is the purpose of the AICPA Nonprofit Audit Risk Alert and what does it cover? l Provides auditors of not-for-profit

entities with overview of recent economic, industry, technical, regulatory, and professional developments that affect audits

l Helps auditors identify significant risks that may result in material misstatement of financial statement

l Delivers information to help auditors understand audit risk of issuing an unmodified opinion incorrectly

2. Based on the Audit Risk Alert, how should auditors approach an audit and what is the impact of the economy on the audit? l Auditors are either doing risk

assessment procedures or further audit procedures

l Audit Risk Alert covers tests of controls, tests of details, and substantive analytical procedures

l Auditors should develop an audit plan to include the nature and extent of planned risk assessment procedures

l Auditors should obtain an understanding of the industry, regulatory, and other external factors relevant to the audit

l Auditors need to understand relevant general and specific economic conditions facing the client’s industry b Economic activities could include

factors such as interest rates, credit, consumer confidence, economic growth, or labor market conditions

3. How has the pandemic specifically impacted not-for-profit entities? In what ways have these same issues impacted your organization or clients?

l Impact on NFPs: b The full effects of the pandemic

still remain to be seen b Increase in demand for services b Loss of staff b Staff working remotely b Changes in internal controls b New compliance requirements

and accounting for funding provided by the U.S. government

l Participant response based on personal/organizational experience

4. What has been the impact from COVID-19 on the financial resources of not-for-profits and what have they had to do as a result? What has been the impact on your organization or clients? l Impact:

b Many sources of revenues were affected by the pandemic, including the cancellation of special events and other benefits

b Pledges have become uncollectible with people out of work

b Declines in membership of some organizations and changes in government funding

l What NFP’s have had to do: b Strategic cost saving measures b Increase spending from

endowments b Use board-designated funds

originally set aside for other purposes

b Ask donors to reclassify restricted contributions for general operations

l Participant response based on personal/organizational experience

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Suggested Answers to Discussion Questions (continued)

5. How do remote work risks involving data have an impact on a nonprofit organization’s financial statement and what should the organization do to meet this risk challenge? How is your organization meeting this risk challenge? l Unsecured data may be vulnerable to

exploitation and compromise l If data is unrecoverable and cannot

be recreated, information on financial statements may be inaccurate or incomplete

l Organizations should define who is working remotely and why they are accessing data

l Controls can be monitored once this assessment is completed

l Enhanced acceptable use policies and increased training awareness may be necessary

l Incident management policies and procedures should support timely identification, containment, and resolution

l Participant response based on personal/organizational experience

6. What steps can auditors take to do their work differently in the age of COVID? What type of audit work is being conducted differently by your clients and organization in this environment? l Different steps and procedures:

b Virtual and remote audits may extend into the foreseeable future

b Turn computer cameras on during all virtual meetings

b Make it convenient for clients to scan and upload documents to a secure portal

b Use screen sharing and video conferencing to replicate certain work environments

l Participant response based on personal/organizational experience

7. What are some considerations for auditors of nonprofits regarding internal controls in the COVID-19 environment? What has been the experience of your clients or organization reviewing internal controls in a remote environment? l Considerations:

b Internal controls are always the cornerstone of an organization’s operating system

b Auditors need to gain an understanding of internal controls and document that understanding

b Some controls are no longer functioning properly or at all in a remote environment

b Many employees may continue to work remotely

b Some organizations may have a hybrid system of onsite and remote work

b Auditors need to brainstorm and collaborate with clients on how to obtain sufficient audit evidence

b New fraud risks may result from the pandemic

l Participant response based on personal/organizational experience

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1. Which of the following is correct regarding the AICPA Nonprofit Audit Risk Alert, according to Allen Fetterman?

a) may be used by management to understand areas of concern

b) long document of about 200 pages

c) excludes information about emerging practice issues

d) represents authoritative guidance on the application of auditing standards

2. Along with its reputation, what did Allen Fetterman identify as arguably an organization’s most important asset?

a) employees

b) data

c) knowledge

d) brand name

3. Which of the following represents a type of substantive audit procedure?

a) inquiries of management

b) document inspection

c) test of details

d) test of controls

4. Which of the following helps end-users understand their role in securing an organization’s data?

a) anti-malware protection

b) acceptable use policies

c) incident management procedures

d) encryption

5. Which of the following is the cornerstone of an organization’s operating system that auditors will want to audit, according to Allen Fetterman?

a) going concern assessments

b) employee engagement

c) bank reconciliations

d) internal controls

6. What do auditors need to apply when evaluating forecasts, underlying assumptions, and areas where significant judgment is applied?

a) risk assessment

b) tests of details

c) data analytics

d) professional skepticism

7. According to the non-profit tracker Candid, what percentage of nonprofits in the U.S. may close because of the coronavirus crisis?

a) 3%

b) 7%

c) 18%

d) 24%

8. Auditors in which sector(s) appear to have lower Type I and Type II going concern error rates than auditors in other sectors?

a) health and human services

b) education

c) arts and culture

d) religion-related

You may want to use these objective questions to test knowledge and/or to generate further discussion; these questions are only for group live purposes. Most of these questions are based on the video segment, a few may be based on the reading for self-study that starts on page 5–12.

5. The AICPA’s 2021 Not-for-Profit Entities Audit Risk Alert: An Overview

Objective Questions

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9. Why do a large proportion of nonprofit organizations report no fundraising expense while receiving some amount of donations?

a) organizations do not measure their fundraising expenses

b) poor financial reporting systems

c) lack of diversity in revenue sources

d) donors perceive high fundraising expenses as operational inefficiency

10. OMB Circular A-133 audits require auditors to audit at least what percentage of all federal assistance received by non-low-risk auditees during the year?

a) 100%

b) 75%

c) 50%

d) 25%

Objective Questions (continued)

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Self-Study Option

Reading (Optional for Group Study)

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NOT-FOR-PROFIT ENTITIES INDUSTRY DEVELOPMENTS – AUDIT RISK ALERT

l In order to ensure adherence to NASBA guidelines regarding self-study, the CPA Report and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers are no longer available. Customers should contact their company administrators for information on taking course exams and receiving CPE credit for the courses.

l Customers may contact Kaplan Financial Education at cpesupport@kaplan.com to obtain certificates previously earned through the CPA Report Self-Study and CPA Report Government/Not-for-Profit Self-Study Professional Education Centers.

l Customers interested in the self-study format of the CPA Report can find information on Kaplan Financial Education's self-study libraries at Online Accounting CPE Courses.

CPA Report Gov/Not-for-Profit Update

AICPA – https://www.aicpa.org/cpe-learning/publication/not-for-profit-entities-industry-developments-audit-risk-alert

Covers the most important developments affecting not-for-profit entities and the issues auditors may face.

What you need to know! Taking you straight to what you need to know in the coming year, this alert covers current business environment issues, accounting and auditing challenges, and changes on the horizon for not-for-profit entities (NFPs). Learn about the following emerging practice issues:

l Operating and auditing in the COVID-19 environment

l Accounting for PPP loans and other COVID-19-related funding

l Implementation of new accounting standards

l Changes to the auditor's report

And more

Gain knowledge, in an easily digestible format, about legislative and regulatory issues like the unrelated business income tax and changes to IRS Form 990-T as well as a discussion of the 2020 OMB Compliance Supplement.

Prepare yourself — through targeted discussions of current economic, accounting, and auditing issues affecting not-for-profits —for informed conversations about risk.

Updates

Learn about economic, legislative, regulatory, and standard-setter changes affecting not-for-profit entities in 2021.

Browse samples of the updates covered.

l FASB ASU No. 2014-09, Revenue From Contracts With Customers (Topic 606)

l FASB ASU No. 2016-02, Leases (Topic 842)

l FASB ASU No. 2018-08, Not-for-Profit Entities (Topic 958): Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made

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Source: https://www.fasb.org/jsp/FASB/FASBContent_C/CompletedProjectPage&cid=1175805486538

Overview On May 28, 2014, the FASB completed its Revenue Recognition project by issuing Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606). The new guidance establishes the principles to report useful information to users of financial statements about the

nature, timing, and uncertainty of revenue from contracts with customers.

To that end, the new guidance:

l Removes inconsistencies and weaknesses in existing revenue requirements

l Provides a more robust framework for addressing revenue issues

l Improves comparability of revenue recognition practices across entities,

l FASB ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting

l FASB ASU No. 2020-07, Not-for-Profit Entities (Topic 958): Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets

l Changes to the auditor's report (SAS Nos. 134–140)

l CARES Act and other COVID-19 legislation

Key Features and Benefits

Among other topics, this alert focuses on risks related to recent nonprofit industry trends, NFP accounting and financial reporting changes, changes in exempt organization tax compliance.

Also included is information on emerging issues such as:

l COVID-19-impacts on NFPs

l FASB ASC 606 disclosure requirements

l FASB's lease accounting update

l Changes to the auditor's report

l Data security and privacy considerations

l Tax policy changes for exempt organizations

Awareness of key trends affecting the nonprofit environment informs audit planning, risk management, strategic planning, and oversight, thereby promoting greater success and sustainability of not-for-profit entities.

Who Will Benefit

l NFP financial statement auditors

l CPAs working in the NFP industry as financial professionals

l Those with governance or financial management roles at NFPs, including staff, board members, and volunteers

For more information and to purchase the Not-for-Profit Entities Industry Developments – Audit Risk Alert please visit https://www.aicpa.org/cpe-learning/publication/not-for-profit-entities-industry-developments-audit-risk-alert

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ASU 2014-09 REVENUE FROM CONTRACTS WITH CUSTOMERS (TOPIC 606)

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industries, jurisdictions, and capital markets

l Provides more useful information to users of financial statements through improved disclosure requirements

l Simplifies the preparation of financial statements by reducing the number of requirements to which an organization must refer.

The new guidance affects any reporting organization that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts).

Effective Dates l Public organizations: the new guidance

on revenue recognition is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Accounting Standards Update No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, defers the original effective date of December 15, 2016 by one year. Early application is permitted as of the original effective date.

A public organization is an organization that is any one of the following:

l A public business organization

l A not-for-profit organization that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market

l An employee benefit plan that files or furnishes financial statements to the U.S. Securities and Exchange Commission.

l For nonpublic companies and organizations (including not-for-profits): the new guidance was required for annual reporting periods beginning after December 15, 2018, and interim and

annual reporting periods after those reporting periods. Nonpublic companies and organizations may elect early application, but no earlier than the effective date for public entities. Accounting Standards Update No. 2020-05, Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842): Effective Dates for Certain Entities, defers the effective date by one year for certain entities that had not yet issued their financial statements (or made financial statements available for issuance) reflecting the adoption of Revenue, as of the date the ASU was issued (June 3, 2020).

Additional Information l Accounting Standards Update

l Press Release

To Learn More l Educational Resources

l Revenue Recognition: Objectives —a video featuring FASB Fellow Kristin Bauer and FASB Chairman Russell Golden

l Revenue Recognition: Recognition & Measurement —a video featuring FASB Practice Fellow Kristin Bauer and FASB Chairman Russell Golden

l Revenue Recognition: Disclosures —a video featuring FASB Practice Fellow Brian Schilb and FASB Member Marc Siegel

Post-Issuance Activities l The FASB and the IASB have

established a FASB/IASB Joint Transition Resource Group for Revenue Recognition to help the Board evaluate the need for implementation guidance.

l The FASB issued additional Updates related to Topic 606, Revenue from Contracts with Customers, to address challenges identified by the TRG in implementing and applying the new revenue standard in certain areas.

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Have A Question?

Submit questions about the new requirements using our Technical Inquiry System.

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DONATIONS SOAR BUT NONPROFITS STILL STRUGGLE WITH PANDEMIC

Source: EBSCO This article is for educational use only. Please do not use, distribute or share outside this course.

SEATTLE _ The American spirit of generosity this holiday season may be no match for the coronavirus.

Despite record amounts of charitable donations this year, the effects of the pandemic are suffocating nonprofits across the country as organizations face soaring costs and demand for help, yet are largely without their own support systems, including volunteers and in-person fundraising events.

December is typically the most important month for non-profit revenues, as Christmas and end-of-year tax deductions drive a flood of charitable giving. The holiday campaign season that charities big and small rely on is underway in full force amid a resurging pandemic that has infected more than 16 million people and claimed nearly 298,000 lives in the U.S. alone.

The Salvation Army, already down 18% in funding this year, projects its Red Kettle campaign will net half as much as it did in 2019. That's a $60 million drop for the iconic fundraising drive being crippled by the pandemic in numerous ways.

Thousands of kettle locations were eliminated because the businesses that once hosted them have closed and foot traffic has diminished as much of the public opts to stay at home. Its pool of volunteer bell ringers is smaller, as many older helpers _

some who dress up as Santa Claus _ are unable to participate because they're at high-risk for COVID-19. There's even a national coin shortage, in part because pandemic shopping has turned increasingly digital.

The Salvation Army's thrift stores as a separate funding stream are also projected to take a $150 million hit this year.

The Christian social services charity expects 6.6 million people _ a 155% increase over last year _ will seek their help between Thanksgiving and Christmas, for food, toys, and rent assistance as eviction moratoriums expire.

"The numbers in terms of the people who we are serving are simply off the charts and how we're going to meet the increased need is causing us to be concerned about the giving levels we're seeing so far," said Kenneth Hodder, the U.S. national commander for the Salvation Army.

But multiple studies and surveys say more people than ever are giving and at greater amounts than usual.

The GivingTuesday Data Commons estimates there was a 23% jump in the number of people who participated in the movement to donate on the Tuesday after Thanksgiving in the U.S.

The organization said 16.8 million people across the country gave a collective $2.47 billion on Dec. 1 _ a 25% increase in total dollars compared to Giving Tuesday last year. That's more than what any single U.S. philanthropic foundation gave in 2019, with

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the exception of the Bill and Melinda Gates Foundation, said Woodrow Rosenbaum, GivingTuesday's chief data officer.

Fidelity Charitable said it has distributed 32% more grants and seen a 20% increase in people setting up investment accounts for charitable giving this year. But, the donor-advised fund operator, which generally caters to a wealthier donor base, also said two-thirds of its surveyed donors decreased or stopped volunteering during the pandemic.

There have been efforts to encourage more giving since the coronavirus took hold of modern life in March.

The IRS is urging the public to utilize a special $300 tax deduction that can be claimed next year for cash donations in 2020 to tax-exempted nonprofits. The initiative allows non-itemized filers to get the tax break only for 2020, as part of the Coronavirus Aid, Relief and Economic Security Act passed by Congress last spring.

Big philanthropic players have also stepped up.

The Ford Foundation said it has already surpassed last year's total giving with $580 million in grants. It's giving another $400 million through a bond. Ford and four other foundations announced earlier this year they would borrow $1.7 billion through bonds to help keep afloat donations-dependent nonprofits through the crisis.

"Even in the best of times, even the most well-known nonprofits live on the edge financially," said Hilary Pennington, an executive vice-president at Ford.

That all might not be enough.

When stay-at-home orders were first issued in March, Adam Porter, the Meals on Wheels director for the non-profit Sound Generations in Seattle, feared the worst because volunteers typically deliver more than half of the hundreds of thousands of meal kits the organization provides to the elderly.

"I said to myself: `Well, game over. We gave it a good shot but we won't have a program without our volunteers,"' Porter said.

The program has made do with 40 fewer active volunteers this year compared to last, while Sound Generations has raised $200,000, or nearly 10%, more in donations overall. The remaining volunteers, Porter said, have taken on more work to ensure there's no waitlist for food.

Nationally, Meals on Wheels America said its 5,000 community programs are, on average, serving 77% more meals this year compared to 2019, and nearly all of them are facing financial strain because they've also had to buy additional safety equipment and pay drivers to replace volunteers. Though the national organization has given emergency grants worth more than $31 million to local programs since April, increasing donations are simply not bridging the gap in many cases.

The non-profit tracker Candid also projected in July that 22,000 or 7% of nonprofits in the U.S. may close because of the coronavirus crisis.

Among those struggling the most are arts organizations, which have collectively lost an estimated $14.6 billion in revenue to date this year, according to the Americans for the Arts. The national advocacy group projects 12,000 arts and cultural nonprofits are at risk of being wiped out forever.

But as the world recovers from the isolation of the pandemic, Rosenbaum of GivingTuesday said, arts and social services organizations that draw people together will be among the most integral to rebuilding a sense of community.

"They have a role of community," Rosenbaum said. "And a role of healing."

(c) 2020, The Canadian Press. All rights reserved.

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COVID-19 AND NONPROFITS

Big changes — and big differences between grant- and contribution-funded organizations

Source: EBSCO This article is for educational use only. Please do not use, distribute or share outside this course.

Numerous factors (both internal and external) can affect the success of nonprofits’ fundraising and recruitment efforts, but the effects of the COVID-19 pandemic on these organizations — as in nearly every sector and industry — have often been more far-reaching than anything we’ve seen before.

In a recent Wipfli LLP survey of nonprofits , three primary concerns emerged: employee burnout, fundraising and recruitment.

As nonprofits navigated the early months of the pandemic, many found themselves facing the challenge of keeping staff and volunteers safe as they provided essential services. Fundraising naturally became a challenge, as communities faced a unique level of need.

Yet these effects were not felt equally across nonprofits.

Grant-funded clients (GFP) for the most part remained open throughout 2020. Many received stimulus funding — sometimes in the millions of dollars. For those groups, careful documentation of how they are spending this money will be a top concern. This is especially true for those who have not yet (or only recently) received the funds and now must determine how to spend that money while staying within the confines of the grants’ parameters.

These GFP organizations were able to continue serving their communities, thanks in large part to that funding. Their core staff continued working to provide essential services — many times in response to exacerbated community need. These

workers might now be facing increased burnout.

In contrast, many community-based nonprofits, most of whom are contribution funded, were required to close their doors for indefinite periods. Their primary means of fundraising — local in-person events — was shuttered. For these organizations, the pandemic made it impossible to conduct business as usual for staff and visitors as well as those they served.

One silver lining was the unexpected success of virtual fundraising drives, many of which exceeded previous years’ efforts.

Any community-based groups that received pandemic funding will also need to focus on staying on the right side of any regulatory demands — which might be an even bigger challenge for organizations unused to managing the ins and outs of government funding.

For almost all nonprofits, the pandemic magnified — albeit in different ways — internal challenges and opportunities for improvement. The need to conduct virtual fundraising events, to enable remote work for nonessential services, to deploy safety measures for volunteers who continued to work in person, to stay connected with colleagues and to implement electronic or digital functionality in their time-keeping all exposed the importance of technology for efficient and effective operations.

As a result, a common need this year for many nonprofits is likely to be more robust and digitally ready financial software. Many organizations — especially communitybased nonprofits — found that their current solutions simply weren’t sufficient for remote work. These systems lacked appropriate internal controls, which were vital as staff attempted to conduct work remotely. Time-keeping also became a pain point for nonprofits that didn’t have electronic solutions in place. Some organizations didn’t have sufficient

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equipment, such as laptops, to support a remote workforce.

Another area of impact was internal control systems. Many nonprofits took a conservative approach, requiring multiple signatures to approve invoices or sign checks. Without staff centered in the same physical location, these processes required an update. While painful in the moment, these updates are likely to result in greater efficiency and flexibility for these organizations going forward. Nonprofits would be well-advised to devote time to documenting these new procedures and developing standard procedures for using them going forward.

For nonprofits who found themselves needing to update technologically, another focus this year will likely be on evaluating those changes for long-term appropriateness. In the rush to implement products and services for specific and urgent needs, many will benefit from taking a second look at how best to train staff on correct usage. Some systems or software might also have additional functionality or optimization features that could provide additional advantages for nonprofits.

With the current rate of retirements, and through all the changes impacting the current work environment, nonprofits will

need to continue to address engagement in the workplace.

As painful as the past 18 months have been, the pandemic necessitated changes across the nonprofit sector that are likely to have a positive impact going forward. Many organizations were pushed, albeit under high stress, to make changes that were in fact quite necessary and that will help them to operate more effectively in the long run. Others were inspired to find new ways of engaging donors and serving their clients. And some were prompted to make difficult programming decisions that might lead to greater efficiency and more targeted community support. Our job as their trusted advisers is to continue listening to our nonprofit clients, help them make the most of these opportunities and prepare for the new future as we emerge from this hectic time.

Copyright of On Balance is the property of Wisconsin Institute of Certified Public Accountants and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use.

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Source: EBSCO This article is for educational use only. Please do not use, distribute or share outside this course.

This study investigates whether material noncompliance (MNC) with laws and regulations and internal control deficiencies (ICDs) in a nonprofit charitable organization (NPO) affect the likelihood that the NPO receives a going concern audit opinion (GCO) and the viability of the NPO. I find that noncompliance and ICDs are positively associated with the likelihood that an NPO receives a GCO. The results also suggest that the entity-level ICDs increase auditors' propensity to issue a GCO but ICDs that occur at the federal program level do not. The evidence from the survival analysis shows that only ICDs have significant influence on the viability of NPOs. The results of the survival analysis also show that GCO -receiving NPOs are more likely to discontinue operations than their financially distressed peers, indicating that either auditors are correct in issuing the GCOs or GCOs become self-fulfilling prophecies. Analyses of Type I/Type II misclassifications suggest that auditors make more Type I errors than Type II ones, and the accuracy of going concern decisions seems to vary by auditor type, sector, and time period. The overall findings of this study provide evidence of hidden costs of noncompliance and ICDs in NPOs, which can motivate regulators and the managers of NPOs to enhance NPOs' governance to lower the probability of getting a GCO and improve the NPO's sustainability.

Keywords: going concern audit opinion; nonprofit audit; noncompliance; internal control deficiencies; viability; financial distress

Introduction In the for-profit world, auditors started to evaluate and report firms' internal control

over financial reporting only after Section 404 of the Sarbanes-Oxley Act (SOX) of 2002 took effect.[ 3] In contrast, the Office of Management and Budget (OMB) Circular A-133 (A-133 hereafter), Audits of States, Local Governments, and Non-Profit Organizations has required auditors to give an opinion on compliance and internal control of nonprofit charitable organizations (NPOs) since 1990 ([24], [25]).[ 4] In an A-133 audit, an auditor reports material noncompliance (noncompliance or MNC hereafter) when he (or she) considers the NPO not compliant with laws, regulations, grant contracts, and so on, and reports an internal control deficiency (ICD) when he (or she) identifies weaknesses in the NPO's internal control, either in financial reporting or over compliance.[ 5] This is a more expansive requirement than Section 404 of SOX, which requires only the disclosure of material weaknesses in internal control over financial reporting.

Internal control/compliance and financial statement audits are joint products of the audit process as required by Auditing Standard No. 5 ([27], [28]). Noncompliance and ICDs can adversely affect NPOs through reduced donations and grants, low employee morale, or potential criminal and civil penalties, and so on. ([26]; [30]). With such adverse impact from ICDs and noncompliance, it is an open empirical question whether auditors are influenced by the presence of noncompliance and ICDs when they make decisions in NPOs' financial statement audits.

This study examines whether an NPO client's noncompliance and ICDs affect an auditor's propensity to issue a going concern audit opinion (GCOs), one important decision in financial statement audits. An auditor issues a GCO to an NPO when he (or she) has significant doubts about whether the NPO can continue to operate within one year beyond the financial statement date. The impact of MNC and

THE IMPACT OF NONCOMPLIANCE AND INTERNAL CONTROL DEFICIENCIES ON GOING CONCERN AUDIT OPINIONS AND VIABILITY OF NONPROFIT CHARITABLE ORGANIZATIONS.

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ICDs (if any) on the likelihood that an NPO receives a GCO shows auditors' perceptions of how important these factors are in the going concern decisions. This article also investigates whether having MNC or ICDs affects the viability of the NPO. The impact of MNC and ICDs (if any) on the viability of an NPO reflects whether the perceived effects that MNC and ICDs have on the issuance of GCOs actually play a role in the NPO's survival. Both [16] and [ 9] call for more research on GCOs in NPOs, especially when many NPOs were hit hard during the recent economic recession.

I first model the likelihood of a GCO as a function of MNC and ICDs and other distress and GCO-related indicators that are pertinent to NPOs. The results show that the likelihood of a GCO increases when an NPO has either only MNC, only ICDs, or both MNC and ICDs, suggesting that auditors consider MNC and ICDs to have significant detrimental effects on NPOs' ability to continue to operate. When I make a distinction between entity-level ICDs and program-level ICDs, I find that entity-level ICDs significantly increase the likelihood of a GCO, but the program-level ICDs do not play a significant role in the going concern decisions. Auditors appear to weigh the overall assessment of noncompliance and ICDs more heavily than the individual incidence of ICDs within federal programs in their going concern assessments.

Next, I use a survival analysis to analyze whether the factors that are included in the going concern analysis actually have significant influence on an NPO's ability to survive. The overall results suggest only ICDs play a significant role in viability of NPOs. Perhaps auditors should allocate more time to assist NPOs to develop corrective action plans to mitigate ICDs. The results also demonstrate that NPOs with GCOs are more likely to discontinue their operations during the post-GCO period than their financially distressed peers, suggesting that either auditors are correct in issuing GCOs or that GCOs become self-fulfilling prophecies.

To examine the accuracy of auditors' going concern decisions, I also analyze auditors' Type I (i.e., the GCO-receiving NPOs that remain viable)/Type II (i.e., ceased NPOs that did not receive a GCO prior to its demise) misclassifications. The overall evidence shows that auditors have higher Type I error rates than Type II error rates regardless of auditor type, sector, and time periods. The results show that specialist auditors make fewer Type II errors, compared with Big4, the regional, and nonspecialist auditors. Auditors in the Health and Human Services sectors have lower Type I and Type II error rates than auditors in other sectors. Also, I find that auditors issue more GCOs and have lower Type II error rates during the recession than either before or after the recession perhaps because of increased conservatism during the recession.

This article makes three primary contributions in the accounting literature. First, this study systematically examines and provides the evidence of the impact of noncompliance and ICDs on the likelihood of the issuance of a GCO. Furthermore, this article investigates the differential effect that the entity-level versus program-level ICDs have on the likelihood of a GCO and reports that only the entity-level ICDs matter in auditors'GCO decisions. The findings help to further our understanding of going concern decisions in NPOs and thus assist the management of NPOs to take corrective actions on a timely basis to mitigate GCO-inducing factors to avoid potential unfavorable economic results (such as decreases in the NPO's contributions and grants) subsequent to a GCO as documented by [12]. Second, this study offers the first investigation on whether noncompliance and ICDs ultimately affect viability of NPOs using a survival analysis. Managers can utilize the findings to mitigate the risk factors that are detrimental to the NPO's viability. The analysis of Type I/Type II misclassifications of GCOs by auditor type, sector, and time periods can be helpful for auditors to investigate the root causes of their errors and in turn mitigate these mistakes. Third, the findings provide evidence of hidden costs of noncompliance and ICDs in NPOs,

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that is, the positive associations between the presence of MNC and ICDs and the issuance of GCOs as well as the viability of NPOs. The evidence of the additional adverse effects of MNC and ICDs supports Petrovits et al.'s (2011) calling for more rigorous governance in the nonprofit sector to avoid adverse consequences.

The next section reviews the relevant literature and discusses the relation between MNC, ICDs, and the likelihood of a GCO. The following two sections examine other GCO-related risk factors and the relation between MNC, ICDs, and the viability of NPOs. The section "Methodology" specifies research methodology and describes sample selection procedures, the section "Empirical Results" presents empirical results, and the final section provides conclusions.

Noncompliance, ICDs , and GCOs

As mentioned in the section "Introduction," noncompliance refers to violations with the provisions of laws, regulations, contracts, or grant agreements related to major federal programs of an NPO. An A-133 audit requires auditors to report whether an NPO's noncompliance with laws, regulations, or contracts is material after they evaluate all the findings or questioned costs. Grantors often cease to fund an NPO if the NPO has noncompliance. For instance, the New York State Homeless Housing and Assistant Corporation (HHAC) disqualifies NPOs that have noncompliance from applying for funds (The New York State Office of Temporary and Disability Assistance [The New York State OTDA], [23]). Noncompliance may also reduce contributors' confidence and thus result in fewer contributions which in turn reduces the viability of a distressed NPO. ICDs in NPOs can occur either in financial reporting or over compliance, which is different from the for-profit setting where firms are required to provide only the disclosure of material weaknesses in internal control over financial reporting but not the disclosure of compliance.

In the for-profit literature, [15] found that firms with deficient internal control are more likely to receive GCOs because weak internal control causes greater audit and litigation risk, as well as a higher cost of capital ([ 5]). [13] documented that company-level material weakness in internal control increases auditors' propensity to issue a GCO.

In the nonprofit literature, [26] reported that ICDs can lower the confidence of contributors and creditors and thus make it more difficult for NPOs to obtain additional funding or favorable credit terms. Weak internal control also allows fraud to be perpetrated and hinders an NPO from operating efficiently ([ 4]; [14]). All the adverse effects of ICDs can be detrimental to an NPO's ability to continue to operate. [36] provided some evidence that internal control related audit findings are associated with going concern decisions in NPOs in 2001. Therefore, I expect that an ICD or noncompliance increases the likelihood that an NPO receives a GCO.

In an A-133 audit, auditors may report ICDs at the entity-level or at the program-level when ICDs relate to individual compliance requirements for major federal programs. I expect that an entity-level ICD, compared with a program-level ICD, has more influence in auditors'GCO decisions, simply because an entity-level ICD is likely to affect more aspects of an NPO's operations while a program-level ICD may mainly affect whether the NPO achieves the desired outcomes from a specific program.

Although auditors may consider an NPO to be inefficient or lacking integrity when they observe noncompliance and ICDs in the NPO, the presence of noncompliance or ICDs may not trigger auditors to ultimately issue a GCO. For instance, auditors may focus more on financial distress rather than noncompliance or ICDs when they decide whether to issue a GCO. In addition, over years auditor may have observed that noncompliance or ICDs do not seem to have significant impact on an NPO's survival. Thus, whether having noncompliance or

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ICDs affects auditors' going concern decisions is an open empirical question.

Other Risk Indicators and GCOs

Financial Performance

The for-profit literature associates the likelihood of a GCO with a firm's financial distress. [10] have documented that the debt default status is very useful in identifying firms that have received a GCO. [20] found that other factors such as short-term liquidity, profitability, and organizations' ability to generate sufficient cash flow from operations influence GCO issuance decisions. I control for short-term liquidity and profitability in my analysis and expect them to be negatively associated with the likelihood of a GCO. Debt default status is not available for NPOs and cash flow is not a conventional distress indicator. I incorporate an alternative distress measure, equity balance, which is more pertinent to NPOs, as described next.

In the nonprofit literature, [33] have developed four indicators for measuring the financial vulnerability of an NPO: insufficient access to equity (measured by equity balance), lack of diversification in revenue sources (measured by revenue concentration ratio), low administrative costs (measured by administrative cost ratio), and negative margin (measured by the differences between total revenues and total expenses deflated by total revenues). An NPO's positive margin and equity balance reduce its financial risk while an NPO with a higher administration ratio has more administrative costs to cut back in the event of revenue losses. I adopt the four distress measures and expect the probability of a GCO to decrease with equity balance, administrative cost ratio, and margin. [19] hypothesized that some NPOs tend to manipulate their records in an attempt to minimize reported profits and avoid losses. Given the potential manipulation, I use two consecutive years of losses to measure the degree of distress.

The revenue concentration ratio, an index calculated in a similar way to how the

Herfindahl index is constructed ([29]), is the sum of the squares of the percentage share of each revenue source in total revenues. A high revenue concentration ratio indicates that an NPO has fewer resources of revenue to help maintain daily operations in the event of unforeseen funding delays or shortfalls. However, if an NPO is able to consistently secure a large proportion of its revenues from one revenue source, the lack of diversity in revenue sources may not affect the NPO's viability. Thus, I do not have a directional prediction for this ratio.

Following prior going concern literature ([10]; [20]; [22]), I also include short-term liquidity (measured as current ratio) as an additional GCO-predictor and expect sufficient short-term liquidity to mitigate the likelihood of a GCO.

Reporting Zero Fundraising Expenses

[18] have documented that a large proportion of NPOs report zero fundraising expenses while receiving nonzero donations. These NPOs understate fundraising expenses to attract donations because donors perceive a high fundraising expense ratio as a sign of operation inefficiency ([ 6]; [31]; [37]). Poor reporting quality will motivate auditors to take more thorough audit procedures and thus lead to more unfavorable opinions such as a GCO toward the organization ([16]). I use the understatement of an NPO's fundraising expenses as a measure for reporting quality and expect it to increase the likelihood of a GCO.

Low-Risk Status in A-133 Audits

OMB Circular A-133 uses the low-risk and non-low-risk determination to regulate the amount of auditing to be performed. A-133 audits require auditors to audit at least 50% of all the federal assistance received by non-low-risk auditees during the year. For low-risk auditees, the limit drops to 25%. To qualify for a low-risk status, an NPO needs to meet two requirements. First, the NPO must have been audited at least once in the last two years; and second, the NPO

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must have no audit findings when it was last audited. Compared with non-low-risk auditees, low-risk auditees have fewer prior audit findings to begin with, go through less stringent audit procedures because of the low-risk status, and thus have a smaller chance to receive a GCO. Having a low-risk status can serve as a mitigating factor in auditors'GCO considerations.

Auditor Type

[26] classified auditors as Big4, Regional, and Specialist and found that auditor type affects the likelihood of ICDs. I adopt their classification and investigate the effect of auditor type on the probability of GCOs. Following [26], I define an auditor to be a nonprofit specialist if the auditor (non-Big4, non-Regional) has at least 100 A-133 audit clients in a year, and a regional auditor to be any of the 25 largest accounting firms next to Big4 firms from Accounting Today's 2008 Top 100 Firms list (ranked by revenue). These dominant auditors typically have more training and experience and are more likely to detect risk that can trigger the issuance of a GCO. Nevertheless, self-selection may lead these audit firms to generally have less risky NPOs as clients and thus they are less likely to issue GCOs. Because of the tension, I do not have a prediction how auditor type affects the likelihood of a GCO.

Noncompliance, ICDs , and Viability of an NPO

I conduct a survival analysis to examine whether noncompliance, ICDs and other risk factors that influence auditors'GCO decisions play significant roles in NPOs' survival. To validate auditors'GCO decisions, I also use the survival analysis to investigate whether a GCO is an indicator of the likelihood that an NPO will cease to operate. If auditors are good at detecting potential bankruptcies, I should find that the NPOs with GCOs are less likely to survive. This will provide at least some evidence that the GCO is an incrementally useful signal of a potential bankruptcy in the nonprofit sector just as it is in the for-profit sector. However, it is also possible that the GCO brings negative economic

consequences as documented by [12]. Anecdotal evidence also confirms the negative effects of GCOs. For instance, the New York State HHAC, a subsidiary of the New York State Housing Finance Agency (HFA), lists going concern uncertainties as one of the criteria that make an NPO ineligible to apply for funding under the Homeless Housing and Assistance Program (HHAP; [23]). Other federal and state funding agencies also disqualify an NPO from making grant applications or renewals if the NPO has a GCO. The negative reactions to GCOs in the nonprofit sector are consistent with those documented in the for-profit literature (e.g., [ 7]).

You may find the full article at Journal of Accounting, Auditing & Finance. Jul2020, Vol. 35 Issue 3, p637-664. 28p. 7 Charts.

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SURRAN: The American Institute of CPAs helps auditors understand current risks by publishing annual Audit Risk Alerts. The Not-for-Profit Entities: 2021 Audit Risk Alert reviews what the auditor needs to know with regards to current business environment issues, accounting and auditing challenges, and changes on the horizon for not-for-profit entities.

This year’s Alert covers a number of emerging practice issues including: operating and auditing in the COVID-19 environment, accounting for PPP loans and other COVID-19 related funding, implementation of new accounting standards, changes to the auditor’s report, and other issues.

FOSTER: The 2021 AICPA Not-for-Profit Audit Risk Alert also focuses on risks related to recent nonprofit industry trends. Awareness of key trends affecting the nonprofit environment helps auditors with their audit planning, risk management and other important engagement tasks. Helping us to understand the issues reviewed in the Audit Risk Alert is Allen Fetterman.

Allen lectures extensively throughout the country on not-for-profit accounting related issues and is a CPA and long-time discussion leader for Kaplan Financial Education, Allen explains exactly what the AICPA Nonprofit Audit Risk Alert covers.

FETTERMAN: The Nonprofit Audit Risk Alert provides auditors of not-for-profit entities with an overview of recent economic, industry, technical, regulatory, and professional developments that may affect the audits or other engagements that they may perform.

By the way, it can also be used by management. I used to ask my CEOs and CFOs each year to take a look at that year's Audit Risk Alert, because it can help them understand the areas of audit concern that I need to be aware of. If the client is aware of what I'm aware of, it gives them a better understanding of why I might ask certain questions. But understand that this is for all the Audit Risk Alerts, not only the nonprofit ones, but there are many that the AICPA publishes in different industries and sectors. These are what they call other auditing publications. They are not authoritative.

However, the goal is to help the auditor understand and apply Generally Accepted Auditing standards.

The Audit Risk Alert contains a number of parts. For example, it starts with how this alert helps you and we'll talk about that. Then it goes into economic and industry developments,

legislative and regulatory developments, audit and attestation developments, and accounting issues and developments.

It also talks about recent pronouncements, what's on the horizon, and a few other areas. So, it's pretty comprehensive in a short document. The document only runs 70-80 pages, plus some indices, so it's really chock full of a lot of very good information.

FOSTER: Allen tells us more about how the Audit Practice Alert helps the auditor.

Video Transcript

5. The AICPA’s 2021 Not-for-Profit Entities Audit Risk Alert: An Overview

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t FETTERMAN: The Audit Risk Alert helps auditors plan and perform audits. So, the Nonprofit Audit Risk Alert helps auditors plan and perform audits of not-for-profit entities. It provides information to assist us in achieving a more robust understanding of the business, economic, and regulatory environments in which not-for-profits operate.

It helps auditors identify the significant risks that may result in material misstatement of financial statements. And let's face it, that's the objective of the audit, to opine on financial statements that they are free of material misstatements. That's the goal.

The Audit Risk Alert delivers information about emerging practice issues and current accounting, auditing, and regulatory developments. The auditor should understand the meaning of audit risk. What is audit risk? Audit risk is the risk of issuing an unmodified opinion when, in fact, the opinion should have been modified, and modified means qualified, adverse or disclaimer of opinion. Auditors have to obtain sufficient appropriate audit evidence to support their opinion. And in order to draw reasonable conclusions on which to base their opinion, they perform various types of audit procedures.

FOSTER: Next Allen describes how auditors approach an audit.

FETTERMAN: Now the interesting thing is, with all the things that auditors do during an audit, really you can break down an audit into the following areas.

Auditors are either doing risk assessment procedures or further audit procedures, and that can be broken down between tests of controls and substantive procedures. And substantive procedures can be broken down to tests of details and substantive analytical procedures. So really, when you put it all together, anything we do in an audit, we're doing one of those types of procedures, and the Audit Risk Alert talks about each of those.

The auditors should develop an audit plan and that plan should include the nature and extent of the planned risk assessment procedures, which are audit procedures performed to obtain an understanding of the entity and its environment, including its internal control, to identify and assess risks of material misstatements, whether due to fraud or error both at the financial statement level and the relevant assertion level.

Now, as part of obtaining the required understanding of the entity and its environment, the auditor should obtain an understanding of the industry, regulatory and other external factors relevant to the audit. And this Alert that we're talking about, assists the auditor in the risk assessment process and expands the auditor's understanding of other important considerations relevant to the audit.

FOSTER: What is the impact of the economy on the audit? Allen explains.

FETTERMAN: When planning and performing an audit, an auditor should understand both the general and the specific economic conditions facing the industry in which the client operates. Remember, we have to get an understanding of the client and its environment that includes the industry in which it operates. So, we need to understand economic activities.

Economic activities relate to factors such as interest rates, availability of credit, consumer confidence, overall economic expansion and contraction, real estate values, labor market conditions. All of those are outside of the entity.

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t So that's the environment, but all of those are likely to affect an entity's business and therefore its financial statements.

FOSTER: The pandemic has wreaked havoc on the economy and all aspects of life in the United States, in fact all over the world. Allen provides his insights into how specifically the pandemic has impacted not-for-profit entities.

FETTERMAN: Every year I've read this Audit Risk Alert cover to cover. And this year for the first time, for obvious reasons, it is concentrating extensively on the impact on auditors and auditees of the COVID-19 pandemic. So, let's talk briefly about that because we're going to spend some time on that. The full effects of the COVID-19 pandemic are yet to be seen.

Now remember, the Audit Risk Alert was written; it came out sometime in the summer. I don't remember exactly. Let's say it came out in July or August. So therefore, it was probably written back in March, April, May. Back then they made the statement in the Audit Risk Alert that the full effects of the COVID-19 pandemic had yet to be seen. I think today here it’s later in the year, and we're saying the same thing.

Operating during this crisis has been and continues to be challenging for many not-for-profit entities. There's been an increase in demand for services. And I'll tell you a quick story on that. I serve on the governing board, and I chair the audit committee of a charity up here in Rockland County, where I live. It’s a crime victim's agency, in fact, the only crime victim’s agency in Rockland County. But it focuses on things such as domestic violence, sexual assault, and human trafficking, among other things. There's been such an increase in demand for services that when the pandemic hit, the increase in demand for services went up by about 76%. Well, think about it.

Sexual assault, domestic violence, people were home all day now with their spouses. So, you can understand the reason why. But at the same time, what other impacts did the pandemic have on all entities? Loss of staff, people were sick, people were quarantining.

Staff working remotely. We've all been doing that for the past year and a half. Changes in internal controls, because controls are different when you're not working in the office versus when you are and change in fundraising plans with many organizations taking their events online. So, what happened?

The U.S. government took unprecedented action to provide funding to individuals, to businesses, to not-for-profit entities. Nonprofits need to figure out the funding availability, the compliance requirements, because there are so many new compliance requirements and how to account for some of these fundings, some of these monies.

SURRAN: COVID-19 has had a major impact on technology. Flexible and remote working arrangements became essential to continued operations for many not-for-profit entities during the pandemic.

Remote work presents unique challenges, particularly for information security controls, because remote work environments do not usually have the same safeguards as office environments. When people and computers leave the office and work remotely, new risks arise for the organization and additional security policies become necessary. Not-for-profits should consider the following practices amongst others.

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t Establishing and communicating remote work security policies, such as avoiding public wireless networks and use of personal devices at home. Addressing authorization and authentication of information. Ensuring employees are aware of current phishing and malware campaigns which have become much more common during the pandemic.

Securing communication channels, providing vigilant IT support and encrypting sensitive data.

FOSTER: In addition to technology, COVID-19 has had an impact on resources. Allen Fetterman offers his view on what has happened and what not-for-profits have had to do as a result.

FETTERMAN: Many sources of revenue have been affected by the pandemic. Special events have been canceled, dinner dances, theater benefits. They've been canceled. Last year, in this organization I mentioned earlier where I'm on the board, the big annual dinner was canceled. That was a six-digit fundraiser we gave up. This year we had it, it was reduced a little, but we had it.

Schools had been closed. That's created other types of problems. Pledges have become uncollectible because people are out of work. There's been a decline in membership of some organizations and a decline or a change in government funding. So, all that means that nonprofits are now faced with how to continue to provide services. Remember I mentioned increased demand. How do they continue to provide services with fewer resources?

Nonprofits must consider the impact of the reduction in resources on the financial viability of the organization, both in the short-term and in the long-term. Not-for-profit entities with going concern issues have had to immediately assess the current situation and create financial plans going forward.

That includes things such as, taking strategic cost saving measures, which is not easy for most nonprofit organizations. If they can't do that, maybe increasing spending from endowments, something that we really don't want to do. But if we are faced with that, we might have to.

Similarly, using board-designated funds. Funds the boards have set aside for other purposes now have to be used for ongoing program purposes or asking donors to reclassify restricted contributions for general operations. Because some organizations have a lot of restricted resources, but they're running out of unrestricted resources.

FOSTER: We’ve reviewed the impact of the pandemic on technology and resources. The biggest impact of COVID-19 has been on the workforce. Allen explains.

FETTERMAN: Many not-for-profit entities provide services, which tend to be labor intensive. When I was in practice, and I still do say this, the overwhelming majority of not-for-profits, two thirds to three quarters of their total costs are labor driven, salaries, payroll, taxes, benefits. At the beginning of the pandemic, most not-for-profits were not set up for remote work and had difficulty transitioning.

Flexibility and a focus on security and communication were critical as well as health safety and the wellbeing of staff. Challenges included staff retention and recruitment as budget cuts impacted compensation, benefits, and staffing plans.

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t Even for nonprofits that are hiring, recruitment and onboarding processes had to be conducted remotely. And we know that, but in the interview process and the recruitment process, remote action is more difficult to gain an understanding of who it is that you're interviewing and trying to bring onboard.

FOSTER: One of the most important considerations for auditors when performing an audit is internal controls. Allen talks about the impact of the pandemic on controls.

FETTERMAN: Well, remote work environments have brought changes to the internal control systems and that increases risk in those areas.

Many nonprofits have had to reevaluate existing controls for unintended gaps and have needed to design and implement new or mitigating controls. Updates to existing policies and creation of new policies have been needed to accommodate adjustments in roles and responsibilities, new funding sources, changes in information technology, et cetera, et cetera.

The challenge of maintaining an appropriate segregation of duties has been magnified by the pandemic environment. The virtual work environment has necessitated changes in processes and duties. Management needs to consider things, such as today in a remote environment, who holds physical custody of assets? Who is responsible for recordkeeping for assets? Who can authorize and approve transactions? Management needs to assure that these functions remain separate.

Thorough explanations and supporting documentation for management estimates, including assumptions and methodologies applied, will be more important given the heightened risk in areas such as asset impairment, debt covenants, and assessments of an entity's ability to continue as a going concern.

And lastly, detailed recordkeeping also will be necessary for any COVID-19 related funding received and costs incurred and charged against that funding.

FOSTER: Allen touched upon devices and working remotely. Next, he delves into data management and physical device management in greater detail.

FETTERMAN: Data management and physical device management. They're kind of two sides of the same problem.

Data is arguably an organization's most important asset. I've said for many years, reputation is a nonprofit's most valuable asset. Certainly, data is vital. If they don't have data that they can't operate.

Organizations must maintain the confidentiality, integrity, and availability of critical, sensitive, and proprietary data. When data is housed solely on an internal network, controls to protect the data are relatively simple and manageable. Organizations generally know where the data is and how it is accessed and by whom.

With the move to more remote work, managing data becomes more complex. Staff members may, without malicious intent, implement applications to increase productivity or to fill a need that they are not getting from their IT department. If organizations do not know what technology staff are implementing, they cannot secure it. And the staff member could be unknowingly exposing the organization's data to

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t outsiders. When systems are connected to an organization's network, it is easier for the IT department to apply controls and investigate and resolve discrepancies. When devices leave the managed network, implementing and monitoring controls may be more difficult.

Organization-owned devices are usually equipped to meet baseline security standards. However, personal devices may be unsecured, they may not have anti-malware protection. They may not be updated, and they may not be encrypted. The risk of loss of the confidentiality and integrity of data grows if devices are shared with other members of the staff member’s household, for example, children attending school virtually or using devices for recreational purposes. And the use of public wireless or home networks by staff members to access organization resources further increases that risk.

FOSTER: Do these remote work risks have an impact on the financial statements? Allen offers his perspective on this issue.

FETTERMAN: If unmanaged, these risks could significantly affect not only the general security of the organization and its data, but also its financial statements.

If an organization does not know where its data is and/or fails to secure it, that data may be vulnerable to exploitation and compromise via malware, ransomware, and other forms of corruption or loss.

All of these risks tie into the financial statements. If data is unrecoverable and cannot be recreated, information presented on the financial statements may be inaccurate or incomplete.

FOSTER: Allen tells us what a nonprofit organization can do to meet this risk challenge.

FETTERMAN: Organizations should measure their risk by defining who is working remotely and how and why they are accessing and storing data via applications, hardware, and other technology. Once this assessment is completed, controls can be monitored and enforced.

When enforcement and centralization are not possible, enhanced acceptable use policies and increased training and awareness may be necessary to ensure that end users understand their role in securing the organization's data. Organizations should plan for the inevitable. They should ensure that their incident management policies and procedures support timely identification, containment, and resolution when remote data applications or systems are compromised.

FOSTER: Allen explains how the risks that we have been discussing change the way audits are conducted.

FETTERMAN: Organizational shifts to remote working environments may prompt audit teams to consider remote risks when evaluating the technology controls over financial reporting. And because of that, significant additional testing may be necessary.

SURRAN: The COVID-19 pandemic has already had sweeping effects on not-for-profits, but there's still a lot of uncertainty that remains. For many organizations, there may be future risks and uncertainties that are relevant to GAAP-based financial statement users.

Management will need to determine whether the COVID-19 pandemic has created disclosable circumstances that exist as of the date the financial

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t statements are issued or available to be issued. And whether they are expected to continue into the future.

Not-for-profits and their auditors will need to consider how these future risks and uncertainties might affect the nonprofits GAAP-based financial statements and the accompanying independent auditor's report.

FOSTER: The pandemic has had a major impact in the nonprofit world. It has also affected how auditors do their job as a result of all of the remote work that has occurred. Allen reviews the steps auditors can take as well as what they can do differently in the age of COVID.

FETTERMAN: As the COVID-19 pandemic hit the United States, a new way of conducting field work became an immediate necessity.

Firms had to quickly pivot and adjust the auditing operating procedures to ensure that audit quality was maintained. Performing virtual and remote audits may extend into the foreseeable future.

Now, again, that statement comes right out of the Audit Risk Alert, which was probably written back in the spring. Here we are much later in the year and the same statement holds. It will extend into the foreseeable future. There are a lot of companies.

My son works for a large nonprofit and they own their office in the 42nd street area on the east side. And they've pretty much decided when the pandemic is over, they're going to sell their property, their office space and rent small office space as a conference room, and everyone's going to continue to work from home. So, it's not, will it extend, or may it extend, it will. It definitely will extend into the future.

FOSTER: Allen tells us more about how auditors need to adjust their procedures for today’s pandemic environment.

FETTERMAN: Audit procedures should be designed to uphold audit quality and adhere to audit standards. We can't let that wane. So, what do we do?

We use available technology. There's a lot out there. Turning computer cameras on during all virtual meetings allows auditors to read body language, engage non-verbal clues. We do that all the time when we're auditing in person. We're interviewing people, we're listening to their answers, but we're also watching their face. We're gauging their body language.

Making it convenient for clients to scan and upload documents to the audit firm's secure portal can be beneficial in compiling audit evidence. But there's a learning curve there on both sides, the audit team and the auditee.

Using screen sharing and video conferencing to replicate certain work environments and gain comfort about documentation legitimacy. For example, asking a client to hold up a specific piece of supporting documentation so that it can be seen and reviewed.

Now, I would prefer looking at it in person, but if we're working remotely and that's going to continue, that may be the future. We’re going to have to figure out how we're going to do this and how legitimate the documents are.

FOSTER: How important is communication when auditing in a pandemic environment? Allen offers his insights.

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t FETTERMAN: We have to keep lines of communication open. Ongoing communication with clients is critical. We have to build client communication into the team plan, into the audit team plan. Team based chat software or private chat rooms segregated by client and by engagement team can help to stimulate an advantageous working environment.

Client's staff may also be working remotely. So, it's not only the audit team that's working remotely, client's staff is working remotely and it'll be necessary to build in more time for client's staff to scan and organize document selections and deliver them to the audit team.

Now, I don't want to make it sound like the audit team and the staff or management of the client will never be together in the same room. I have a meeting tomorrow; I'm the chair of the audit committee of this nonprofit organization here in Rockland County. Tomorrow I'm having an in person meeting with the audit manager to review last year's financial statements, to decide what changes we might want to make in this year's. This is their first year as the auditor. So, they're new and I want to meet with them. I'm an old-fashioned kind of guy. I want to meet in person because I think it would be more productive than to do it on Zoom, but that's me.

Monitoring cybersecurity is another way of performing effective remote audits. There will be an increased reliance on technology, which increases the risk of hackers obtaining information, private information from the organization. Auditors need to be more vigilant when receiving data and email attachments and audit firms have to evaluate cybersecurity policies and procedures.

FOSTER: Earlier Allen talked about internal controls from the client’s perspective. He now continues discussing internal controls from the auditor’s point of view.

FETTERMAN: Well, internal controls are always the cornerstone of an organization's operating system. It's also the cornerstone of what we want to audit. For years we learn, we can rely on internal controls to reduce substantive testing. And I don't want to get into a discussion today; we don't have to do that. We can just gain an understanding and document. We can do a fully substantive audit, but we still have to gain an understanding of internal control and document that understanding.

Auditing standards require auditors to obtain an understanding of internal controls relevant to the audit. As not-for-profits have adjusted operations and employees are substantially working remotely, new systems, controls and documentation procedures have come into play.

Auditors should look at what controls are new due to the pandemic and client staff working remotely. Auditors should consider which controls are no longer functioning properly or at all in the current environment. Understanding and evaluating internal controls without physically being on site will require a new way of thinking for auditors.

Most of a not-for-profit’s employees may continue to work remotely, as I mentioned a little while ago, or they may have a hybrid system of both onsite and remote work. Video conferences and key not-for-profit employees and audit team members likely will be needed to discuss the design of controls, both old controls and new controls.

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t Auditors will also need to assess what new fraud risks may result from the pandemic. (OUT)

Consider the pressure element of the fraud triangle. For example, are employees likely to feel entitled to the not-for-profit’s assets due to pay cuts? Or were furloughed employees that disgruntled enough to take actions detrimental to the organization?

FOSTER: Next Allen talks about asset impairment considerations brought on by the pandemic.

FETTERMAN: Given the duration, severity, and economic impact of the pandemic, it is likely that extra care will be needed with respect to impairment assessments. For example, the COVID-19 environment could affect collectability and payment terms for receivables. Auditors will need to apply professional skepticism, which has become a real buzzword now in the auditing profession. It appears in all the new SASs that have come out in the last year or so that have mentioned professional skepticism. So, auditors will need to apply professional skepticism when evaluating forecasts, underlying assumptions, and areas where significant judgment was applied.

FOSTER: Allen Fetterman concludes our segment with some key takeaways.

FETTERMAN: To quote one paragraph in the Audit Risk Alert, it says, and actually this was not a quote, it's more of a paraphrase, as part of obtaining the required understanding of the entity and its environment, the auditor should obtain an understanding of the economic, industry, legislative, regulatory, and other external factors relevant to the entity. The Alert that we've been discussing will assist the auditor in that risk assessment process.

In this discussion we've been having, we've reviewed some of these factors. During an audit, in carrying out the audit process and the risk assessment process. We may identify significant risks of material misstatement of the financial statements. And if we do that, we need to respond to those significant risks of material misstatement.

Some of the possible audit responses to significant risks of material misstatement include increasing the extent of audit procedures, performing procedures closer to year-end, and modifying audit procedures to obtain more persuasive evidence.

We used to call that in the textbook days, back when I was in college, nature, timing, and extent of audit procedures.

Auditors should remain alert to economic, industry, legislative and regulatory developments, as well as audit and accounting issues. They all play a role in the risk assessment process.

Auditors should consider changes in the environment throughout the audit, not up until just at the beginning, but throughout the audit and potentially modify audit procedures to ensure that risks that have been identified and continue to be identified are adequately addressed.

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Evaluation Form

Please rate the segments on the November 2021 issue 5 = Excellent, 4 = Very Good, 3 = Good, 2 = Fair, 1 = Poor

Please comment on each segment you used. (Attach additional pages if needed.)

I. Segment

Overall Speakers Format Content Topic

1.2021 Emerging Enterprise Themes – Part II _____ _____ _____ _____ _____

2. What Makes Convertible Bonds Popular? _____ _____ _____ _____ _____

3. Auditing Standards Update: NOCLAR, Management Specialists and Pricing Services _____ _____ _____ _____ _____

4. Corporate & Individual Tax Updates (November 2021) _____ _____ _____ _____ _____

5. The AICPA’s 2021 Not-for-Profit Entities Audit Risk Alert: An Overview _____ _____ _____ _____ _____

Segment 1:__________________________________________________________________

Segment 2:__________________________________________________________________

Segment 3:__________________________________________________________________

Segment 4:__________________________________________________________________

Segment 5:__________________________________________________________________

Suggested Topics to be covered in future volumes (please comment):

_______________________________________________________________________________

_______________________________________________________________________________

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rm Please rate the discussion leaders 5 = Excellent, 4 = Very Good, 3 = Good, 2 = Fair, 1 = Poor

II. Discussion Leader

Were learning objectives met? o Yes o No

Were prerequisite requirements appropriate?: o Yes o No

Were course materials valuable? o Yes o No

Was course content up-to-date? o Yes o No

Were completion times appropriate? o Yes o No

Were the facilities satisfactory? o Yes o No

III.Summary

Send to:

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A. By Citation

Accounting Standards Update – see: ASU

ASU No. 2014-09 June – 5

ASU No. 2016-13 April – 2

ASU No. 2020-05 September – 5

ASU No. 2020-06 November – 2

ASU No. 2020-07 September – 5

FASB or Financial Accounting Standards Board – see: ASU

IRS Notice 2020-32 January – 2

IRS Notice 2020-46 September – 4

IRS Notice 2020-65 December – 4

IRS Notice 2021-42 September – 4

IRS Notice 2021-53 November – 4

IRS Rev. Proc. 2016-47 December – 1

IRS Rev. Proc. 2020-46 December – 1

IRS Rev Proc 2020-51 January – 2

SSARS No. 25 December – 1

Statement on Standards for Accounting & Review Services – see: SSARS

B. By Topic

Accounting and finance priorities, The Hackett Group's October – 1

Accounting Changes and Error Corrections, Exposure Draft on August – 5

Accounting, diversity in December – 2

AICPA Audit Guide, 2020 May – 5

AICPA Not-for-Profit Audit Risk Alert, 2021 November – 5

American Families Plan, key proposals of the June – 4

American Rescue Plan Act (ARPA) April – 4; May – 4; June – 4

American Rescue Plan Act, changes to September – 4

American Space Commerce Act August – 4

Annual Comprehensive Financial Report (ACFR), name change to August – 5

ASC Topic 326, FASB's reasons for issuing April – 2

ASC Topic 606, implementation of January – 4

ASC Topic 842, transition to July – 2

AU-C Section 540, proposed amendment to November – 3

AU-C Section 620, proposed amendments to November – 3

Big data, finance and January – 4

Bitcoin and Ethereum December – 3

Blockchain, accounting and June – 1

Index

Note: At the request of several subscribers, this Index reflects the most recent 11 months of CPAR programming rather than the current calendar year.

December 2020 – November 2021

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Blockchain, managing inventory & transactions with June – 1

Blockchain, tax implications of December – 3

Brand licensing, ethics and January – 3

Brand, personal May – 3

Business needs, challenges of meeting November – 1

Business roundtable statement May – 2

CAA, disaster relief and February – 4

CAA, tax relief and February – 4

CARES Act February – 1

CARES Act, not-for-profits and February – 5

CECL, COVID-19 and April – 2

CECL, not-for-profits and September – 5

CFOs, focus and expectations of October – 1

Consolidated Appropriations Act 2021 (CAA) Feb. – 4; April – 4

Convertible bonds, classification of November – 2

Corporate misconduct, reasons for May – 2

Cryptocurrency June – 1

Current Expected Credit Losses (CECL) April – 2; Sept – 5

Cybersecurity, internal audit and Jan. – 1; June – 1

Data analytics, business vs. audit May- 1

Data security and privacy September – 4

Digital assets, tax implications of December – 3

Digital currency transactions, IRS and July – 4

Digital transformation in finance November – 1

Diversity, equity and inclusion (DEI) December – 2

Earnings per share (EPS) July- 3

Economic Aid Act Feb. – 1; Feb. – 2

Economic Impact Payments, third round (EIP3) May – 4

Economic value added (EVA) July – 3

Employee Retention Credit April – 4; Oct. – 5

Employee stock options April – 1

Employee stock purchase plans (ESSPs) September – 1

Environmental, social and governance (ESG) issues April – 3

Ethics and compliance, management of May – 2

Ethics IQ test October – 3

FASB & GASB Chairman Collaboration April – 5

FASB and IASB convergence project June – 5

FASB, pandemic and February – 3

FASB Topic 850, related parties and September – 3

Flexible Spending Account (FSA) April – 4

Fraud triangle October – 3

FTE Safe Harbor February – 2

Further Consolidated Appropriations Act 2020 August – 4

GASB revenue and expense recognition project June – 5

GASB Statement No. 62 August – 5

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Going concern considerations February – 5

Governmental Accounting Standards Board (GASB) April – 5

Hackett Group's 2021 Key Issues Study Oct. – 1; Nov. – 1

Human capital April – 3

IAS 24, related parties and September – 3

Inspection report, PCAOB July – 2

Internal auditing, COVID-19 and January – 1

Internal auditing, technology and January – 1

Internal controls, not-for-profits and Feb. – 5; Nov. – 5

International Standard for Review Engagements 2400 December – 1`

IPOs and SPACs July – 1

IRC Section 409A April – 1

IRC Section 482, transfer pricing and April – 1

IRC section 501(c)(3), tax-exempt organizations and July – 5

IRC section 501(c)(6), tax-exempt status and Feb. – 1

IRC section 7623(a) August – 4

IRC section 7623(b) August – 4

IT best practices, not-for-profits and November – 5

Leases, accounting for July – 2

Leases, not-for-profits and September – 5

Licensing, impact of technology on January – 3

Net Investment Income (NII) Tax July – 4

Next generation internal auditing December – 2

Next Generation Internal Audit study, 2020 January- 1

Non-Compliance With Laws and Regulations (NOCLAR) November – 3

Not-for-profits, finance and accounting challenges for February – 5

Not-for-profits, accounting updates for September – 5

OMB Compliance Supplement, 2020 May – 5

Online security, tax professionals and September – 4

Organization for Economic Co-operation and Development (OECD) April – 1

Pandemic, employee mental health and October – 5

Payroll tax deferral December – 4

PCAOB inspection report July – 2

Personal brand, auditing your May – 3

PLUS model October – 3

PPP loan forgiveness, deductability of expenses for January – 2

PPP loan obligations January – 2

PPP, changes to February – 4

PPP, second draw Feb. – 1; Feb. – 2

Principal-Agent problem April – 1

Privacy, social media and January – 4

Proposed Quality Management Standards October – 2

Public Company Accounting Oversight Board (PCAOB) July – 2

Regulation S-K April – 3

Related party transaction September – 3

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Remote working, cybersecurity risks and November – 1

Retirement plan regulations, changes to February – 4

Return on investment (ROI) July – 4

Revenue and expense recognition, three approaches June – 5

Revenue recognition, not-for-profits and September – 5

Revised Uniform Unclaimed Property Act (RUUPA) June – 2; June – 3

Role of finance in analytics October – 1

RPA, finance and November -1

Sarbanes-Oxley Act October – 3

SAS 144 November – 3

SBA, second program February – 1

SEC, related party transactions and September – 3

SEC, SPACs and September – 2

Sick leave and family leave, paid November

Simplification initiative November – 2

Social credit model January – 4

Special purpose acquisition companies (SPACs) July – 1; Sept. – 2

SQMS 1 and 2, differences between October – 2

SSARS No. 25, purpose of December – 1

Stock options, primary forms of April – 1

Strength, weaknesses, opportunities and threats (SWOT) analysis December – 2

Sustainability Accounting Standards Board (SASB) April – 3

Sustainability, long-term April – 3

Talent and skills, management of November – 1

Tax challenges with digital and global economy April – 2

Tax Cuts and Jobs Act – see: TCJA

Tax-exempt status, activities that jeopardize July – 5

Taxpayer First Act August – 4

Tax Relief and Health Care Act of 2006 August – 4

Technology and risk, managing of October – 1

Technology, GASB and April – 5

Transfer pricing April – 1; April – 2

Triggers, single vs. double stock option April – 1

Unclaimed property, audits and June – 3

Unclaimed property laws June – 2; June – 3

Unclaimed property, types of June – 2

Uniform Prudent Management of Institutional Funds Act (UPMIFA) February – 5

Vehicle depreciation limits, revised October – 5

Virtual currencies, valuation of December – 3

Virtual work environment, coping with October – 5

Whistleblower complaints August – 4

W-2 reporting & deferral, IRS guidance on Dec. – 4; Nov. – 4

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Group Attendance and CPE Recordgr

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d Company __________________________________________________ Date __________________

Segment Title _______________________________________________________________________

Location of Seminar _______________________________________________________________

SS# Name State Hours Earned

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I hereby certify that the above individuals viewed this portion of CPA Report, participated in the group discussion, and earned the recommended hours of CPE credit.

Discussion leader _______________________________ Date completed ____________

All CPE hours listed are recommended. They are developed in a manner consistent with AICPA guidelines. Since CPE requirements vary by state and/or professional organization, we suggest you contact the appropriate organization for information about their requirements.